ACT 4193 CURRENT ISSUES IN ACCOUNTING AND AUDITING

1. ACT 4193 CURRENT ISSUES IN ACCOUNTING AND AUDITING Lecturer : Dr. Zulkarnain Bin Muhamad Sori Group : 1

2. TOPIC:AUDITOR INDEPENDENCE Present By: GOH WEI KEE 110033 LEE BEE HOOI 110177 LEE POI NOO 109953 YOEN KEAT YEE 110175

3. Definition of Auditor Independence • “independent” • first used in conjunction with accountant • not subject to another’s authority • not being influenced or controlled by others in matters of opinion or conduct

4. Concept of Independence (Mautz and Sharaf) • Practitioner-independence – a state of mind and equates to the notion of the integrity and objectivity of the individual auditor. • Professional-independence - the apparent independence of auditors, as a professional group, to the public.

5. Appearance of Independence • Evaluated at two levels • user’s perception • General public’s view

6. ISSUE 1 Does The Provision Of Non-Audit Services Impair Auditor Independence?

7. Recent expansion of non-audit services (NAS) by public accounting firms has cause SEC to question whether auditors can remain independent of their clients to whom they provide both audit and NAS. • NAS creates a working relationship between the auditor and the client that is too close, while others believe the provision of these services enhances the auditor’s knowledge of the client, thus increasing the auditor’s objectivity and independence (Goldwasser ,1999)

8. Provide NAS Impair the Auditor’s Independence • An audit firm faces increased audit independence risk as incentives to satisfy client demands increase. • As the economic bond between the audit firm and client increases, the audit firm’s independence risk increases (DeAngelo 1981b). • Audit fees represent the fundamental economic bond between the client and auditor because of the continuous demand for audit services.

9. Provide NAS Impair the Auditor’s Independence(cont…) • Auditor independence may be adversely affected by the provision of NAS if those services are perceived as escalating the economic bond between auditors and their clients. • Non-audit fees further increase the client auditor bond by increasing the portion of audit firm wealth derived from a client, thereby increasing the audit firm’s independence risk (Simunic 1984, Beck, Frecka, and Solomon 1988).

10. Non Audit Fees and Audit Fees • Significant and positive relationship (Vivian Li, David Hay and Robert Knechel, 2003 ). • Impair the independence of appearance when auditors jointly provide audit and NAS. • Financial statement users view the auditor as having motivation, opportunity and insufficient mitigating circumstances to violate independence. • No evidence of any impact on independence of mind.

11. Non-audit Fees and Auditor Tenure • Auditors who are more independent may have more disputes with management and be more likely to be sacked • Audit firms may try to retain clients that purchase non-audit services, and could lose their independence in doing so. • Auditors lose their independence when there are high non-audit fees then there will be fewer disputes and less frequent auditor changes

12. Non-audit Fees and Auditor Tenure (cont…) • Then high non-audit services will be associated with longer auditor tenure. • No significant relation that auditors receiving high non-audit fees are less likely to terminate their relationship with a client (Vivian Li, David Hay and Robert Knechel, 2003 )

13. Conclusion • Auditor independence depends upon an auditor’s incentive not only to find errors but also to report them. • Auditors’ decisions to qualify their opinions are not affected by the provision of NAS (based on study done using publicly available information for Australian listed companies for 1984,1987 and 1994 ) • In each of these years, the evidence does not support the suggestion that NAS impose a threat to auditor independence.

14. ISSUE 2 Why is Auditor Independence Still Impaired Although there is Strict Enforcement of Laws and Regulation?

15. The Malaysia has institutionalized a set of regulations to governing auditing that create an environment in which auditor independence is virtually impossible. • Auditor independence still impaired although there is strict enforcement of laws and regulation. • The structural features of the auditor-client relationship that create conflicts of interest have contributed to this problem.

17. Managers Hiring and Firing Auditors • Clients, who have the freedom to choose their auditors, have many reasons to select an auditing firm based on the likelihood that the auditor will deliver an affirmative audit opinion.

18. Managers Hiring and Firing Auditors (cont…) • One practice that auditors might use to signal their willingness to accommodate the client’s wishes is known as “low-balling”. • The careers of particular audit partners depend a great deal on their success with individual accounts.

