Professional Ethics for Auditors

The main aim of this report is to highlight the professional ethics that govern Auditors in Australia. To this end, it will identify and discuss the fundamental principles of professional ethics and the applicable audit standards and sections of the Corporations Act. Other than that it will highlight the concept of “audit expectations gap” and explore the factors that have led to the decline of this gap in the recent past with particular reference to the 2008 global financial crisis. It will generally be argued that the application of stringent rules and regulations in the aftermath of the global financial crisis has contributed a great deal to diligence on the part of auditors which has seen them perform their responsibilities more effectively. Meanwhile, there has been a negligible change in managers’ expectations, which implies that the expectations gap has been dwindling over the years.

The Accounting Professional & Ethical Standards Board (APES) 110 Code of Ethics for Professional Accountants stipulates that there are five fundamental principles of professional ethics. They include integrity, objectivity, professional competence and due care, confidentiality, and professional behavior (APESB, 2010). The integrity principle imposes an obligation on all auditors in Australia to be honest and straightforward in all their business and professional relationships, which calls for truthfulness and fair dealing. The principle also prohibits auditors from knowingly being associated with communications, reports, returns or any other information that contains statements that are materially false or misleading, information or statements that have been furnished recklessly or reports that are characterized by the omission of vital information hence rendering them misleading. If an auditor finds out that they have been associated with such information, they should make deliberate efforts to dissociate themselves from that information.

The objectivity principle imposes an obligation on all auditors not to compromise their business or professional judgment due to conflict of interest, bias or undue influence from others. In the event that an auditor is exposed to a situation that could potentially impair their objectivity, they should refrain from performing the professional service in question.

The principle of professional competence and due care imposes an obligation on auditors to have sufficient professional knowledge and skills to enable them to offer competent professional services to clients. They are also required to act diligently and consistent with applicable professional and technical standards when providing professional services. In order to offer competent professional services, auditors should exercise sound judgment in applying professional knowledge and skills while performing such services. Apart from attaining professional competence, they should also ensure that they maintain it, which in turn calls for them to constantly enhance their awareness and understanding of relevant professional, technical and business developments. This puts them in a position to develop and maintain capabilities that go a long way in helping them to work effectively in a professional environment.

Diligence entails the responsibility to act according to the requirements of an assignment, thoroughly, carefully and produce results timely manner. Auditors should make a reasonable effort to ensure that those working under their authority in a professional capacity have the appropriate training and supervision. Where applicable, they should disclose the limitations inherent in their professional services to their clients.

The confidentiality principle imposes an obligation on all auditors to refrain from disclosing confidential information acquired through professional and business relationships to outsiders without proper authorization from the contracting organization unless they reserve a legal or professional right to do so. Similarly, they should refrain from using such information for their own personal gain or to the advantage of third parties. It should be noted that the principle of confidentiality is also applicable to prospective employers or clients and continues to exist even after the relationship between the auditor and the client has come to an end. While they are allowed to use prior experience with subsequent clients, auditors are prohibited from disclosing any confidential information regardless of whether it was acquired or received through a business or professional relationship. Other than that, auditors should maintain confidentiality of information at all times including in social environments, where they should be cognizant of the possibility of inadvertent disclosure, particularly to close family members or business associates.

Finally, the principle of professional behavior imposes an obligation on auditors to comply with relevant laws and regulations and avoid at all costs any action or omission that might discredit the profession. “This includes actions or omissions that a reasonable and informed third party, weighing all the specific facts and circumstances available to the [auditor] at that time, would be likely to conclude adversely affects the good reputation of the profession” (APESB, 2010, p. 22).

