Audit Firm: Personality of Auditor

There are a few personal characteristics that are important for an auditor to have:

• Auditors should possess a strong ethical framework and report on issues (or anticipated issues) as they come across them. There is a temptation to "let things go" as further investigation may require more work or reveal embarrassing processes, performance and/or fraud.

• Good communication skills allow auditors to have a rapport with a variety of employees, managers, directors and external parties. As auditors establish good rapport with a variety of individuals, however, they should keep in mind the objectives of the audit (for instance, the reliability, verifiability, accuracy and timeliness of information), as they can often be tempted to not report on issues discovered.

• Strong interpersonal skills are important, due to the variety of informational requests - and often, resistance to those requests - required from a variety of sources. Strong and/or ambitious types may attempt to dissuade auditors from revealing embarrassing findings.

• Auditors need to be team players. As the scope of the audit can be fairly large, it is beneficial to help in other areas of an audit when resource constraints warrant it.

• Finally, "professional skepticism" is an important trait to have, especially when reviewing a company's internal controls. One needs to assess how perpetrators of fraud can beat a company's controls, and auditors need to design and implement a system that can effectively protect the organization's assets.

Audit Exam Ultimate Pass Key

Last summer I successfully passed ACCA exam, P7 “Advanced Audit & Assurance”. While preparing for the exam, I designed succinct and universal “question tackling plan”, which helped to structure my ideas on auditing. In this post I would like to share my knowledge just before coming ACCA examination session.  

I believe it would be useful for all exams related with financial audit. So the candidates for qualifications like CPA or ICAEW are welcomed to utilize it as well. J

The logic is simple: the plan consists of common subjects/questions and points suggested to be addressed.

Question Tackling Plan

1.      Ethics area question

1.1.   Technical competence;

1.2.Objectivity/Independence (possible threats: self-review, familiarity, intimidation, self-interest, advocacy)

1.3.   Professional behavior;

1.4.   Integrity;

1.5.   Confidentiality.

Mnemonic: TOPIC

2.      Professional (audit business) area question

2.1.   Competence;

2.2.   Resources/costs;

2.3.   Reputation;

2.4.   Staff quality;

2.5.   Quality control: Acceptance; Directorship; Supervision; Review; Consulting; Disputes.

3.      Audit Opinion related question

3.1.   Clarity;

3.2.   Details (standards, amounts, scope);

3.3.   Structure (is heading on the right place?) of opinion and its Consistency (starts like “except for” and finishes like adverse opinion);

3.4.   Types of appropriate opinions. This depends on evidences (sufficient, mistake material and pervasive?);

3.5.   Prior year opinion.

4.      Audit Matters (audit evidence/process) question

4.1.   Materiality;

4.2.   Standard breached (IFRS, recognition, valuation criteria etc.);

4.3.   Risks of misstatement;

4.4.   Impact on Audit Opinion;

4.5.   Reliability (source of evidence).

5.      Audit Evidence question

Mnemonics:

Sources of evidence -  DADA3: Document Asset Director (interview/representations) Accounting record 3rd Party

Procedures AE IOU: Analytical (plausibility/predictability)   Enquiry & Confirm (written/verbal)     Inspection (documents/assets)       Observation (assets, process) RecalcUlation (opening balance check)

Elements of evidence:

5.1.   General: budgets/plans, accounting policy;

5.2.   Calculations: rates, models, risks, probabilities, impairment reviews, useful lives, assumptions reasonableness explanation;

5.3.   Disclosure: draft notes;

5.4.   Documents types:

5.4.1.      Bank statements, invoice, bill, dispatch/delivery note;

5.4.2.      Contract, agreement, insurance policy, title deed;

5.4.3.      Claim litigation copy, insurance claim;

5.4.4.      Log books, time-sheets;

5.4.5.      Minutes, orders, policies;

5.4.6.      Correspondence, letters;

5.4.7.      Tax returns;

5.5.   Reconciliations (with tax authority, debtor), confirmations;

5.6.   Record of discussion, interview, talk with employees;

5.7.   Valuation reports, surveys;

5.8.   Breakdowns (check for misclassification), samples.

Golden Rule:

Your answer should be always close to the question scenario: (1) the answer should be relevant; (2) the question text contains hint for answer.

You are welcomed to share your tips for audit exams. Good Luck! J

          Disclaimer:
"This group is not associated with or approved by ACCA and the views expressed on this page do not necessarily reflect the views of ACCA".

