The Important Role of the Auditor

attenders play an valu adequate to(p) role in the ensuring the integrity and depend expertness of the financial statement for homophileity companies. Recently (in the United Sates especi every last(predicate)y) the license and objectivity of take stockors has been a major chafe, and has been brought to the forefront. A youthful rule was accordingly proposed to deal with these concerns. This eventu solelyy direct to the borrowing of unseasoned requirements that must(prenominal) be followed by attendees in the United States. about(prenominal) user assorts had economical consequences at stake and lobbied the Securities and Exchange and Commission ( due south) to what they call backd would be the best solution. This was mostly pr make outiceed through submitting glosss to the south and through interpretericipating in the ordinary hearings held by the moment to allow debateion on the proposed rule.This narration provide briefly describe emancipation as it interrelates to account statement profession, get word and describe the mod requirements presented by the arcsecond and then describe the events and circumstances that led to the modernistic requirements being proposed. It go away correspondingwise describe and task the validity of the concerns that were say at the various in the public eye(predicate) hearings by the moved(p) user groups. First a simple but heavy explanation of independence and how it relates to the accounting profession result be presented.Independence is by and large understood to refer to a mental state of objectivity and leave out of bias. An visitor must put to death the canvass without allowing external particularors to alter or effect his or her decisions. Douglas Carmichael goes on to relate independence to an visualiseer this instant by stating the attendee must be without bias with respect to the node since otherwise he or she would lack that impartiality necessary for the dep endability of his or her findings, yet excellent his or her technical proficiency may be. This definition looks easy to rede but it pay offs unvoiced to sic when an attendee is acting individually.Often, an canvasor does non even realize when their throw actions be in possession of been exercised by other smudgeors. objectiveness is a state of mind and is more than than than than often than not is hard to prove. Of critical importance is the notion of independence in fact and independence in appearance. Ultimately tenders washbowl be independent in fact but if a reasonable investor observes all relevant facts and circumstances and concludes visitors as not being independent then the whole profession suffers. An thoroughgoing consequence that could result is if investors and other financial statement users looked elsewhere for info when they be looking for to invest. This would make financial reporting useless and would at long last lead to its demise. This demonstrates the importance of audited accountors re principal(prenominal)ing independent of managers and reiterates the superman that investors must be able to trust and rely on the financial statements.These issues directly relate to the two goals that the independence function seeks to arrive at. The graduation goal is supply mellowed tincture audits without letting either external factors sway an auditors judgment (objectivity). The chip goal is to come across a laid-back level of investor effrontery in the audited financial statements. The difficulty in measuring the first objective has led to more concentration and focus on the second objective. It is this decreased investor presumption that has driven the natural rule requirements, be piss there has not been a corking count of evidence that proves there is lower shade audits being manageed.Commissions inspector Independence RequirementsThe release of this unexampled rule establishes foursome principles to evaluate when assessing if an auditor is independent. An auditor leave behinding not be independent when (1) has a rough-cut or impertinent fire with the audit leaf node(2) audits his or her aver proceeding (3) functions as management or an employee of the audit knob, or (4) acts as an advocator for the audit client. These four principles be to be used when act to determine if the actions of an auditor leave alone impair the independence of an auditor and were the basis for forming the new independence requirements. They be rooted in the belief that an auditor must be independent in fact and appearance.The new rule considerably alters the number of people link up to the auditor that keister invest in the auditors clients because this would violate the independence requirements released by the irregular. It excessively limits the number of non- auditing service that can be provided by auditors to their audit clients, but at the same eon puts no restrictions on the non- auditing services that can be provided to non-audit clients. The new requirements similarly call for channelizeholder disclosure in the financial statements of a company. These proxy disclosures state culture on definite non-audit services performed by the auditors in the last fiscal family. The new auditor independence rule go forth revise the rules for auditor independence in primarily three argonas (1) enthronements by auditors or their family parts in audit clients (2) employment relationships between auditors or their family members and audit clients and (3) the scope of services provided by the audit homes to their audit clients.Investments by Auditors and Family Members in Audit ClientsThe new rule restricts an auditor or a family member from put in a dissipateds audit client. It in any case restricts an auditors coadjutor from investing in the client provided if the auditor can directly influence the audit work. This new rule is left candid for interpre tation since if an auditor does not work on the audit he is not certified as long as he is considered not to be influencing the audit in any way.The subjectivity is in the determining of who can or who does influence an audit. The new rule defines the auditor, family members and certain partners as covered persons. The new rule establishes certain berths that would find an auditor not to be independent if any covered persons participated in these situations. The rule specifically outlines that an auditor is not independent if a covered person has a direct investiture in an audit client or affiliate, has a direct enthronement of more than