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Impacts of Commercial Pressures on Audit Performance

Given the commercial pressures are Auditors doing a good job? Introduction
For two decades the debate has raged regarding whether auditors are performing their tasks adequately, within the bounds of the commercial pressures they are under. In preparing this paper, we have studied current research and comment surrounding this issue. Our opinion is that, although there are areas of serious concern and issues that need to be addressed, generally the auditing profession is doing a good job.
“The debacle of Enron has shaken core assumptions about auditors and auditing.” (Kay and Carsberg 2002). Following the collapse of Enron, and its auditor’s Andersen, the role, competency, quality and standards of auditors came under increasing scrutiny, resulting in a raft of headlines such as the one quoted.
The call from Kay and Carsberg, and others, for national and international standard committees to be set up, was quickly responded to. The US Sarbanes-Oxley Act (2002) and UK Combined Code of Corporate Governance (2003), both of which imposed stringent conditions onto the audit process, were swiftly introduced. As a result, the profession, through the IFA[1] (2006) responded with a complete overhaul of standards.
All these regulations and standards have been subject to constant revision since their inception. However, concerns still exist regarding auditor performance as recent attempts by the UK government to criminalize certain audit failures shows (Parliamentary Correspondent 2006). In the same article audit firms responded, stating such a move would be “both costly and ineffective”[2] and that the “proposed offence will inevitably lead to defensive auditing, which is not in the interests of the profession or clients.”[3] .
The auditing process, particularly in respect of Plc’s[4] is a complex procedure. There is a significant amount of preparatory work to be undertaken prior to the audit itself, including an understanding of the client’s business, evaluation of the risk, and the costing and construction of the audit itself (Dassen et. al. 2004, ch.6). This will determine the depth, breath, and percentage of testing required, fulfilling their tasks and complying with the requirements of all the applicable regulations and codes. This process also includes reaching an agreement on the fees to be charged. The audit task is even more complex when the organisation involved is a multi-national or transnational corporation. In addition, auditing firms have to ensure that they, and all of the persons involved in the audit, when preparing the audit, need to take into account all modifications and improvements to IFA standards, Company Law and the Combined Codes (Grey and Manson 2004).
To monitor audits standards the government set up the Audit Inspection Unit (2006). The task of this unit is to ensure audits have complied with all current regulations (see page 6 of the report). Their latest report covered the “big four” firms and, for first time, the next five largest auditing firms. Seventy-seven audits were reviewed, over a number of sizes and industry sectors (see Appendix 1). Although, in general terms, the report responded positively, concluding that auditing firms are maintaining a reasonably high standard, there were some concerns. They found that progress on previous recommendations had been slower than expected, although there were mitigating circumstances (see section 4.1.1, p.11). In addition there was some concern expressed regarding the audit documentation (section 4.4.7, p.21). However, in other areas, such as leadership and human resources (section 4.2), improvements had been seen. In their final analysis, only in three areas did the Unit make further recommendations.
Addressing the position from the government viewpoint, a report was commissioned by the FRC[5] (Oxera Consultancy Group 2006). This report concentrated on the availability of auditor choice to corporations, and the competitive aspect of the profession in general. Whilst agreeing with the Audit Reporting Unit’s conclusion that generally the audit profession was performing their tasks well, this report expressed concerns in other areas. These focused on the dominance of the major audit firms within Plc and international fields. The fear is this leads to lack of choice and has produced increases in fees that exceed inflation by a significant amount, as much as 11%. There was also recognition that, from a logistical and cost point of view, it was virtually impossible for other auditing firms to compete for this market.
One of the resultant fears that most corporate management expressed, was the problem that would be caused if there was a consolidation from four to three firms, and the impact this would have on other accounting and financial services, as well as the audit choice.
Conclusion Having studied all of the research, we would concur with the conclusion that in view of the commercial concerns, audit firms are generally performing a good job. However, in our opinion, there is a need to address the competitive issues surround audit firms in the cases of quoted company audits. We would recommend that the laws of competition should be applied to the audit industry to ensure the numbers of firms do not reduce still further, and that ways should be considered to enable other firms to compete successfully in this market.
References Audit Inspection Unit (2006) 2005/6 Audit Quality Inspections. Financial Reporting Council. London. UK
Dassen, R., Schilder, A., Wallage, P. and Hayes, R. (2004) Principles of Auditing: An Introduction to International Standards on Auditing. FT Prentice Hall.
Gray, Iain and Manson, Stuart (2004). The Audit Process: Principles, Practice and Cases. Third edition. Thomson Learning.
Handbook of International Auditing, Assurance, and Ethics Pronouncements. (2006). International Federation of Accountants. New York.
Kay, John and Carsberg, Bryan (2002) Stiffening the auditors’ backbones. Financial Times. UK
Oxera Consultancy Group (2006). Competition and choice in the UK audit market. Report prepared for Financial Reporting Council. London.
Parliamentary Correspondent. (2006). Auditors may escape criminal sanctions. Accountancy Age, UK.
Sarbanes-Oxley Act (2002) Retrieved 6 November 2006 from
The Committee on Corporate Governance (2003). The Combined Code on Corporate Governance. Financial Reporting Council. London.

