Quality Control Procedure for Statutory Financial Audit

An Empirical Study

Siddhartha Sankar Saha, Mitrendu Narayan Roy

• Publisher: Emerald Publishing Limited
• Year: 2017
• Print ISBN: 9781787142275
• eBook ISBN: 9781787149137
• Topic: Business
• Subtopic: Financial Accounting
• Index: Business

Quality Control Procedure for Statutory Financial Audit: An Empirical Study takes a comprehensive look at the quality control framework for statutory financial audit. The authors, Saha and Roy, begin with a conceptual discussion on the quality of statutory audit of financial statements, focusing on identifying the different factors governing quality of audit, and establishing a comprehensive framework for quality control. They delve into the quality control framework in three specific countries: USA, UK and India, based on select parameters, and a comparative study is made among them. Lastly, the authors examine the effectiveness of the existing standards and other legal and regulatory requirements in enforcing quality control policies and procedures and suggesting modifications in those regulations which have been made based on a few respondents' perceptions. Their recommendations can improve the future audit environment in safeguarding stakeholders' interest.

CHAPTER
1

Introduction

In matters concerning truth and justice there can be no distinction between big problems and small; for the general principles which determine the conduct of men are indivisible. Whoever is careless with truth in small matters cannot be trusted in important affairs.

— Albert Einstein

1.1. Preamble

Business as a social organisation is formed within society with the help of a few social members, commonly known as its stakeholders, whose financial and nonfinancial interests are fulfilled by the respective business concern. It is critical for them to be up-to-date with the working affairs of the business. Financial transactions made by the business enterprise are translated into accounting language in the form of financial statements in accordance with Generally Accepted Accounting Principles (GAAPs), statutory norms, pronouncements and announcements of the professional body, etc. This is done to fulfil the information needs of the respective stakeholders.¹ Management of corporate enterprises comes under regulatory instructions to prepare and publish ‘financial statements’ comprising Income Statements, Balance Sheets, Statements of Changes in Equity, and Statements of Changes in Financial Position, Notes to Accounts and Schedules to Accounts. Directors Report, Management Discussion and Analysis (MD & A) and Corporate Governance Reports, etc., are also prepared as per statutory requirements to fulfil the diverse information needs of stakeholders.² The correct decisions of users of financial statements are enabled if the statements possess certain qualitative characteristics such as understandability, relevance, reliability, comparability, timeliness, and benefit over costs and verifiability.³ If all these attributes are present in a financial report, the report conveys authentic and reliable information. A quality financial report guides the stakeholders through the financial performance, financial position and future prospects of the business for the purposes of decision making,⁴ which ultimately protects their financial interests. In order to maintain the quality of financial statements, a competent authority external to the enterprise must verify the authenticity of financial statements with respect to accounting principles and the legal norms. Highly skilled accountants with an affiliation to a professional body are appointed by the shareholders of the corporate enterprise to perform this role.⁵

There is no denying the fact that a quality audit is likely to detect earnings management and ensure the quality of financial reporting, thereby protecting stakeholders’ interests. Many sections of stakeholders recognise audited financial statements as being free from manipulation and fraud. Thus, auditors are supposed to play a significant role in the economy in protecting stakeholders’ interests.⁶ On the other side, it was observed that big audit firms (e.g. Price Waterhouse Coopers, Ernst & Young, KPMG, Deloitte) failed to impart quality audit in some companies whose financial irregularities are not investigated properly ignoring stakeholders' interest. As a result, stakeholders were betrayed and the professional integrity and ethical responsibility of the auditors were questioned.⁷ However, because of recent corporate accounting scandals, the extensive growth in white-collar crime, and the ensuing lack of precision and sincerity in reporting, the accounting professions have been facing challenges as to how quality of audit can be excelled with the ultimate goal of safeguarding stakeholders’ interests.

Since financial decisions of a large part of society depend upon auditors’ opinions, the regulatory authorities enforce certain regulatory pronouncements for auditors within the respective country.⁸ Professional institutes and other regulatory bodies governing statutory audit operations in several countries across the globe have come up with several professional and ethical standards for maintaining the quality of statutory audit of financial statements.⁹ Compliance with applicable professional and ethical standards and issuing reports which are appropriate in particular circumstances is the basic prerequisite of audit quality.¹⁰

Accounting firms of auditors take responsibility for controlling the quality of their professional engagement. They formulate quality control policies and implement them for all of their professional engagements. These policies cover the leadership responsibilities of the accounting firm, relevant ethical requirements, acceptance and continuance of client relationships and audit engagements, assignment of engagement teams, engagement performance, and monitoring and documentation of the system of quality control. Appropriate compliance with quality control policies by all members of an accounting firm ensures the quality of their engagement. Audit and assurance, being one of the important professional engagements of a firm, also come under their quality control framework.¹¹ Other professional standards and applicable regulations also take a pioneering role in controlling the quality of statutory audit of financial statements.

In India, professionally qualified chartered accountants (CAs) are supposed to play the role of independent statutory financial auditors. Professional pronouncements, like company law, auditing and quality control standards, and code of conduct, issued by the Central Government and professional bodies like the Institute of Chartered Accountants of India (ICAI) are issued to guide them in maintaining good faith, integrity, independence and transparency. Standard on Quality Control-1 (SQC-1), issued by the ICAI, monitors the quality control policies of a firm and Standard on Auditing (SA)-220 influences the quality control policies at an engagement level. Any underperformance of these functions, or noncompliance with any binding rules, is taken into consideration as a serious matter.