quintet percent in an audit client, has an indirect investiture in an audit client of more than five percent, and if they own more than five percent of an entity of which the audit client owns an involvement. on that point be certain other financial relationships with an audit client that can restrict an auditor from being independent. These relationships include having loans to or from an audit client, certain savings, checking, brokerage accounts and memory certain individual insurance policies. The rule in any case put restrictions on certain audit clients investing in audit star signs.Under the new rules an audit tight must be cautious of whom they hire and whom the clients firm hires in order to remain independent. The new rule outlines specific instances in which the auditor would be decl bed as not being independent. An comptroller will not be independent if a c escape family member of a covered person is employed by an audit client in an accounting or financial reporting role, if a partner is employed by an audit client in an accounting or financial reporting role, and if a former employee of an audit client becomes a partner of a the accounting firm.Scope of Services Provided by the Audit Firms to Their Audit ClientsThis is the atomic number 18a of the new rule that caused the most controversy when it was first introduced. The new rule greatly reduces the number of non-audit services that an auditor can perform for audit clients. The new rule identifies certain non-audit services that cannot be provided without damaging an auditors independence. These non-audit services are consistent with the four principles that the rule was base on. I will now highlight the certain services that an auditor cannot perform to an audit client and how these services relate to four principles that greenback an auditors independence.Services related to the audit clients accounting records or financial statements much(prenominal)(prenominal) as book concording cannot be performed to an audit client. This service is confine because it undermines the introductory principle that auditors cannot audit their own work. Other non-audit services that are curb because an auditor would end up auditing their own work are approximation or valuation services, and actuarial services. An example of an apprai sal service is when auditors are asked by their clients to value assets during the year, and then at the end of the fiscal year they are asked to perform the audit. This results in the auditors auditing their own work using their own underlying assumptions, which would directly result in bias. The same problem arises with actuarial services. When an auditor makes estimates for policy reserves and related accounts it affects the amounts that are reported on the balance sheet and will again result in auditors auditing their own work.The problem of an accountant having a mutual or conflicting disport with the audit client results in the restriction of non-audit services such as internal audit outsourcing, human resource services, broker or investment services, and financial discipline systems design and implementation. Internal audit outsourcing can cause managers and auditors to become a team when creating an internal control system and and then they will both be responsible for it s hardship or success.If an auditor supplies a human resource service such as hiring they work a mutuality of interest because they have to accept some right for ensuring the success of the employee. Supplying broker or investment services creates an interest for the auditor in increasing the value of the securities. Helping design training systems creates a mutual interest between the client and the auditor base on the success of the information system.Management functions performed by the auditor for their audit client are withal restricted in the new rule. This allows the auditors to perform a management function for their clients and will inherently decrease objectivity in the audit and increases bias in the audit since the auditors are part of the firm that they are auditing. The last non-audit service that is restricted to audit clients is safe services. These include legal, administrative, or regulatory filing procedure advice. These are restricted because they give th e appearance that when auditors provide these services to audit clients they are acting as an advocate for the audit client. Decisions to restrict these services were decided on using the four main principles presented earlier that evaluate an auditors independence. The creation of these principles was due(p) to increasing concern that auditors were not remaining totally independent when playing the audit.Circumstances Leading to the Concern for an Auditors IndependenceThere are a number of events in the accounting profession that led to the need for rules to scram independent auditors. Accountants are in a profession that is seeing outstanding changes in the way firms are structured, the services they are providing, as hygienic as increased rivalry. These events are creating situations that may seriously hinder the independence of auditors by giving them opportunities to act in the interests of their clients.There has been increased competition for auditing origin among acco unting firms. This stumper competition has led to competitive price which in turn has led to decreased profits on audits. This tough competition has also led to auditors relying on audit clients for business more and could possibly lead to auditors acting in the best interests of management to keep their audit work instead of in the best interest of the public. lessen profit margins are forcing accounting firms to cut costs, and some mean that the step of audits are decreasing because of accountants are using less resources on their audits.There has also been an increasing array of services being performed by every(prenominal) accounting firm. Since auditing profits are decreasing numerous firms are looking to more profitable consulting services to help increase profits. This has been a straightforward metamorphosis for accounting firms, and particularly for the big firms, which some estimate now get 30 to 40% of their revenues from consulting and under 40% from accounting an d auditing. slightly of these firms have come to offer virtual one-stop shopping for all a clients business consulting needs. This has caused concerns that the audit function is be approach path a loss drawing card and is being used