The Role of Big4 in promoting IFRS

The audit of IFRS reports is one of the major services provided by the international accounting networks. This is because they possess necessary knowledge and skills, which could be used all over the world. However, there are negative moments in this process, which could be illustrated by conclusion made by Sucher and Alexander (2002) in their research:

     “Given their power over both the production and audit of IAS accounts, the Big Five firms play a very large role in interpreting and implementing IAS standards in a particular country.  This raises issues of power and responsibility with respect to compliance with IAS that need to be addressed clearly by the IASB”

So this post is going to address this issue and point out on existing problem especially in emerging markets.

Illustrations

The issue was substantially researched by Sucher and Alexander (2002) based on the example of Russia and by Sucher and Jindrichovska (2004) in study of situation in Czech Republic.

The problem is that companies in emerging economies suffer from lack of knowledge and expertise in preparation of IFRS accounts. The probable solution could be to hire IFRS specialist or to outsource reporting process. But on the one hand there is a shortage of qualified and experienced professionals in emerging markets. On the other hand, outsourcing by one and afterwards auditing by another independent firm are seen as superfluous costs. Finally, these companies opt into simple solution – they ask audit firms both to prepare and audit their IFRS accounts. This state of things as honourable auditors we can’t tolerate, can we?

Sucher and Alexander (2002) illustrated the situation by remark of one of Big Five (at the moment of research) interviewees:

“As you know we do not prepare accounts for our clients – it is an independence issue….however, we do provide a degree of assistance….. Some accountants in enterprises crunch the numbers (for IAS) and others say, ‘look guys we pay you to do it.  It is a fairy tale’”

It is not only willingness to save money, the issue is also related with the perception of an audit as no-value-adding activity. Interviewees in Czech Republic complained that the earlier Big 4 audit firm provided such package of services while the latest Big 4 auditors refuse to do this (Sucher and Jindrichovska 2004). One of the Big 4 auditors (interviewee) added fuel to the fire:

“Some financial managers and accountants [in enterprises] do not know what is going on [with IFRS]. They are only the passive receivers. In [X audit firm], there are templates that transform Czech accounting to IAS. The knowledge is kept in the audit company. It is big business [for the audit firm]. You can train companies to do the supporting sheets hut the final bit is done by the audit firm.”(Sucher and Jindrichovska 2004).

Meanwhile, management of the companies would always be keen on saving costs on such things like audit. It is quite likely that such kind of cosy relations are more beneficial to audit firms. At least they could have separated audit and accounting team, but according to research it would be too costly for audit firms and they end up by assigning one team of people to do both jobs, which is a shame.

Problems

The basic issue which arises here is how far should we trust financial statements prepared in emerging markets? To what extent this practice spread in other emerging countries, where corporate governance and law enforcement are not developed enough? I think that it is highly probable that similar “reporting-auditng” is practiced in China, where local management is rather pushy in accounting issues (see Deloitte’s case).

The other question how can we deal with the issue in sensible way. For example, one is audit manager and one is doing audit of IFRS reports of Brazilian company. The resourceful Brazilian finance director provides auditor with financial statements (FS) essentially based on Brazilian GAAP, but with name of IFRS on its face. The trick is that you will do honest auditing, spot discrepancies from real IFRS and provide list of adjustments which need to be done J It is foxy tactic, isn’t it?

What do you think about truthfulness of IFRS accounts of companies from emerging markets listed on global stock exchanges? Have you faced approach mentioned above in your reporting or auditing practice? How to discourage auditors from doing that especially in the context of coming “pure-audit-firms” legislation? Please share your knowledge and experience.

References

Sucher, P. and Alexander, D. (2002) IAS: Issues of Country, Sector and Audit Firm Compliance in Emerging Economies (London: Centre for Business Performance of the Institute of Chartered Accountants in England and Wales).

Sucher P., and Jindrichovska I. (2004) Implementing IFRS: A Case Study of the Czech Republic. EAA, Accounting in Europe, Vol. 1, pp. 109-141.

Audit in Politics: Russia vs Yukos vs PwC

There have been two events in recent days which triggered me to write post on this subject. First, last week The Economist published the article about auditing in China. Second, the recent decision of European Court of Human Rights (ECHR) regarding the Yukos vs. Russia case.

The article in The Economist considers the issue which happened between Deloitte and Longtop, a Chinese company once listed in NYSE. Here is remarkable abstract:

     “… After signing off Longtop’s financial statements for several years, the firm smelled trouble during its audit for the financial year that ended in March. Its subsequent questions did not go down well at Longtop, which seized some of Deloitte’s papers and threatened to keep Deloitte staff from leaving company premises. Deloitte quit as auditor, and Longtop’s shares ended up being delisted from the New York Stock Exchange in August.”