1.2. Research Problem

Companies desiring to demonstrate exaggerated accounting profits and a strong balance sheet using complex accounting methods often find themselves in serious trouble when Government oversight agencies (e.g. the Securities Exchange Board of India (SEBI) in India and the Securities and Exchange Commission (SEC) in the United States of America (USA)) launch an enquiry into their financial books. In many cases, a massive accounting fraud perpetrated using a systematic accounting technique for quite a long period of time has been unearthed. Financial fraud has grown to be an widely known issue in the public arena all over the world since the outrageous exposure of the financial scam of Enron and a series of other companies, including WorldCom, Satyam, etc.

Until a financial fraud is detected, the management of the corporate enterprise continues publishing falsified financial reports year after year. This has the consequence of giving an ambiguous impression of their financial status. It is difficult for stakeholders to understand the possible red flags in the company’s financial statement. Naturally, when the scandal is exposed, stakeholders do not have enough time to move out of such a company, which can bring them serious financial hardship. Shareholders and other investors lose their invested corpus and suppliers and creditors with considerable dependence on the company face serious adversities when the company goes insolvent. Employees find themselves unemployed. Financial manoeuvring also deceives Government from the correct tax revenues. If the company is multinational, the impact of its demise may be far-reaching and the Government will lose possible foreign reserves. Foreign investors may be reluctant to invest in that country in the future; and other companies from the same country may face difficulties in accessing the international capital market.¹² A corporate fraud brings a negative impact on the national economy. A series of corporate failures all over the world have shaken the foundations of investor confidence in the transparency, honesty and accountability of corporations and financial markets.

However, inadequacies in the quality control environment for statutory audit of financial statements may go a long way towards publication of falsified financial reports over a number of years, which ultimately brings about a massive accounting fraud which can impact the national economy and society as a whole. Hence, quality control of statutory audit of financial statements in the backdrop of recent corporate accounting scandals and their irreversible impact on stakeholders of the respective businesses is a major problem area of the current research study.

1.3. Research Questions

Keeping in mind the research problem of the study, the following appropriate research questions came about to conduct a thorough research into quality control for statutory audit of financial statements:

• (i) Is the regulatory framework in India governing quality control for statutory audit of financial statements adequate in comparison to other developed countries?
• (ii) What is the opinion of CAs and students on quality control for statutory audit of financial statements?
• (iii) How far does the opinion of CAs and students converge on the theme?
• (iv) Have professional audit practices had any influence on the opinions of people on quality control for statutory audit of financial statements?
• (v) What are the important issues governing quality control for statutory financial audit?
• (vi) How do the issues relating to quality control for statutory audit of financial statements relate to overall audit quality?

1.4. Review of Literature

Researchers from India and abroad have contributed their thoughtful research on the related fields of quality control procedures for statutory audit of financial statements in the forms of books, research papers, research projects, etc. In order to address those research questions, a survey of literature related to audit quality has been thoroughly conducted:

• (1) Akpom and Dimpkah¹³ (2013) in their research paper empirically analysed the perceptions of auditors and nonauditor executives on the provision of nonaudit services, audit regulations, audit firm size, and audit market capitalisation in a Nigerian context. The result showed that both groups agreed on the general factors that enhance statutory auditors’ independence. However, the degree of agreement differed.
• (2) Bakshi¹⁴ (2000) discussed the basis of professional ethics in the accounting profession. Measures to improve ethics in auditors were also enumerated. Morality, personal judgement and value orientation were the basis of the formation of this code. Ethical codes should be kept up-to-date.
• (3) Bazerman and Lowenstein¹⁵ (1999) in their research paper critically reviewed the reasons behind auditors’ bias towards management while auditing financial statements. They observed that auditors always tried to reach a favourable conclusion about the financial statements based on the evidence readily available to them.
• (4) Becker, Defond, Jiambalvo, and Subramanyam¹⁶ (1998) examined the relationships between audit quality and earnings management. Audit carried out by the Big Six firms was considered to be of high-quality and audit done by non-Big Six firms was considered as lower quality. Earnings management is captured by discretionary accruals to audit clients. A sample of 10,379 audits by the Big Six auditors and 2,179 audits by non-Big Six auditors were selected and empirically analysed. Lower audit quality is associated with the highest earnings management.
• (5) Bhaskar¹⁷ (2009) in his research paper discussed the implications of the Public Company Accounting Oversight Board (PCAOB) in an Indian scenario with special reference to the importance and limitations of Clause 49 of the Listing Agreement. According to him, an organi...

Table of contents

• Cover
• Title Page
• Chapter 1 Introduction
• Chapter 2 Quality of Statutory Audit of Financial Statements: A Conceptual Discussion
• Chapter 3 Quality Control Framework for Statutory Audit of Financial Statements in Select Countries: A Conceptual Review
• Chapter 4 Quality Control Framework for Statutory Audit in Select Countries: A Comparative Study
• Chapter 5 Respondents’ Perceptions on Quality Control Procedure for Statutory Financial Audit: An Empirical Study
• Chapter 6 Concluding Observations and Suggestions
• Appendices
• Bibliography
• About the Authors
• Index