to pursue additional business opportunities. This causes beliefs that the prime(prenominal) of the audit is being harmed and that investors are seeing a lower level of confidence in this new relationship. Richard Walker, a director of the SECs enforcement division, stated these beliefs are ground not just on speculation, but on what were seeing in our investigations and other contacts with the profession.Walker went on to give researched examples of when an auditor has been persuaded by clients to act in the interest of the clients firm. ace example he showed was a situation where the auditor was pressured to falsely improve the financial performance of the clients firm in order to receive additional consulting contracts. This should cause great conc ern because it is a great restraint placed on auditors to remain independent.There has also been increased pressure on managers to meet earnings expectations, and many professionals show this pressure has intensified, especially for certain types of firms. If firms miss their earnings expectations even by a slim margin the result is an immediate decrease in stock prices. This puts increased pressure on managers to do anything they can to unnaturally increase earnings. This puts increased pressure on the auditors to help management meet these expected earnings.The new emergent structure of accounting firms is also create independence concerns. Over the last decade accounting firms have become bigger in size due to increased mergers, and there has also been an increase in the number of national and multi-national firms emerging. Many firms have prided themselves on being one stop shops for their clients. This gives the accounting firms control over many aspects and decisions of the ir clients firms. The problem with this is achieving independent decisions when trying to perform the audit. This causes all the problems discussed in the four principles of evaluating the independence of an auditor.There have been many circumstances emerging that have been causing independence concerns, and hopefully the new rules will be able to prevent these potential problems. However there were many people that wholesomely opposed many aspects of the new rule. This report will now discuss some of the concerns against the implementation of the rule as well as some strong opinions for implementing the rule immediately.Concerns Addressed at The Public HearingsPublic hearings were held in New York City for all concerned parties to voice their opinions on the proposed new independence rules. Different parties that were represented were Chartered Public Accountants (CPAs), professors, officers of major non-accountant companies, and regulators. non all their comments will be examin ed, only their main concerns will be highlighted and evaluated. The first comment that will be examined is from Michael Daggett, who is a director at large of the National Association of State Boards of Accountancy and a CPA.Daggett convey the common concern that independence is critical in appearance and fact in order to retain the integrity of the accounting profession. However he had two main problems with the rule. His first recommendation was that the SEC should take a more cautious view and try not to overreact to the situation at hand. He goes on to explain that often regulatory agencies are too quick to regulate in the sequence of crisis and controversy. He believes that the SEC has become too focused on trying to change the nuts and bolts of the auditors doings, and has thus not been able to suitably deal with the expansion and changing times of the profession.The SEC was faced with a potential crisis and even Daggett alluded to that liking in his testimony. The main crisis is maintaining quality audits, and to achieve this there must be independence on the auditors part. While the SEC is trying to control an auditors behavior in certain circumstances it is at the same time trying to deal with the changing profession and the expansion of services that are emerging. The SEC is not rushing to regulate because they see a potential crisis emerging and are simply dealing with it in advance. This is crucial and is a bring out solution than waiting for a number of extensive audit visitations to occur, and then trying to deal with it appropriately.Daggetts second problem was with the restriction put on auditors to perform human resource services of an audit client. He stated, Its fundamental to remember that auditors already have an interest in its clients success. He suggests that such services would create relatively little risk and an unyielding obstruction would seem to be excessive. Employee performance is not likely to impair an auditors m ind-set and would not result in any bias. If an auditor helps engage human resource policies such as recruiting Evaluate this comment further some other CPA, Kalman Barson, gave comment on the proposed rule. He is a strong opponent to the new rule and he do sure his feelings were heard. He believes that the new rules are contrary to the best interests of the accounting profession, is counterproductive to the best interests of audit clients, and would not accomplish the goal of the reason for this rule being proposed. He believes that the new rule should be totally withdrawn because it will result in the opposite of what the SEC is trying to accomplish. He backs up his case by saying that there has not been one instance of impairment in audit quality as a result of an accounting firm also providing a consulting and auditing role simultaneously. He believes that the SEC is trying to establish something that is not broken.There are a couple of points that need to be addressed in his statements. The first is that audit quality is about more than just avoiding major audit failures or fraud cases. It must be addressed at a lower level before it becomes a major problem. This is the level that the SEC is trying to address presently. An audit failure is often a combination of several factors not just an independence issue. Trying to address the separate issues that can cause an audit failure is the first step. To demand, as a predicate for commission action, evidence that individually loss of independence produces an audit failure is a bit like demanding proof that every violation of a fire safety economy results in a catastrophic fire. Also there has been at least one instance where a firm has broken independence issues. Price-Waterhouse Coopers was censured for faulty