Subsequently, SEC issued subpoena for Deloitte’s audit working papers in relation to Longtop. After Deloiite’s refusal to cooperate the PCAOB threatened to decertify its Chinese division.

Medvedev and Putin

Several features of the above case look like Yukos-PwC affair which I would like analyse in several following articles. Yukos-PwC matter is perfect case for audit, accounting, tax and business ethics studies. It is rather complicated and requires accurate consideration of all facts. I am going to cover audit related professional and ethical issues. In this post I will give brief overview of the issue.

Essence of Issue

Yukos was one of the largest Russian oil companies with successful growth strategy and was listed on the LSE. However the company eventually had to file for bankruptcy (2006) after the Russian Ministry of Taxation proved in court (in 2003) that Yukos’ tax evasion amounted around $28 billion. The hypotheses standing behind this case are as follows:

1.      Tax evasion. This is obvious: company tried to pay less taxes using illegal schemes;

2.  Politically motivated expropriation of the company. The major shareholders and top-managers of Yukos, Mr. Khodorkovsky and Mr. Lebedev, were arrested in 2003 with criminal charges including tax evasion, fraud, forgery and embezzlement of assets. Meanwhile it is believed that Khodorkovsky and Lebedev had political ambitions and tried to influence state parliament by financing both left-wing and right-wing parties. Eventually, Mr. Putin being the president of Russia (now prime minister) decided to punish these independent oligarchs.

Khodorkovsky and Lebedev

The issue is that both hypotheses might be truthful partially. The fact is that similar tax evasion models were used at those time (and now used also) by almost all oil and gas companies in Russia and the only company which carried its part of punishment was Yukos. Nevertheless, I do not want to focus on this dispute, I am interested in the role of auditors in all this mess and here they come…  

Involvement of the Russian PwC firm

Unfortunately, PwC was an auditor of Yukos, acted as advisor on tax strategy, worked closely with Kodorkovsky on financial and accounting issues. After years of cooperation with client, PwC decided to withdraw its audit opinions in 2007 issued in respect of Yukos consolidated financial statements for 10 years from 1995 to 2004!

The Russian PwC office claimed that during tax investigation the prosecutors revealed new facts, which managers of Yukos misrepresented during previous audits. So what facts were revealed? The level of cooperation with client on tax issues was so close that there are significant doubts about this?

The other peculiar matter is that PwC-Cyprus has not withdrawn its audit opinions in respect of Yukos Cuprus subsidiaries.

Third, there are beliefs that Russian PwC was a coerced into opinion revocation by the Russian authorities.

Questions

Finally, based on the above overview I would like to raise following questions in my further blog posts:

·      What were the audit evidences, which had dramatic impact on PwC’s opinion?

·      Could Yukos case raise the same concerns of PCAOB about reliability of the Russian PwC audit working papers as in case Deloitte-Longtop affair?

·      Might the significant share of audit fees incoming from state owned giant company, Gazprom, somehow impact PwC’s decision?

·      What are ethical stances behind PwC deed?

The specialists, blogers who would like to contribute to the discussion of this issue and probably post their own article in “Audit is Cool” blog are welcomed (please send me message) or you can just leave your comment.

PS: Funny Reality

Here is the real phrase from Russian court ruling on the second case against Khodorkovsky and Lebedev (p. 613):

“… Khodorkovsky and Lebedev kept two sets of financial accounts (reporting per Russian Accounting Principles and US GAAP) and concealed from shareholders consolidated financial reports, by publishing them only in English language…”

This funny words were noticed by my friend in Livejournal, tema57 J

Sources:

The Economist. 2011. Auditing in China.September 17

The Wall Street Journal.2010. Oil Tycoon Says PWC Caved to Pressure. September 7

Financial Times.2010. Russia:Chain retraction. September 6.

Khodorkovky and Lebedev Communication Center:

·       http://www.khodorkovskycenter.com

·       http://www.khodorkovsky.ru/

Q&A from the defense team on the PwC investigation - A Q&A with the defense team inrelation to PwC's withdrawal of 10 years of its YUKOS audits

ECHR. 2011. Case of OAO neftyanaya kompaniya Yukos v. Russia. Applicationno. 14902/04

Second Case Ruling Khodorkovsky and Lebedev.2010

Ethical Auditor: Independence vs Rotation

Rotation

My previous post on ethics was rather popular, which gives me reasons to suggest that people are interested in auditors’ behavior and their place in business culture. Last week The Economist published interesting article about independence of auditors. Here are very appealing facts in the article:

    “… 1896 was also the year that Barclays, a British bank, chose an ancestor of PwC as its auditor, a relationship unbroken to this day. Fidelity is the norm in auditing. GE, Procter & Gamble and Dow Chemical have also clocked up centuries with their auditors. The average tenure for an auditor of a British FTSE 100 company is 48 years. Two-thirds of Germany’s DAX 30 have had their auditors for over 20 years.”

