British Petroleum (BP) is one of the world’s leading integrated oil and gas companies, and it is the third largest energy company and the fourth largest company in the world. It provides customers with energy for heat and light, fuel for transportation, lubricants to support the performance of engines and petrochemicals products to diversify daily use items. BP was founded in 1908 by William Knox D’Arcy to exploit oil discoveries in Iran. Nowadays key persons are Carl-Henric Svanberg (Chairman) and Bob Dudley (CEO).
The BP Foundation, Inc., established in 1952, is a private non-operating foundation and an independent charitable organization – separate from, but funded entirety by, BP – that exists for the public benefit. It supports philanthropic activities around the world, helps communities by supporting STEM (Science, Technology, Engineering, and Mathematics) education programs across America, economic development, and by drawing attention to environmental issues.
First of all, BP Foundation is widely known for contribution to the development of STEM educations. It has supported several initiatives in Illinois by donating $5 million to the Museum of Science and Industry; $400,000 to the University of Chicago Collegiate Scholars Math
Literature Review on Audits and Auditing
2.1 Introduction This chapter reviewed the detail literature on important keys in this research such as the audit, audit firm tenure, audit firm size, fraudulent financial reporting and relevant past research findings on (i) the relationship between audit-firm tenure and fraudulent financial reporting and (ii) the relationship between audit-firm size and fraudulent financial reporting.
2.2 Audit Definition of audit is different among many scholars. Audit function is defined by Nagny et al. (2002) to the function that an independent, objective assurance and also consulting activity that designed to add value and improve an organization’s operations. In the other study, Kathleen M. Jackson (2010) has further explained that an auditor can perform the two types of audits namely limited-scope or full-scope. It was proven in past studies that some clients opt to choose in receiving a limited scope audit in order to reduce audit costs. In fact, the impact of limited scope exemptions is decreased in audit procedures and as a result it can lead to lower in audit fees. In addition, a long list of audit procedure for investments is needed in the full-scope audit.
2.2.1 Quality of Audit firm
The audit services as proposed by Watts (1977) is required as the monitoring methods due to the conflicts that may arise between managers and owners, and also for them who come from different classes of security holders. In addition, in past studies conducted, it was showed that audited statements’ provision is the least cost contractual response to intra-owner and owner- manager’s conflict of interest, as an example agency costs. The agency costs is different from different firms and also for over time to some clients. Besides, a heterogeneous demand required by clients for the audit services is resulted from different agency cost for some firms such as when the levels of auditing that requested is not as usual. Moreover, Watts (1977) also argued that the audit services’ quality is mentioned as the market-assessed joint probability where the auditor is able to find out a breach in the client’s accounting system and report the breach. On the other side, the specified audits may enhance the financial information’s credibility as the result of the independent verification of management-provided financing reports, thus may minimize the investor’s information risk as proposed in the study conducted by Watts and Zimmerman (1986); Mansi et al.(2004), Dye (1993) and Johnson et al. (2002).
On the other side, many past studies has proven that bad financial reporting’s quality resulted from short audit-firm tenure as indicated in the study by Johnson et al., (2002); Myers et al., (2003) and Ghosh and Moon, (2005). The above mentioned past studies conducted revealed that low level of knowledge in the early years of an audit and also on the mandatory auditor rotation between audit firms has lead to low quality of earnings owned by a short audit-firm tenure. Based on the result from the past studies, it was known about the mandatory auditors rotations’ potential weaknesses of audit firms. But, it also revealed that if the rotation requirement is targeted at auditors within an audit firm, the loss of learning will not happen.
Besides that, based on the past studies conducted by Mautz and Sharaf (1961); Shockley (1981) and Lyer and Rama (2004), there are a lot of arguments on the issue of client and auditor’s relationship’s duration might affect the audit quality. One of the studied has proven that audit quality is affected as auditor tenor increases, while on the other study, auditor tenure increase in line with audit quality.
2.2.2 Issues in mandatory audit firm
In order to improve the quality in financial reporting, it shown that mandatory audit firm rotation is a solution. Carey (2006) has been argued that in order to improve audit quality, there is a need of policy in the mandatory rotation of audit for particular clients besides able to increase of quality for financial purpose in financial statements. Among countries that practised the policy of mandatory rotation includes: Austria, Australia, Brazil, Greece, India, Italy, Israel, Singapore, South Korea, Taiwan and the USA as mentioned in the past researched conducted by Cameran et al., (2005); Catanach and Walker (1999); Kim et al., (2004); Chi and Huang, (2005); Chi et al., (2005) and Carey and Simnett (2006).
