Conflicts of Interest in Auditing and Consulting

Conflicts of Interest in Auditing and ConsultingConflicts of liaison how can the provision of consulting and consultative run be consistent with the requirements of attendant independence?One of the key issues identified as a ready of the Enron turd is that the participation managed to offer up misleading financial information to investors and analysts everywhere a period of several years, indicating rough $100 billion of one-year revenues. However, once the accurate numbers emerged showing the state of the comp eithers balance sheet, lenders withdrew their funding the SEC increased the press on the comp either and the comp whatever went bankrupt in less than two months. Sloan et al (2002) implore that the only authority to repeal such incidents happening is to discourage companies from producing venal numbers, whilst making attendees afraid of certifying anything which could be seen as misleading. In general, the principle of size upor independence should mean that canvassors be vigorous and unrelenting in their substantiation of be data.However, in the case of Enron, the attendees Arthur Andersen, were write off pro engraft amounts of history data from their own consulting arm, who were providing Enron with consulting and informative work. As such, in that respect was apparent corporal render that Arthur Andersens auditors ignored several material accounting violations caused by twain Enron and Arthur Andersens consultants. Unfortunately, it is difficult to prove this evidence given that entirely documents related to Enron were shredded by the auditors as soon as the scandal came to light, making it difficult to be certain around the extent of the complicity or the conflicts caused by Arthur Andersen providing Enron with substantial amounts of consulting service, at the same time as signing off company accounts which were later found to be almost on the whole inaccurate (Sloan et al, 2002).As a result of this, the legislat ion governing in public listed companies in the United States was rapidly tightened through the Sarbanes-Oxley, or SOX, Act which was intend to boost investor confidence. This legislation was based on the argument that a stock-taking grocery is formed from a collection of parcel issuing smasheds undivided and institutional investors and a body of accountants, lawyers and analysts. As such, the SOX Act was intended to match that each of these groups regained their own confidence in the system, and besides confidence in each other(a). As such, the Act focused on promoting transparency and intelligible data from the viewpoint of the final users of accounting data, rather that the provider (Kalafut, 2003).The chief(prenominal) method by which SOX attempts to background and avoid conflicts of interest within the firm is by requiring corporations to establish somatic auditing delegacys which are responsible for dealing with the auditors. This is because, previously, if audito rs had any queries around the content of the financial statements, they had to seek out the focus force-out responsible for generating the data. This meant that the managers could potentially shape the auditors interpretation of the information, especially if the auditing company were in any case providing consulting or informative services as occurred at Enron. In such an instance, the consultive staff may well themselves give exerted influence over their own auditors to ensure that the information was treated in a way that is favourable to the consultants, and not in a way that provided a sure representation of the actual situation and data.The audit committee is supposed to avoid this by ensuring that the auditors only communicate with the committee members, who are all independent from the management of the firm, and hence can look at any advisory services provided by the auditor with an independent and hypercritical eye (Lansing and Grgunch, 2004). As a result, the act excessively recommends that one of the audit committee members should be a financial expert with a dependable k flatledge of accounting principles and financial statements from a firm or firms in similar industries. This allows the committee to accurately discern the true nature of any financial instruments, such as the off balance sheet pay and other special purpose entities used by Enron to cover up its financial difficulties. This pass on also be vital if an auditing firm is providing important non auditing services, as they may well use their auditing experience to advise their leaf node on how best to structure their production line to present it more than favorably from an accounting point of view. Financial experts on the audit committee provide have similar experience, and hence will be able to assistance the auditors make a fair assessment of the true nature of any creative accounting.The other main part of the SOX Act which is designed to minimise any conflicts amidst the provision of consulting services and advisory services is that the penalties for beingness caught have been increased dramatically. In particular, the Act has increased the penalties which any CEOs and CFOs found guilty of violating any provisions of the Act would face. As part of this, CEOs and CFOs now have to sign off on the audited accounts and other statements that their companies file with the SEC, and will thus be held responsible if they certify statements which contain any misguided or misleading information. CEOs and CFOs who do so could face fines of up to $5,000,000 and potentially imprisonment for up to 20 years. As such, this places a significant righteousness on CEOs and CFOs, who are typically the board members responsible for appointing auditors and any advisory services, to ensure that there is no conflict of interest between the auditing and advisory services provided.With all this regulation, one would expect that the disadvantages of auditors provi ding their audit clients with other services would be so great that many companies would not even rate it. However, it is important to note that there are some benefits which can be obtained within the current legal and regulative framework. For one, Marks (2007) argues that auditors in information knowledge of their clients and comparable firms accounts can allow them to advise firms on their organisation processes, efficiency and other aspects of their financial performance and how to improve them. In addition, audit firms will be better able to advise firms how to legally avoid as much revenueation