19. Auditors Taking Jobs With Clients • Several studies have found that auditor independence and the quality of auditing decisions deteriorate over time as the auditor-client relationship lengthens. • There can hardly be a more effective means of establishing a common identity between auditor and client than rotating personnel between the two. (Andersen’s relationship with Enron)

20. Auditors Taking Jobs With Clients (cont…) • Independence is compromised when an auditor hopes to develop job opportunities with the audited firm. • The minimal restrictions on personnel rotation established by the Sarbanes-Oxley Act are clearly insufficient, given the high frequency with which auditors at all levels take jobs with audit clients.

21. Non-audit Services • Non-audit services proved to be an important growth area for accounting firms. • The SEC (1978) required companies to disclose any non-audit services their auditors performed for them.

22. Non-audit Services (cont…) • The SEC (1982) concluded that the required disclosure of non-audit services “was not generally of sufficient utility to investors to justify continuation” • Despite evidence showing that knowledge of a consulting relationship creates a perceived lack of auditor independence

23. ISSUE 3 Is the Mandatory Auditor Rotation Necessary?

24. Two ways in applying audit rotation are whether the changing of the former auditors to a new auditors or changing the partner of the audit firm. • Proponents of the audit firm rotation believe that the auditor of the company are become more independence. Auditor independence is the cornerstone upon which the audit profession has been built, and indeed, discharged its duty to its clients and the market large. • The characteristic of this independence is the state of mind of the auditor, strength of character to stand up for what is right and freedom, but must be seen to exist.

25. Audit rotation can make financial look beautiful or fresh look. It is important that the value of the ‘fresh look’ can protect the shareholders, creditors, and other parties who rely on the financial statement. • A new audit firm would bring a fresh viewpoint on a regular basis. They allege, if the auditor become too close to the client, identifying with management’s problem and losing the skepticism needed if they are to remain objective. • In other hand, criticism of rotation on audit and reporting quality are likely to be mostly keenly felt where group structures are very complex. Empirical evidence on the practical consequences of the rotation is hard to find.

26. The new auditors are lack knowledge of the company’s operations, system and financial reporting practices. So, the clear message is that the better an auditor understands the client’s operations, the more effective the audit will be. • Besides that, it will increase costs incurred when appoint the new auditor and fraud was found. Research conducted into fraudulent reporting in US public companies between 1987 and 1997 found that fraud was much more likely to occur during an auditor change period. • Audit rotation will increase the risk of an audit failure during the initial years as the new auditor. AICPA research into 400 cases of audit failure found that the alleged failures occurred almost three times and often when the auditor was performing his first and second audit of the company.

27. From our finding from journal, United States General Accounting Firms surveys said that have a two party which some of them support audit rotation and some of them oppose audit rotation. • Therefore, it exists the issues ‘whether audit rotation better to apply or not in the real world’. Application audit rotation in the real world is subject to the pro and contra of the audit rotation. • Based on the party who support the audit rotation said that audit rotation can improve audit independence through the quality of work and quality of opinion.

28. They also believe that periodically a new auditor will bring a fresh look to the public company financial reporting and believe the value fresh look to protect shareholders, creditors and other parties who rely on the financial statement. In this situation, fresh look refers in the preparation of financial statement. • The new auditor usually prepared the beautiful financial statement which shows that public companies in a good position even in some cases have a fraudulent in the previous financial statement which prepared by former auditor.

29. While, the party who oppose audit rotation said that the new auditor lack of knowledge about the company such as companies operation, systems and financial reporting practices. It will make the audit work take more time compare from the previous years. • Audit rotation which is changing auditors increase the risk of an audit failure during the initial years and it will increase cost incurred by both the public accounting firm and the public companies. • For example, starting from March 2002, the Monetary Authority of Singapore stipulate that banks incorporate in Singapore should not appoint the same public accounting firm more than 5 consecutive financial years. The main reason mandatory audit firm rotation for local bank was to promote the independence and effectiveness of external audit.

30. Recommendations • Public Accountant Board of Singapore • prohibited from providing certain NAS to their audit clients, e.g. book-keeping, specialist valuation. • if fees exceed a certain percentage of the audit firm’s total fees, auditor’s independence is not compromised.

31. Recommendations (cont..) • Rules proposed by Securities Exchange Commission • Require that an audit committee pre-approve all audit and NAS provided by the auditor; • Prohibit partners on the audit engagement team from providing audit services to audit client for more than five consecutive years.

32. Conclusion • In our opinions, the effectiveness of the regulating regime is not a matter of elaborate rules, but the commitment of the public accountants to abide their professional ethics and code of conduct. Auditors must bear in mind that they are not only accountable to their clients but also to the stakeholders especially the investing public.