Audit partner rotation such as audit firm rotation can lead to decrease in audit quality as based on the past study, audit partner’s knowledge of a client’s business increases with his/her tenure on the audit. However, it was revealed that there are a few differences between audit partner and firm rotation which have impact on the tenure on audit quality. Chi et al (2005) has mentioned that audit quality is improved by the audit partner rotation during the first year of the relationship while on the other parts, audit firm rotation lead to decreases audit quality.
Meanwhile, the audit firm rotation is occurs around the world, and even in Malaysia where the issue of audit firms or partners was not specified in detail of Malaysiaan official documents, for example in Companies Act 1965, the Security Commission regulations, approved auditing standards, and so on. It was found that rejection of such rotation idea by the business community is because of lack in official pronouncements on this issue. Even in findings of one study conducted by Jaffar and Alias (2002) showed that only 35 per cent of the audit firms’ partners and only 32.4 per cent of the chief finance officers surveyed favored audit firm rotation every three years of engagement. Meanwhile, the Edge (2002) has revelaed that in light of the Enron case, the Chairman of the Malaysian Accounting Standard Board announced the intention of the board to make it mandatory to rotate the audit firm once every five years.
2.3 Audit firm tenure In the definition of audit firm tenure, Johnson et al. (2002) has clarified that the audit firm tenure is the number of consecutive years that the audit firm has audited the client (computed by counting backward from the year the fraud began). The definition of short auditor tenure is explained by Carcello et al. (2004) by the meaning of three years or less and long auditor tenure as nine years or more. Based on the previous studies conducted by other academician, the other researches on this term revealed that imposing mandatory limits on auditor tenure is expected to improve audit quality by reducing client firms’ influence over auditors as proposed by Turner (2002); Brody and Moscove (1998); SEC 1994; AICPA 1978; U.S. Senate (1977) and Mautz and Sharaf (1961).
2.3.1 Short audit- firm tenure
From the previous study conducted by Aminada and Paz-Ares (1997), the scholars has suggested that in order to replace client-specific assets, it will involves a technological limit, if not most, of them cannot be replaced immediately. Due to this, the financial-reporting quality is projected to increase as client-specific knowledge also increases in the early years of an audit engagement. Meanwhile, a client-specific asset (such as knowledge) that in line with transactions costs may allow the incumbent auditor to earn quasi rents from maintaining existing client relationships as specified by DeAngelo (1981). It was further suggested that if the existence of quasi rents skews the auditor’s incentives toward maintaining the client relationship, financial-reporting quality could be reduced in early engagement years.
2.3.2 Long audit- firm tenure
As proposed by Shockley (1981), it was mentioned that the impact of the long relationship audit firm is by having a “learned confidence” in the client besides the scholars also suggests that the above mentioned learned confidence may result in the audit firm using less strenuous and less innovative audit procedures. Another author, Knapp (1991) in his past study on audit firm tenure has further defined that different audit tenure in an experimental setting besides able to gather that experienced audit committee members perceived that auditors with 5-year tenure were more likely to detect errors than auditors in the first year of an engagement or auditors with audit tenure of 20 years. On a part of it, Geiger and Raghunandan (2002) found that short-tenure auditors to issue going-concern opinions for clients that subsequently declared bankruptcy as compared with long-tenure auditors that is still on the preference in this study.
2.4 Audit firm size In term of the audit firm size, it was revealed that smaller audit firms have justified proposed wealth transfers from clients and from larger audit firms, where in general the audit quality is independent of auditor size as supported by Deangelo (1981) in his study. Moreover, in some of the audit quality term, where it was found in the study done by previous researchers, the term of quasi-rents, it might serve as collateral against such opportunistic behavior in the subject to loss from discovery of a lower-than promised audit quality. This finding can be proven on the theory of ceteris paribus, where the less incentive the auditor has to behave opportunistically and the higher the perceived quality of the audit when the larger the auditor as measured by the number of current clients and the smaller the client as a fraction of the auditor’s total quasi-rents is exist.
The famous author on the theory and study done, namely DeAngelo (1981) also argues no single client is important to larger accounting firms as accounting firm size is a proxy for auditor quality, and beside, larger accounting firms are less likely than smaller accounting firms to compromise their independence. In fact, theory supported by the research taken by Dopuch and Simunic (1980) who further proposed that larger accounting firms provide higher quality services because they have greater reputations to protect. It finally defined that quality is not independent of auditor firm size when incumbent auditors earn client specific quasi-rents. Moreover, audit fees do not meant to be adjusted in full term to the incumbent auditors, with the view to the extent that the bilateral monopoly between client and incumbent auditor implies a sharing of these costs mentioned, whereby in the above mentioned case, a successful prevention of discrimination which refer to the competition from large audit firms that definitely represents a windfall gain to smaller auditors at client expense. Therefore, it can serves as an excuse to justification of the wealth transfer results from a wealth transfer from clients to smaller audit firms which under this scenario of voluntary contracts might become unfair and discriminate smaller firms.