There are several opinions presented in article, one of which suggests that to address the issue it necessary to impose audit firm rotation. After reading I decided to discuss independence, because it is quite disputable area.

Current Situation: Partner Rotation

The literature on audit states that there is familiarity threat, which could arise between staff of audit firm and client. The risk is that auditor would lose professional scepticism because of too close relations with client. To address this issue official documents like SOX (in USA) and accounting codes like ACCA Code of Ethics and Conduct set specific requirements on audit partners rotation in case of dealing with listed (or public interest) clients. The requirements are as follows:

1.  Engagement partner should be rotated after 5 years;

2.    Other key audit partners should be rotated after 7 years;

3.    Partner responsible for quality control should be rotated after 7 years

However, current talks about rotation of firm suggest that above measures are not enough to provide independent audit opinion.

Who to Decide

Now we are coming to the point of appointing auditors on top management level. As known auditors, which expected to be appointed have to be approved by shareholders on annual general meetings. If shareholders did it for 100 years as in above case with Barclays then it all right. They bear all risks of such appointment and they should have understood it. 

However, in current stakeholder theory – shareholders are not the only persons who are affected by activity of listed Company. If it is “public interest entity” then the potential effect on other members of public gives right to public to interfere in the process of auditor appointment. I wrote about it in previous post considering proposals of European Commission on extra audit regulations.

The appointment of auditor becomes especially significant in case of financial institutions in our days as panic on market related with bankruptcies might jeopardize whole economy.

More Regulation – Better Results?

The above article gives example of number of studies which founded that rotations do not necessary results increase of audit quality. On the contrary, because of lack of client knowledge the quality might deteriorate. On the other hand, then it would be necessary to establish special rules for information transfer between auditors to provide better client understanding. The third point is that all these regulation might become too huge for auditors and add much more to existing bureaucracy in our profession.

What are your ideas in this issue, please share your thoughts in comments.  

Ethical Auditor: Being Holier than the Pope

     Ethics issues in business have been always matter of discussions. Audit profession is especially subject of this arguments. Probably only medical workers have as sound ethical principles as auditors do.

     In the beginning

     IFAC code of ethics explains this phenomena in following way: ‘A distinguishing mark of the accountancy profession is its acceptance of the responsibility to act in the public interest. Therefore, a professional accountant’s responsibility is not exclusively to satisfy the needs of an individual client or employer’. European Commission acknowledges this fact by emphasizing that auditor has to fulfill societal mandate.

     Unfortunately these statements do not stick in the mind of young beginning auditors. It is very rare if anyone from accounting firm’s HR or management would ask candidates during interview: “Do you really aware that you are going to hold societal mandate and act in public interest?” It a fantasy, isn’t? Especially for accounting firms operating in emerging markets with low level of law enforcement and legal awareness of society.

     Men and women of principles

     At this point I think I must list fundamental principals auditor’s ethics:

• Integrity
• Objectivity
• Professional Competence and Due Care
• Confidentiality
• Professional Behavior

     The principles are really very bright and constitute best moral qualities of humanity. For example, integrity means that auditor being honest should never allow his/her name to be associated with something dishonest. Professional behavior means that auditor must comply with relevant laws and regulations and avoid any action that may bring discredit to the profession. As my honorable lecturer, John Stead, says that ‘it is not just a coat you put on when you go to the work in the morning and leave the office in the evening, it is an attitude of mind’. May be it is not the newest thought in the world, but I like the reasonableness and fairness of these words.

     Of course! When students hear such things from their lecturers there are ironic smiles on their faces. They know that human beings tend to lie and act irresponsibly in their own interest, because human beings are not perfect from birth.

     Some illustrations. For example, I am shareholder and I do not want financials of my company to be audited by the guys who illegally download some software/music from internet. They commit crime and if this information becomes public this would negatively impact audit profession. Or, for example, audit partner is in cahoots with criminal authoritarian government members. Is it just a friendship or something related with corruption? We do not know, but reputation of audit partner willingly or not would be damaged at this case. There are no immaterial things here – even if you are stowaway in a bus, it still matters!