Auditing Standards are stipulated by Section 336 of the Corporations Act, which intern refers to the Auditing and Assurance Standards Board as the primary benchmark for auditing standards in Australia. The AUASB prescribes the overall objectives of an independent auditor and how they should conduct an audit that is consistent with the Australian Auditing Standards (AUASB, 2013). According to the board, while auditing a financial report, the main objectives of an auditor are twofold. First, they should obtain reasonable assurance as to whether the financial report as a whole is completely fee from material misstatement, either as a result of fraud or error, hence enabling the auditor to express their professional opinion on whether the report fully complies with the relevant financial reporting standards. Secondly, they should report on the financial report and use their findings to communicate as stipulated by the Australian auditing standards.The provisions of the AUASB mainly revolve around these two objectives

Different researchers have different definitions for the term exception gap. The phrase was first applied by Liggio (1974) who defined it as the disparity between the levels of expected performance as envisioned by an auditor and by the users of financial reports (Koh & Woo, 1998). This definition was later extended by the Cohen Commission, which considered whether a gap may exist between the public’s needs and expectations and what auditors can and should reasonably expect to accomplish (Commission on Auditors’ Responsibilities, 1978). After reviewing several definitions, McEnroe & Martens (2001, p. 345) conclded that the expectations gap is generally “the difference between what the public and other financial statement users perceive auditors’ responsibilities to be and what auditors believe their responsibilities entail.”

In light of the global financial crisis and a series of corporate failures and scandals across the globe, several stakeholders have raised their concerns about the quality of auditing (Holm & Zaman, 2012; Sikka, 2009). Consequently, several countries have made deliberate attempts to regulate auditing practices in a bid to alleviate the exception gap. At the same time, the international community is also making concerted efforts to prevent the occurrence of financial crises and corporate scandals by tightening the disclosure requirements of multinational corporations. This has exerted a lot of pressure on organizations, which has caused them to have higher expectations of their auditing partners. From the foregoing, it is evident that while tightened rules and regulations have prompted auditors to perform their duties more diligently, they also have the capacity to raise managers’ expectations of auditors, hence exacerbating the expectations gap. As such, it is difficult to conclude whether such rules and regulation have reduced or increased the expectations gap. This section will therefore focus on evaluating the impact of the auditing policies and standards in various countries on the expectations gap.

After extending prior research by directly comparing the perceptions of audit partners and investors about the responsibilities of auditors involving various dimensions of the attest function, McEnroe & Martens (2001) found that there was an expectations gap because investors had higher expectations for various facets and assurances of the audit than auditors did. The author suggested that the accounting profession should engage in appropriate measures to reduce this gap. Several efforts have since been made towards this end. The biggest milestones were however made after the 2008 global financial crisis which served as a wakeup call for financial sector stakeholders across the globe. Some notable auditing related measures that were taken to prevent the reoccurrence of similar crises in future include the revision of the International Standard on Auditing (ISA) 700 framework and the enactment of the Sarbanes Oxley Act.

In a recent study that sought to test the effectiveness of expectations as mandated by the revised ISA 700 auditor’s report in reducing the audit expectations gap, Gold, et al., (2012) used a summary of a firm’s financial statements and an auditor’s report to experiment on German auditors and financial statement users. The reports were manipulated to appear as though they had been mandated by ISA 700 as opposed to being a mere audit opinion. The Participants were asked about their perceptions regarding the responsibilities of auditors versus the responsibilities of managers and their opinion about the reliability of the financial statements. Even though there was strong evidence to suggest that there was a persistent expectations gap with regard to auditor’s responsibilities, both auditors and financial statement users reached a reasonable consensus about the responsibilities of managers and the reliability of financial statements. However, it was found that the explanations of the ISA 700 auditor’s report do not contribute a to smaller expectations gap. The findings of the research further suggested that a mere audit opinion was sufficient to provide relevant information to users.

Despite the failure of the ISA 700 to reduce the expectations gap, several other policies have proven to be quite successful at achieving this. The Sarbanes Oxley Act has for instance had a profound impact on corporate culture for both auditing firms and organizations in the United States. Senior management employees are forced to ensure the accuracy of their financial disclosures, failure to which they might be liable to criminal prosecution. As such, they take financial disclosure very seriously and use rigorous processes to ensure that they are confident of the information they release to the public.

The Sarbanes Oxley Act generally prompts senior managers to engage in ethical reporting. The managers in turn make deliberate efforts to ensure that junior managers and other employees within their organizations are also engaging in ethical practices (Ferrell, Fraedrich, & Ferrell, 2013). Similarly, they impose pressure on auditors to rigorously inspect their financial reports to ensure that they are free of errors. The Act therefore not only promotes the adoption of an ethical corporate culture within audited firms but also within auditing firms. Ethical corporate culture is therefore mutually beneficial to both organizations and auditing partners. Nevertheless, there will always be unscrupulous business practitioners who will seek to make profits using unorthodox means and as such further misconduct is bound to occur. In light of this, Daugherty (2006, 53) conducted two experiments to explore the potential unintended impact of the Sarbanes Oxley Act on the professional judgment of auditors and the expectations gap.

