Auditing 审计essay

Q:Making reference to specific suggestions for change in the way in which external auditing is regulated, critically evaluate the case that reform is needed in order to ensure auditing provides its intended contribution to the financial reporting process. Answer:

In this essay, I would like to describe what is auditing and the way that auditing regulation changed. On the other hand, I would like to analyze a case (Tyco) to conclude that reform is needed to ensure audit quality. 1 Introduction

External auditing is performed by external auditors. External auditor is an profession who audit companies following the laws or the principles on the financial statements of the company. Auditing which is primarily concerned with the quality of reliability in financial reporting can be seen as part of a system of control of governance (Deegan&Unerman, 2006). It is very important that the auditor should be independent of the company which is being audited. So, auditing should be regulated to ensure its reliability. Also, there are many improvements for the auditing regulatory system in recent years.

2 change in the way in which external auditing is regulated In early years before 2000, Ethical Standards and Codes and IFAC Code of Professional Ethnics are established to regulate auditors. Later, corporate scandals such as Enron , Worldcom , Tyco, Bank failures and Financial Crisis lead to some regulatory response, such as Sarbanes-Oxley(US), Ethnical Standards(UK), and some changes in discussion paper by European Committee(EC). Changes and suggestions are considered in the EC dabate:(1) Rotation of appointments and limitation on tenure of appointment (2) Firms structure ,policies and organization (3) Restrictions on non-audit services (4) Employment of former auditor (5) Fees (and audit only firms) (European Commission, 2010). 3 Case analysis

Founded in 1960, Tyco International, Ltd. is a corporation, which produces a large variety of products, from fire protection to integrated security service The company’s executives, Kozlowski, Schwartz, together with the former general counsel Belnick, were formally accused of stealing money and selling company stock options illegally, which was one of the most infamous scandals in early 21 century.

From my perspective, external auditor PWC plays a very

important role in this corporate scandal. Scalzo who audited Tyco's financials from the years 1997 until 2001, found that he failed to conduct sufficient steps in audit procedures which related to certain executive benefits, executive compensation, and related party transactions. Furthermore, he also engaged in improper professional conduct (Taub, 2003). For example, the CEO Kozlowski and some senior managers abused the Key Employee Loan (KEL) Program and transferred unauthorized credit to their own KEL account. These loans were neither recorded in the financial reports nor disclosed to stakeholders. Although Scalzo found this problem in the audit working paper, which recorded in details about how the executives in Tyco using the money from KEL, he chose to ignore this problem. As an accounting professional, Scalzo should know the concept of materiality and has the ability to ask the company to disclose this huge amount of money in the financial statement, but he did not require the company to do so. Bonus Plan in Tyco is another case in point. The top executives issue bonuses to themselves and to other employees without the approval of the board of directors. Additionally, they treat their bonus offset their loan from the company arbitrarily. This abnormal accounting treatment gave rise to Scalzo’s attention, but he was persuaded

by the executives for the reason that this amount of money is not important compared with the high profit in Tyco. It is very strange that Scalzo was so easily to be persuaded as an expert in auditing. In my opinion, the main problem is the independence of auditing. PWC has been responsible for Tyco’s auditing businesses about 8 years since 1994. Furthermore, Tyco not only provide the audit services, but also provide the non-audit services which constituted a large proportion of the total amount of money receiving from Tyco. According to Basioudis (2008), non-audit services fees are negatively correlated with modified reports. And high non-audit fees have a detrimental effect especially on going concern reporting judgments. Additionally, Frankel et al. (2002) who report evidence that companies which pay their auditors relatively more non-audit fees have larger abnormal accruals and more likely to meet or beat analysts’ forecasted earnings. This implies that auditors treat clients with larger non-audit fees more leniently, which suggests lower audit quality. Accordingly, the multiple roles of PWC make it difficult for them to audit Tyco’s financial report fairly. As their outside auditors, PwC should have reviewed every transaction between the company and its’ executives. It failed to perform auditing in accordance with GAAS. Their failure in doing so resulted in

them being pulled in the lawsuit and were later required to pay the investors a sum of $225 million. In this case, we began to realize that reform is needed to improve the audit quality, however, in reality, there is little consensus about how to define audit quality and the various frameworks and disclosures that exist are incomplete. The range of definitions is quite broad because they focus on different attributes of the audit, such as outcomes, process, and judgments. As a result, stakeholders cannot observe audit quality in its entirety, just the attributes that manifest through the various phases of the audit itself. While regulators demand that audits be conducted in accordance with GAAS, investors and audit committee members may simply demand that audits uncover frauds. Therefore, to consider what matters the most for improving audit quality, it is important to keep in mind the attributes of the audit itself: incentives, uncertainty, uniqueness, process, and judgment (Knechel et al., 2013). 4 Conclusion

In summary, the failure of Tyco’s auditing is due to the lack of ethics and independence. It is better for the companies to promote competition in the audit market through tendering, improve audit independence by ban of NAS, and enhance

supervision and monitoring system. On the other hand, communication between auditors and stakeholders is also important to ensure auditing provides its intended contribution to the financial reporting process.