    Another good point is that ethics is not only, auditor knows if he is guilty (ethical) or not guilty (non-ethical). It is also about public perception of auditors’ actions.  If society believes that private relationships of audit partner and CFO matter even if auditor sure that it is 100% does not matter, the society is right.

     On the other hand, we are not saint. There is always compromise. The relevant rule here is: “Do not do silly things”. In my opinion, for different people different ethical issues matter. Moreover, I think that the most ethical values are grounded in childhood and youth. If future auditor failed to recognize an ethical issue at the age of 18 it most likely that he/she would struggle to recognize it in adult ages even after completing ethics courses.

     Ethics models

    David Campbell, the examiner of P1 in ACCA qualification, have several useful tips in his article in Student Accountant magazine. He briefly described features of two ethics models: American Accounting Association model with seven steps and Tucker’s 5-question model. I will place here just major points of model, the article is freely available and you can read details there.

       I think they are very clear and useful, even in daily live.

      

       

References:

Campbell, D. (2008). Work ethics. Student Accountant. March 2008, p. 56-59

IFAC (2006). Code of Ethics for Professional Accountants. IFAC, New York

New Regulations for Auditors: European Revolt

Nowadays, when revolutions spread across Middle East and North Africa, the European Commission gently prepares revolutionary changes in audit industry. The cause, as you probably could guess, is financial crunch. Of course, usual "we can’t live like this any more" is also there...

So, how auditors are going to live in near future? What are new regulation ideas of industry? Would it harm our profession? I wish I new concrete answers on this question. Let’s just briefly outline what have happened.

European Commission fed up with current audit practice

In October 2010 European Commission met to raise questions about problems of audit and subsequently issued a document “Green Paper - Audit Policy: Lessons from Crisis”(click to see). The major issues discussed by Commission are as follows:

·        The role of auditor;

·        Ethical issues: governance and independence;

·        Competition in audit market;

·        Supervision of audit practices;

·        Small business problems.

Expectation Gap

I can’t say better than Commission has written: “Given that these stakeholders may be unaware of the limitations of an audit (materiality, sampling techniques, role of the auditor in the detection of fraud and the responsibility of management), this engenders an expectation gap”. 

Yes, there is an expectation gap! Most of people unrelated with audit mistakenly think, that clean audit opinion must give guarantee of financial soundness. Partly they are right. Even under current audit standards the audited entity can’t be totally financially unsound and still get clean opinion. In case of bankruptcy issues and if auditor has reasonable grounds to cast doubts about viability of an entity in nearest year there is an always possibility to issues modified audit opinion with emphasis on going concern issues.  

The bad thing, that even these kind of issues were not emphasised (see e.g. Lehman brothers case described by Sikka).

EU would consider extension of the auditor’s mandate and going to decide whether to enable them to provide economic and financial outlook of audited company or not.

 Competition

Big Four audit firms do audit for 90% of listed companies in vast majority of EU states. Looks like oligopoly, doesn’t it?! EU says that in case of ‘demise of systemic audit firm’ it would raise ‘to big to fail’ situation. There is also potential risk of complete lose of trust by investors and deep crisis of audit profession. European Commission does not have unambiguous answers. Probable ideas to consider: joint audit, mandatory rotation of auditors, reassessment of actual quality of services provided by Big4 and addressing existing bias of perception of Big4 ( European Commission 2010, pp. 15-17).

 Independence  

Green paper clearly states: “The fact that auditors' responsibility is to the shareholders of the audited company and other stakeholders although they are paid by the audited company creates a distortion within the system”.  One of suggested solution to this problem  would  be introduction a third party into ‘auditor-company’ relationships: ‘remuneration and duration of the engagement would be the responsibility of a third party, perhaps a regulator, rather than the company itself’.

Non-audit services also impair auditors’ independence. The tone of document shows that Commission would like to remove any business interest of audit firm in the company being audited. ‘Pure audit firms’, so called, ‘inspection units’ – this is the language used by European Commission.      

Call for help

European Commission asked for response on its Green Paper and promised to announce proposals in 2011. By the 8^th of December 2010 preliminary public consultations (click here for proposals) had been ended and on 10^th of February 2011 high level Conference was held to discuss Green Paper (pls. click link to read about Conference and materials).

I am going to follow European Commission discussions and I will provide some suggestions concerning raised issues in my further posts. Moreover, I would be pleased if you provide me with your ideas in comments.    

  References:

European Commission. (2010). Green Paper - Audit Policy: Lessons from Crisis

Sikka, P. (2011).The EU man cometh. PQ Magazine. No. 1, p. 27.

Smith, P. (2010). Under Pressure. Accounting and Business. Vol. 13, Issue 10, pp. 13-14