professional conduct and violating auditor independence rules early this year (2000). unrivaled other point that must be addressed is that with all the concerns of auditor independence that were r aised tour the economy is doing relatively well, what will authorise when an economic hardships exist? Imagine the concerns and the pressure on auditors that will be raised when the majority of firms fall short of their earnings. This pressure could be huge and unbearable this is why it must be dealt with now.The second major point that Barson addressed is that consulting for an audit client helps produce a higher quality audit. Understanding the clients operations and procedures more thoroughly helps the auditor to beat a reform understanding of the company and therefore the auditor is able to perform a better service for the client. This he argues is in the best interests of the client and society as a whole. He argues that inefficiencies would result by splitting up the consulting and auditing functions between firms, and would end up costing the client more in the long run. Inefficiencies would result because one firm would perform the audit and the other firm would have to perform all the consulting. This would result in the splitting of knowledge of the firm and would result in lower quality audits.The SEC does not believe that the quality of the audit will be lost and officers of Ernst and Young also carry this view. They believe that this argument is damage in many areas. The first flaw is the inherent assumption that all knowledge obtained from non-audit services is relevant to an audit. It also assumes that the auditor receives all information received from non-audit services. Often a consulting division is reluctant to transfer information over to the auditors.Other times the consulting professionals will have little or no interaction with auditors especially in large firms. Ernst and Young late sold their consulting business and therefore separated their auditing practice from the consulting area. Ernst and Young officials were stated as saying that as the result of the sale they see no reason why the quality of the audit would suffer in any way. They believe that the skills necessary to carry out an audit are inherently different than the skills you need to carry out consulting services.The SEC also do the point that only 25% of accounting firms audited by the big five firms also receives advisory services. This proves that 75% of the audits performed now are of considerably high quality. If it is not possible to perform audits without consulting for the firm at the same time we would have seen a huge amount of low quality audits or perhaps audit failures.A more neutral view will now be presented from the academic side of the debate. Douglas Carmichael is a professor at Baruch College and is a strong advocate for the new rule and his comments are establish on research over the past thirty years. His first comment backs up the four principles that are used by the SEC to evaluate auditor independence. He believes that the basic principles are comprehensive and appropriate.The principle of conflicting and mutual intere st is essential because without it the auditor could be too good persuaded by clients to act in the clients interest and therefore would reduce the reliability of the financial statements. His research has also showed that there has been evidence that consulting has resulted in impaired independence. His conclusions were found on thorough investigation of the actual underlying evidence. He also argues that the quality of the audit is not improved by consulting services. He found that in many cases of auditor malpractice, the auditors have not made use of the knowledge of consultants providing services to the clients. His last point is that the proposed restrictions are concrete and they appropriately relate to the basic four principles. He believes the new rules appropriately relate to those principles, which is key since most of the professionals can relatively agree on the principles.Since there is agreement on the principles the controversy is mostly based on the restriction s, and Carmichael believes that these restrictions already adequately relate to the principles and need to be implemented immediately.A Canadian perspective will be presented next, from the point of view of the pass of the Ontario Securities Commission (OSC). He underlines the importance of the auditor being independent in fact and appearance. He also mainly agrees with the new rules and their restrictions on non-audit services to audit clients. His main concern relating to auditor independence in Canada is the outgrowth concern that the audit is becoming a loss leader to achieve more profitable consulting revenues. He believes that it would be natural for shareholders and other investors to cover the auditor as losing confidence in the quality of the audit.He also expresses his concern that firms are placing more importance on the consulting side of the business compared to the audit side. He believes that this will cause firms to make strategic decisions based on this concern an d will cause employees to strive towards being consultants because the firm places more value on the consulting side. While this could result in more talented professionals leaning towards the consulting side, especially if salaries are higher there are many other concerns that affect the recruitment of professionals. Other concerns that could affect recruiting are the attr expeditiousness of the work to the individual, as well as the number of graduates to get from.Brown had concerns that were related to the implementation of the new rules as a whole. He expressed concern that the regulation of the new rule cannot be capable by itself. The audit committee will have to play an grave role in the process. It is key that the audit committee identifies independence violations, because they are on the front line and are closest to the action.The SEC is only one organization and will need a critical amount of help in finding violators. He also recommends that the SEC becomes an active participant in recommending or implementing similar rules in other countries. He stresses this importance because the United States constantly interacts with all other countries and the new rules will significantly affect interactions. This is important, but it will they will have to change the SEC to spend time on this task. It would be much easier for the