Case Study On Evolution Of Auditing In The U S
Auditing as a discipline is dynamic. Largely the evolution witnessed in auditing practices is as a result of significant changes in financial reporting (Gramling, Rittenberg and Johnstone 57). These are changes in reporting standards, increased use of fair values and growth in narrative reporting. Audit profession is facing further challenges in the form of advances in information technology and increase in real-time approaches to conducting business.
Evolution of auditing
Albeit informal auditing practices had been in use for a long time, adoption of formal auditing methods began with industrial revolution and the explosion of the business community that ensued. Traditionally, audits were mainly associated with gaining information about the financial system and financial records of a business. However, this trend has changed in the recent past and audits have begun to cover other areas such as information regarding environmental performance. In the United States, for example, the need to control and report costs, production and operating ratios during the construction of the railroads were a great influence in the development of auditing and accounting profession at large (Gramling, Rittenberg and Johnstone 76).
Similarly, during the same period there was the need for fraud detection and financial accountability. Investors were increasingly reliant on financial reports as companies began to trade in the stock market. However the crash that the stock market experienced in the year 1929 was the main reason that auditing became mandatory in the United States. Audit practices during this period were purely reliant on information from management.
Rules followed by the early auditing practitioners
The crash was followed by legislation, in particular, the Securities and Exchange Act of 1934 which created the Securities and Exchange Commission (SEC). This Act gave the Securities and Exchange Commission the audit oversight function and to enforce periodic submission of reports by publicly traded companies. SEC had an initial responsibility of promulgating accounting standards. The periodic reports were authenticated by public accounting firms so as to ensure they are in line with Generally Accepted Accounting Principles (GAAP).
Financial losses attributable to fraud
Most organizations suffer huge losses due to financial fraud, otherwise known as misappropriation of funds. The most common fraudulent practices include the following: false expense claims; embezzlement where accounts have been manipulated and false invoices are created; and payroll fraud, creation of ghost workers (Gramling, Rittenberg and Johnstone 78).
In 1973, for example, managers of Equity Funding Corporation created false insurance policies and commission income and used many mechanisms to hide the same. This was in an attempt to inflate profits and stock prices. Cendant which is a travel and residential real estate services company had its income inflated by $500 million. Ahold, a retailer in grocery and food service food service provider overstated its earnings by about $500 million in 2000 and 2001.
Value of auditing for financial markets
Audits are necessary because of the following: conflict of interest between the user and preparer of the information; possible nature of decisions to be made based on the information; and complexity in the preparation and verification of the information.
Auditing is necessary so as to ensure efficiency within the market. The market is exposed to risks associated with information problems (Gramling, Rittenberg and Johnstone 87). Biases of the provider, remoteness of the information, big volumes of data involved and the complexity of the transactions all indicate sources of risk in the market.
Information is necessary in order for an investor to make informed decisions. Auditing and assurance services serve to help clear doubts by the investors. It therefore improves confidence and bolsters trust in financial information.
Ramifications of absence of auditing procedures
In case of absence of auditing a firm would experience a lot of problems. These include: difficulty in solving of conflicts between management and shareholders; disputes during major changes in ownership of the business and during mergers which require audited financial statements; obtaining funding from lenders would be hard without audited statements; it would be hard for investors and shareholders to make informed judgment regarding the business; absence of audited statements would allow for fraud to thrive thereby leading to financial losses; it would make it hard for tax authorities to establish the extent to which an organization is liable; it would be hard for the firm to claim insurance compensation in case of damages; and audited statements are necessary in case of purchase and the value of the business is to be established.
What gives value to an auditor
Most users of financial statements, both external and internal, may not have adequate accounting knowledge. An audit therefore gives an assurance to these users that the financial statements of the company are a ‘fair’ representation of the organization’s financial position and the result of its operations.
The main principle that gives an auditor or an auditing firm its respect is its compliance with the code of ethics. International Federation of accountants has issued a code of ethics for professional accountants. These ethical principles include: independence; integrity; objectivity; professional competence and due care; confidentiality and professional behavior. Independence may be affected if the auditor has an interest in the financial statements on which they are reporting (Gramling, Rittenberg and Johnstone 187). A good audit report must be prepared by a competent, independent and objective person or persons who must adhere to the generally accepted standards governing the auditor and the entire audit process.
Gramling, Audrey A, Larry E Rittenberg, and Karla M Johnstone. Auditing. Mason, Ohio: South-Western/Cengage Learning, 2012. Print.