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Auditing and Its Current Importance Report (Assessment)

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Updated: May 3rd, 2022

Introduction

“So long as there are financial, economic or industrial institutions in existence it is likely that the practice of auditing will never really lose relevancy” (Deming, 1979: 197-208). This statement by Deming (1979) shows the current importance of auditing within financial and business practices to date and exemplifies the integration of internal and external auditing practices within an era of increasing financial and commercial integration (Deming, 1979: 197-208). Despite this, it must be questioned whether the practice of auditing in its current form remains fit for its purpose given recent developments which have cast significant degrees of doubt over the integrity/effectiveness of the practice (Ramirez, 2009: 127-149). This is in reference to auditors who have colluded with company management in order to present false financial data in order to cover-up mistakes or create an appearance of improved fiscal performance when in actuality there were significant degrees of performance deterioration. Furthermore, it was noted that internal auditors had a hand in a variety of Wall Street/ London scandals who actually manipulated financial data due to external collusion with third parties involved in a particular case (seen in the manipulation of financial loan data between Barclays and other banks involved in the case).

Failures on the part of external auditors from evaluating the strength of various financial institutions during the buildup to the 2008 financial crisis was also noted as a failure on the part of the profession to prevent the deterioration of the U.S. housing market in favor of “going with the flow” due to the supposedly “secure” nature of the mortgage backed securities system that was developed which many criticized as being nothing more than a stop gap measure which actually caused the crisis to spread to various global financial institutions. Lastly, it must be noted that in the case of regulatory audits the current trend in business process outsourcing wherein companies contract third party manufacturers or providers in order to handle various aspects of their business has created a situation where regulations and standards applicable to a company within the U.K. for instance are not applicable when it comes to the case of a company based in China, India or the Philippines.

This has created a host of problems regarding compliance due to the fact that a company based in the U.K. can comply with various industry regulations and standards which are there to protect workers and the environment but its suppliers or manufacturers do not necessarily have to comply with these standards since they are under a completely different regulatory environment. Such a practice in effect defeats the purpose of auditing since the usual methods of oversight are no longer applicable in this particular instance. Not only that, U.K., U.S. or Australian based auditing practices are not necessarily applicable to foreign based manufacturers such as those in China (who ironically have very little auditing practices) which prevents accurate data about a company’s current level of operational efficiency from being properly evaluated. It is this and a variety of other examples that it becomes questionable whether auditing in its current form remains fit for its purpose of evaluation.

Addressing the Issue of Ethics within the Auditing Profession

In his evaluation of current ethical violations within the auditing profession Broeker & Nest (1967) cites the following classic phrase as the primary reason behind the dubious ethical nature of several auditors: “Quis custodiet ipsos custodes” – namely “who watches the watchers” (Broeker & Nest, 1967: 75-78). Examining auditing practices which have misled investors through the manipulation of financial data or through “glossing over” of the facts in favor of favorable results McKee (2010) explains that one of the primary reasons behind this is due to the fact that auditors often do not receive punishment commensurate to the impact of their activities (McKee, 2010: 60-62). He points to examples seen in 2009 and 2010 which examined the reasons behind the financial crisis and reveals that despite the obvious nature of financial duplicity involved, there were few cases where the internal/external auditors who were meant to prevent such practices from coming to pass were punished in any way (McKee, 2010: 60-62). He points out that a certain level of duplicity was involved wherein despite the obvious problems evident with the internal practices of several financial institutions the auditors in charge either saw the data and refused to publish it or merely did not do their jobs at all and performed a superficial examination of the financial data of the banks and mortgage companies that were responsible for the sheer glut of toxic housing debt (McKee, 2010: 60-62).

This practice, while not endemic to all aspects of the profession, is worrisome given the potential adverse impact this may have on the financial system as a whole wherein through negligence and ethical dubiousness without sufficient repercussions adverse practices may continue to go unchecked resulting in negative spillover effects which could result in more financial turmoil (Carmichael & Fritzemeyer,1970: 67). While it may be true that a variety of auditing organizations do exist within the U.K., U.S. and various other countries these organizations are often times insufficient in their ability to enforce the same amount of punishment seen in cases in the medical profession involving malpractice, unethical behavior or gross negligence of any kind. It is based on this that McKee (2010) recommends the implementation of methods of proportional liability within the auditing industry wherein through evidenced negligence or ethical dubiousness an auditor should be held liable for the full impact of their action/inaction (McKee, 2010: 60-62). By doing so this creates a process wherein auditors would be more inclined to do their jobs properly rather than subject themselves to possible harsh penalties as a result of inaction or unethical action. McKee (2010) further postulates that it would also be necessary to implement far stricter methods of external evaluation of auditors due to the nature of their position. Such practices are often seen in the field of medicine wherein external inquiries regarding the nature of treatments administered and methods of patient care are evaluated in order to determine whether any wrong doing is in effect.

Outsourcing and its Effects on Auditing

As a direct result of globalization and the greater integration of financial markets, it has become all too easy to shift resources from on portion of the world to another. This of course has brought about the practice of outsourcing which has shown the inherent limitations of the practice of auditing given new business process circumstances that auditors have to deal with. External and regulatory audits can no longer be sufficiently implemented in the case of companies that are outsourcing their manufacturing and services processes since third party suppliers and service providers are not subject to the same auditing practices as the company that outsources the services in the first place (Zerni, Kallunki, & Nilsson, 2010: 1169-1206). This was seen in the case of Apple Inc. and it outsourcing of the manufacturing of the iPhone and iPad to companies such as Foxconn whose internal practices are considered “inhumane” by various members of international community due to the long hours and the fact that the wages given are a pittance compared to that of their foreign counterparts. It is based on this that it must be questioned whether auditing has lost its relevancy in a shifting business environment wherein differences in auditing regulations and practices across a varied amount of international locations has in effect limited the ability of the practice to do what it was meant to do. For example, it must be noted that one of the responsibilities of auditing is to ensure that a corporation is complying with local environmental laws and regulations (Kinney, 1975:117-132).