as possible, whilst avoiding anything which could be considered tax evasion. This is especially important in the modern business world, where the removal of exchange controls and art barriers makes tax avoidance more possible than ever before, but also provides significant potential for companies to fall foul of one or more of the tax regimes in which they operate (Sikka and Ham pton, 2005). This helps to explain why many auditing firms also have large tax practices, as well as advisory services.In contrast, the only real disadvantage of a company providing both audit and other services is the potential for restrictive violations and conflicts of interest. Of these, the potential regulatory violations were immediately seized on by the US Congress following the Enron scandal, as it emerged that Enron paid Arthur Andersen $25 million in auditing fees, but a just $23 million in fees for other consulting work. However, it was the potential for conflicts of interest which emerged as the strongest disadvantage, with many corporate boards worrying that continuing to buy consulting services and auditing services from the same firms would damage investor confidence, and lead to a drop in share prices (Kahn, 2002).As a result, of the Big Four accounting firms currently in the market Deloitte, Ernst and Young, PWC and KPMG PWC stopped providing consulting services t o audit clients Ernst and Young sold it consulting business and KPMG and Deloitte both divested of their consulting businesses throughout 2001 and 2002 (Kahn, 2002). This meant that none of the Big Four auditors, which together audited around 90% of the major companies in the US and UK, provided any substantial consulting services following the Enron scandal, although they did continue to provide tax and some transactions advisory services. However, by 2003 Deloitte had reversed its decision, and brought the consulting business back into the overall business, which then comprised auditing, tax accounting, corporate finance and consulting. This decision was taken in spite of assiduity concern around conflicts of interest and the provisions of the SOX Act, in the belief that Deloitte could provide its clients with the advantages of integrated professional and accounting services, whilst avoiding any of the potential regulatory concerns (Bryan-Low, 2003).Indeed, five-spot years after the Enron scandal, Accountancy (2006) reported that the majority of accountancy firms, particularly the Big Four firms, have begun offering a wider range of services, and that the boundaries between these services are blurred, with inconsistent levels of disclosure. For example, PWC details specific revenues for audit, accounting and tax however it also includes advisory services in its revenues as an umbrella term for consultancy, corporate finance, and corporate recovery services. Also, whilst KPMG details separate categories including corporate finance, forensic accounting, transaction services and risk advisory services, the risk advisory services are effectively the same as the consulting work offered by other accounting firms (Accountancy, 2006). This indicates that, even if the regulatory conflicts can be completely resolved, it will be difficult for share brookers to assess the true nature of their auditors revenues, and hence the potential for any damaging conflicts of in terest.Unfortunately, future locomote to address any issues as a result of this are likely to be hampered by the fact that SOX is already proving a significant regulatory burden to publicly listed companies in the United States. In addition, Fisher and fast(a) (2004) claim that the true problem is not the conflict between auditing and other services, but the fact that the Big Four accounting firms are so dominant, auditing all of the FTSE 100 companies in the UK. With there being no true competition to the Big Four amongst their main clients, the market has come to resemble and oligopoly, and with many senior accountants at clients coming from the Big Four firms, there is a danger that former accountants working in senior management may simply favour their alumni firms when choosing auditors. Whilst this should be mitigated by the charge of the audit committee, minimising the impact of this old boys network amongst the major accounting firms would go a long way towards reducing a ny potential conflicts of interest, and change magnitude the scrutiny given to the provision of additional services, particularly amongst the Big Four.In conclusion, and as the Enron scandal demonstrated, whenever an auditor of a publicly listed company also obtains significant revenues from providing their client with additional services, there is always the potential for a conflict of interest. In Enrons case, this led to Arthur Andersen covering up significant losses which ultimately caused Enron to go bankrupt. The SOX Act should help to reduce this, by enforcing the use of an audit committee to prevent such conflicts, and increasing the pressure on executives to ensure that accounting data is fair. However, most of the major accounting firms continue to provide these services, hence the potential for conflict of interest remains. peradventure the only way to avoid this would be to attempt to break up the dominance of the Big Four, and create a more competitive market where th e top firms have a wider choice of auditors, and hence can hold these auditors to higher standards of quality and transparency.ReferencesAccountancy (2006) Blurred boundaries. Accountancy Vol. 137, recognise 1355, p. 35.Bryan-Low, C. (2003) Deloitte headsman Wrestles to Get Consultants Back in Firm. Wall Street Journal eastern Edition Vol. 242, resultant role 33, p. C1-C7.Fisher, L. and Quick, C. (2004) The Big Four old boys club. Accountancy Vol. 133, Issue 1327, p. 29.Kahn, J. (2002) Deloitte restates its case. Fortune Vol. 145, Issue 9, p. 64-69.Kalafut, P. C. (2003) Communicate Value to Boost Investor Confidence. Financial administrator Vol. 19, Issue 5, p. 28-29.Lansing, P. and Grgunch, C. (2004) The Sarbanes-Oxley Act New Securities Disclosure Requirements in the United States. outside(a) Journal of Management Vol. 21, Issue 3, p. 292-299.Marks, N. (2007) Internal Audits of Governance. Internal Auditor Vol. 64, Issue 6, p. 31-32.Sikka, P. and Hampton, M. P. (2005) The r ole of accountancy firms in tax avoidance Some evidence and issues. Accounting Forum Vol. 29, Issue 3, p. 325-343.Sloan, A. Isikoff, M. Hosenball, M. and Thomas, R. (2002) The Enron Effect. Newsweek Vol. 139, Issue 4, p. 34.