This assignment is to be completed in groups of three and comprises twenty percent of the marks for this unit
PART A (7.5 marks) (1000 words)
The Sarbanes Oxley Act sought to enhance auditor independence, objectivity and professional scepticism.
The second title of the Sarbanes-Oxley Act establishes the conditions and regulations governing auditor independence, that is, the extent of services and activities an auditor may perform while remaining independent from the interests of their clients.
The second title specifically reviews nine prohibited activities off limits to public accounting firms when they are performing auditing services. These services include:
• bookkeeping or services related to financial statements
• financial information systems design
• appraisal or valuation services
• actuarial services
• internal audit outsourcing services
• management functions
• broker, dealer, or investment banking services
• legal or expert services
• any other service the Board determines impermissible
These nine prohibited services are established to prevent conflicts of interests so that that an accounting firm will never be in a position to audit its own work.
Prohibiting an auditor from any management functions of the client separates the interests of the client and the auditor, and preventing the auditor from providing other financial services to the firm prevents the auditors from being in a situation where altering or falsifying financial data could materially benefit the accounting. Taking into consideration the corporate scandals of the early 2000s, establishing this list of prohibited activities was a necessary step to reduce the risk of further corporate accounting fraud.
This title also mandates that all auditing and non-auditing services (excluding the nine listed as prohibited activities) must be pre-approved by an Audit Committee of the client. Included in this section is a de minimus exception which waives this pre-approval requirement provided that the total amount of non-audit services do not exceed more than five percent of the revenues paid to the auditor by the client. All such services, however, are required to be disclosed to all investors of the client.
The last major section of title two mandates that a public accounting firm may not provide audit services for a client for more than five years in a row. This provision is yet an addition safeguards against collaboration between auditors and their clients to augment or alter financial disclosures.
Title II of the Sarbanes-Oxley Act outlines the importance of the independence of auditors from the interests of their clients, a necessary condition for honest and open accounting practices
The Big Four Auditing Firms
Firm Revenues Employees Fiscal Year Headquarters
$31.5bn 180,000 2012 United Kingdom
$22.7bn 145,000 2011 Netherlands
Ernst & Young
$24.4bn 167,000 2012 United Kingdom
$31.3bn 193,000 2012 United States
This man believes that the quality of audits will not be improved by the mandatory rotation of audit firms.
Is he right or wrong? Discuss
PART B (7.5 marks) (1000 words)
Are auditors being held to a higher standard than other professionals with regard to Professional Judgement?
Consider for instance the following example
CAPARO INDUSTRIES PTY LTD V. DICKMAN (1990)
The judges held that a duty of care was owed to only third parties who were existing shareholders that the auditors knew would receive and rely on their report. This reversed the findings in the three previous cases which all held that a duty of care was owed to those relying on the accounts regardless of whether they were already shareholders.
Facts of the Case:
Caparo Industries relied on the audited accounts of Fidelity PLC in making a successful takeover bid for that company. The audited accounts for Fidelity showed a profit for the year ended 31 March 1984 of £1.2 million. After taking Fidelity over, Caparo discovered that the result should have been a loss of over $400,000 and alleged that the auditors had been negligent in auditing the accounts.
The trial was whether the auditors owed a duty of care to the plaintiff.
Their Lordships reached their verdict by identifying the statutory purpose for the audit:
The structure of the corporate trading entity, at least in the case of public companies whose shares are dealt with on an authorised stock exchange, involves the concept of more or less widely distributed holding of shares rendering the personal involvement of each individual shareholder in the day-to-day management of the enterprise impracticable, with the result that management is necessarily separated from ownership.
The management is confided to a board of directors which operates in a fiduciary capacity and is answerable to and removable by the shareholders who can act, if they act at all, only collectively and only through the medium of a general meeting, hence the legislative provisions requiring the board annually to give an account of its stewardship to a general meeting of the shareholders. This is the only occasion in each year on which the general body of shareholders is given the opportunity to consider, to criticise and to comment on the conduct of the board of the company’s affairs, to vote on the directors recommendation as to dividends, to approve or disapprove the directors’ remuneration and, if thought desirable, to remove and replace any or all of the directors.
It is the auditors’ function to ensure, so far as possible, that all the financial information as to the company’s affairs prepared by the directors accurately reflects the company’s position in order, first to protect the company itself from the consequences of undetected errors or, possibly wrongdoing (by, for instance, declaring dividends out of capital) and, second, to provide shareholders with reliable intelligence for the purpose of enabling them to scrutinise the conduct of the company’s affairs and to exercise their collective powers to reward or control or remove those to whom that conduct has been confided.
On this basis it was argued that it would he unreasonable:
To widen the area of responsibility ... and to find a relationship of proximity between the advisor and third parties to whose attention the advice may come in circumstances in which the reliance said to have given rise to the loss is strictly unrelated either to the intended recipient or to the purpose for which the advice was required.
The House of Lords argued that the purpose of the financial statement on which auditors express an opinion is to assist the shareholders in their collective function of scrutinising the company’s affairs. It would be unreasonable, therefore, to hold the auditors responsible for their use, by shareholders or others, for any other purpose.
Reaction to the Caparo case verdict
Reaction to the House of Lords verdict in the Caparo case has generally been unfavourable:
The general view of the legal profession is that the verdict appears to treat auditors more favourably than it treats other experts on whom third parties` place reliance. There is a concern that it appears to reverse what is seen as a socially desirable development in law of holding experts liable for the consequences of negligent advice.
The value of auditors` services are seen therefore, to be diminished.
The caparo case was followed by a majority verdict of the Victorian Supreme Court in the Lowe Lippmann Figdor & Franck case.
A good starting point would be
Professional Judgment - Institute of Chartered Accountants in Australia
PART C (5 marks)
Prepare a five minute presentation based on one of the following:
ACCA F8 Lecture 1 - Recap of Assurance Engagements
ACCA F8 Lecture 2 - Recap of Regulation
ACCA F8 Lecture 3 - Recap of Governance
ACCA F8 Lecture 4 - Recap of The Work of Internal Audit
ACCA F8 Lecture 5 - Recap of Ethics