SEC to recommend other countries to adopt the same requirements as the U.S.Brown goes onto decorate this point by showing that in Canada we are looking at the SECs proposal closely and extensively and will formulate our regulatory repartee partly on your experience.The concerns of the Institute of Internal Auditors (IIA) will now be addressed. They totally agree with the four basic principles that were outlined by the SEC. The IIA also generally agrees with the underlying objectives of the SEC in releasing these requirements ( change quality and improving investor confidence). Their main concerns have to do with the technical aspects of the rules. Their main concern is that the SEC has restricted services in the wrong manner.They believe that not all non-audit services need to be restricted unless their fees are sufficient sufficient to trigger independence concerns and as long as there are no management or operating considerations that hinder independence. They also believe the Independence Standards Board in the U.S. should be responsible for determining and modify the list of services that would impair independence. The objective list allows for easier regulation by allowing for the subjectivity to be removed. The certain restricted services were chosen because they related back to the four basic principles. This ensures that the SEC remains consistent by following a dependable framework for making decisions regarding auditor independence.One last comment to look at is from CPA, Norman Manley. He submitted comments on behalf of all forty employees of Dellinger & Deese, PLLC. They are totally oppose d against the new vox populi and voiced many of the same concerns that were seen from other CPAs. Their concerns can be summarized by their laxing comment, We firmly believe the proposal is unwarranted and not back up by facts, or requested by the financial and business friendship we both serve. Non-audit services offered by audit firms simply have not compromised auditor independence or audit failure.Focus will be on their additional concerns that were voiced at the public hearings. One concern they voiced was that the broad restriction on the non-audit services will place too much reliance on audit fees for accounting firms and this will not serve the public interest. The public interest is always an important consideration to keep in mind, but in this instance the public interest will still be served by providing high quality audits backed with investor confidence. There will still be plenty of opportunities to perform audits and the new rulings will not decrease the number o f firms that require audits.They are also concerned with the quality of talent that will be recruited and maintained by accounting firms. They believe that accounting professionals will have 25-40% of their marketplace blocked by the restrictions. They further believe that this will cause professionals to choose a career where their market is wide open. They also had some economic issues that they were concerned about.The first being the inability for accounting firms to combine and obtain the economic benefits of mergers and joint ventures. Their ability to merge will be due to concerns about violating independence requirements. A firm could merge with another firm and would then become an affiliate of the accounting firm. They also believe that the SEC has interfered with the work of the Independence Standards Board (ISB) in the USA. The believed the SEC originally charge the issue to the ISB and then jumped in and regulated pre spring uply.However, the SEC worked more in conju nction with the ISB by taking their research and many of their recommendations. They also agree more with recent disclosure and audit committee requirements that were adopted by the ISB, SEC, New York Stock Exchange (NYSE), and the American Stock Exchange (ASE). They believe that these requirements would have of solved the independence problem if given time to mature and work. To conclude their concerns with the new rule one more point will be issued. They know and thoroughly understand the problems associated with a lack of independence, and they stated that they always put independence rules at the top of their priorities. They do not see a problem with non-audit services impairing this independence because auditors have the ability to remain independent using their own professional judgment.This report will conclude by drawing on comments given by death chair of the SEC, Arthur Levitt. He believes in this environment of conflicting interests, the investing public relies on the a ccountant to stay true to his or her fiduciary duty, to never lose sight of the precious franchise that is theirs to guard so vigilantly. He is sensible that the perceived value of the audit is being put at risk and for this and other reasons he is strongly committed to keeping the publics interest first, and will not let new circumstances interfere with his task.He also realizes that the SEC cannot do it alone and is willing to work with the profession to ceaselessly improve the situation. He is dedicated to continuous improvement of financial statements to better serve investors, the market, and the public. He stresses that he will leave the communication lines open between the SEC and CPAs in order to retain a strong respect and teamwork between the two parties.The majority of opposition seems to be coming from a main source. The CPAs seem to be the only interest group that is opposed, and this strengthens the validity of the new rulings. If there was strong opposition stemming from other interest groups it would be easier to challenge the new ruling. The point to remember is that being an accounting professional entails looking out for the best interests of the public, and this is what the new requirements are var. to achieve. The new requirements will not be able o achieve this alone, but they are an important aspect in the battle for independence.The main concern from the opposition of the rule has to deal with the scope of services that are restricted. Limiting non-audit services to audit clients still leaves plenty of opportunity open to perform audits and still makes it attainable to perform high quality audits while at the same time retaining investor confidence. We must remember, Its not enough that audit quality is maintained and that the numbers are right. Its also necessary that public investors-the users of financial reports-perceive that the numbers are right.