This is an important facet of the practice since it prevents corporations from performing business practices which could cause long term detrimental effects on the environment. Unfortunately, once outsourcing enters the picture this allows a third party to manufacture the product of a company at another location that does not have the same level of environmental laws and regulations which prohibit such behavior (Lehmann & Norman, 2006:65-83). As such, while the main company is for all intents and purposes in “compliance” with regulations as per standards of auditing, in reality its supply chain is in effect in direct violation of environmental regulations. Beattie, Fearnley, & Hines (2012) examines this issue by stipulating that as various societies continue to become more concerned regarding the implications of unregulated corporate action (this has already been noted in the case of China wherein protests regarding environmental and financial mismanagement have subsequently influenced government actions) this would in turn result in the creation of stronger auditing systems within the countries where outsourcing occur thus resolving the aforementioned issues pointed out earlier (Beattie, Fearnley, & Hines, 2012: 111-129). Unfortunately, Beattie, Fearnley, & Hines (2012) points out that this may take a considerable amount of time and as such shows how auditing at the present remains ill-suited to deal with the current issues that it is confronted with given the increased propensity for outsourcing (Beattie, Fearnley, & Hines, 2012: 111-129).

Discussion

Based on the various aspects related to the practice of auditing at the present, it can be seen that the field is currently faced with the necessity of reform in not only implementing a greater degree of responsibility for auditors regarding their actions but also the necessity of implementing methods of operation for auditors that are in line with standard ethical practices. Cases such as those involving auditor complicities in dubious financial transactions casts a shadow on the field whose original purpose was to ensure that such actions were prevented in the first place. Thus, from an ethical practice standpoint, given the current noted deficiencies in auditing practices it can be stated that while the tools of the profession fit its purpose, the ethical structure from which it is based on requires a considerable degree of revision in order to impart a greater degree of personal liability in order to dissuade unethical actions. If such aspects were present prior to the 2008 financial crisis and the various lapses in judgment by auditors in several high profile Wall Street cases, then it could have been possible that such incidents could have been prevented in the first place.

When it comes to the concept of outsourcing and auditing it becomes all too clear that auditing at the present needs to impart a certain degree of responsibility on the main company for distinctly unethical actions in various aspects of its supply line. At the present, auditing is more concerned with whether a company itself, rather than aspects of its international supply chain, is in compliance with various rules and regulations. This I believe is a failing on the part of the profession since the supply chain is an integral component of a company’s operations. The lack of sufficient focus on the supply chain of a company has left “the doors wide open” so to speak when it comes to distinctly unethical actions in violation of financial and environmental regulations and as such practices need to be reformed in such a way that a company’s compliance to rules and regulations must include what it does with aspects of it supply chain. The main purpose of auditing in the first place is to evaluate and ensure compliance, if a company is able to skirt around this by utilizing a loophole in regulatory practices then it is necessary to implement new auditing practices that take this into consideration and adjust as needed.

Conclusion

Based on an evaluation of appropriate academic literature, it has been critically evaluated that the extent to which auditing in its current form remains fit for purpose is such that it is currently lacking in terms of sufficient liability for the actions/inactions of auditors as well as its inability to properly implement policies and regulations when it comes to companies that outsource various aspects of their operations.

Reference List

Beattie, V, Fearnley, S, & Hines, T 2012, ‘A Real-life Case Study of Audit Interactions—Resolving Messy, Complex Problems’, Accounting Education, 21, 2, pp. 111-129, Business Source Premier.

Broeker, M, & Nest, R 1967, ‘Audit Problems Relating to Review of Internal Control’, Journal Of Accountancy, 123, 2, pp. 75-78, Business Source Premier.

Carmichael, D, & Fritzemeyer, J 1970, ‘Accounting & auditing problems’, Journal Of Accountancy, 130, 6, pp. 67-73, Business Source Premier.

Deming, W 1979, ‘On a Problem in Standards of Auditing From the Viewpoint of Statistical Practice’, Journal Of Accounting, Auditing & Finance, 2, 3, pp. 197-208, Business Source Premier.

Kinney, JR 1975, ‘A Decision-Theory Approach to the Sampling Problem in Auditing’, Journal Of Accounting Research, 13, 1, pp. 117-132, Business Source Premier.

Lehmann, C, & Norman, C 2006, ‘The Effects of Experience on Complex Problem Representation and Judgment In Auditing: An Experimental Investigation’, Behavioral Research In Accounting, 18, pp. 65-83, Business Source Premier.

McKee, TE 2010, ‘The ‘Cry Wolf’ Problem in Current Fraud Auditing Standards’, CPA Journal, 80, 1, pp. 60-62, Business Source Premier.

Ramirez, C 2009, ‘Reform or renaissance? France’s 1966 Companies Act and the problem of the ‘professionalisation’ of the auditing profession in France’, Accounting, Business & Financial History, 19, 2, pp. 127-148, Business Source Premier.

Zerni, M, Kallunki, J, & Nilsson, H 2010, ‘The Entrenchment Problem, Corporate Governance Mechanisms, and Firm Value’, Contemporary Accounting Research, 27, 4, pp. 1169-1206, Business Source Premier.

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