The first experiment sought to investigate whether participating auditors were inclined towards using qualitatively inferior methods of selecting accounts receivable balances for confirmation at different levels of competing environmental and organizational pressure. The results of this experiment proved to be very encouraging to both auditors and the public because the respondents appeared to demonstrate a preference for qualitatively superior methods as opposed to succumbing to normative influence to maximize self-interest. The author also lacked sufficient evidence to suggest that environmental pressure has a moderating organizational pressure such that the strongest preference for non-statistical method would occur in the participating group influenced by low organizational pressure and high environmental pressure. The author concluded that individual auditors had responded to increased environmental pressures appropriately and had not allowed vested interest to overcome their professional obligations and responsibilities, which implies that the expectations gap is not as high as it had been anticipated.

The second experiment sought to investigate whether the SOX mandated reports (by both independent auditors and the senior management of public companies) on the effectiveness of a company’s internal control over financial reporting has had any impacts on the expectations of both public companies and their stakeholders. This experiment also addressed some of the basic issues affecting junior employees in the wake of newly mandated reporting on internal control effectiveness by auditors and managers. The results suggest that public expectations have remained largely unaffected by increasing reporting transparency. Junior employees were also found to be more sensitive to reporting standards due to stringent organizational policies.

To conclude, following the implementation of strict rules and regulations for financial reporting, organizations and auditing partners have been prompted to make deliberate efforts to ensure the transparency of their financial reports. Even though this has resulted in both organizational and environmental pressure for auditors, it has had a negligible impact on managers’ expectations. Consequently, there has been a significant decline in the expectations gap because auditors have become diligent in executing their responsibilities while managers’ expectations have remained constant.

 

 

 

References

[APESB] Accounting Professional & Ethical Standards Board Limited, 2010. APES 110 Code of Ethics for Professional Accountants, Melbourne: Accounting Professional & Ethical Standards Board Limited.

[AUASB] Auditing and Assurance Standards Board, 2013. Auditing Standard ASA 200: Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Australian Auditing Standards, Melbourne: Commonwealth of Australia.

Commission on Auditors’ Responsibilities (Cohen Commission) , 1978. Report, Conclusions and Recommendations, New York, NY: American Institute of Certified Public Accountants.

Daugherty, B. E., 2006. An experimental analysis of potential unintended consequences of Sarbanes Oxley on auditors’ professional judgments and the expectation gap, Ann Arbor: ProQuest Information and Learning Company.

Ferrell, O. C., Fraedrich, J. & Ferrell, L., 2013. Business Ethics: Ethical Decision Making & Cases. 10 ed. Mason, OH: Cengage Learning.

Gold, A., Gronewold, U. & Pott, C., 2012. The ISA 700 Auditor’s Report and the Audit Expectation Gap – Do Explanations Matter?. SSRN Working Paper Series, 9 October.

Holm, C. & Zaman, M., 2012. Regulating audit quality: Restoring trust and legitimacy. Accounting Forum, Volume 36, pp. 51-61.

Koh, H. C. & Woo, E.-S., 1998. The expectation gap in auditing. Managerial Auditing Journal, 13(3), pp. 147-154.

Liggio, C., 1974. The expectation gap: the accountant’s Waterloo. Journal of Contemporary Business , 3(Spring), pp. 27-44.

McEnroe, J. & Martens, S. C., 2001. Auditors’ and investors’ perceptions of the “expectation gap”. Accounting Horizons, 15(4), pp. 345-358.

NPR, 2005. How Sarbanes-Oxley Has Affected Corporate Culture. [Online]
Available at: http://www.npr.org/templates/story/story.php?storyId=4673074

Sikka, P., 2009. Financial crisis and the silence of the auditors. Accounting, Organizations and Society , Volume 34, p. 868–873.

Sikka, P., Filling, S. & Liew, P., 20009. The audit crunch: reforming auditing. Managerial Auditing Journal, 24(2), pp. 135-155.

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