[1] International Federation of Accountants
[2] Baroness Noakes, a former KMPG partner
[3] An Ernst

Financial and Management Accounting: Payroll Services

Financial and Management Accounting Case Study: Payroll Services 1. IMPACT ON THE CHARGE PER TRANSACTION:
The payroll department is incurring a total cost of £590,000 at present. The charge per transaction is £236 (see fig 1 Appendix A) which is the charge applied each time a salary transaction is completed i. e the salary is transfered. If the lump sum is paid to the staff to switch over to the monthly payment system, it is forecasted that it will generate a saving of £20,000 in Pay Costs while the services and supplies costs are likely to decrease by £3,000, thereby bringing it down to £98,000. The recalculated total or full cost will be £ 567,000 per financial year. In the new scenario the charge per transaction is reduced to £226 thereby showing a saving of £10. On analysis of the figurework it will not be advisable to have these workers shifted over to the monthly payment system as the figures suggest that bulk of the workers are under the monthly payment system. The authority will have to pay a lump sum of £500,000 to the workers when they shift over to the new system, however in retrspect the cost dished out now will be recovered in a very long time because the savings being made by the authority on different facets of the payroll department are not significant enough. Apart from the savings it does represent harmonisation of the company however there are other aspects to be considered. Bulk of the workers are under the monthly payment arrangement and having the weekly workers under that scheme might cause confusion in the payroll system. However there are some finer points to take into consideration. The ending of the weekly wage payment system might have an adverse effect because the workers who are being offered to shift over to the monthly payment system will still be working on weekly basis. The difference only being that their salaries will be paid on a monthly basis. Alongside these workers there are other workers who are employed on a monthly basis, they work on a monthly basis and recieve their salaries on a monthly basis. If the authority wants to keep the weekly and the monthly workers apart and not mix up or confusion between the two, it would have to operate two different payroll departments. There would be one department keeping the records of staff working on a weekly basis but all of whom will be paid a monthly salary and the second department within the payroll section to keep record of the staff workingon a monthly basis who also get paid on a monthly basis. Operating two separate departments would therefore mean that all the costs associated with the running of the payroll section will be much more than what they stand at now. The increment in the cost is therefore a mojr factor to consider. Considering this the weekly staff should not be asked to transfer to the monthly system. The fact that the authority will probably have to run two departments within a department complicates things and also increases the cost factor which is what the authority is geared towards saving. The government is also urging all the authorities to save on the cost side of things and make the authorities economically more viable. Therefore on the basis of the analysis and considerations it is advisable that the authority should not seek to transfer their weekly staff over to the monthly payment system.
In this case we are faced with the scenario of two options having different lifespans associated with them. Option 1 has a lifespan of 4 years while Option 2 has a life span of 6 years. Facing this situation we will carry out the financial appraisal on the basis of the equal annual cash flow method whereby the option with the lowest cost will be chosen. The Equal annual cashflow supposes that the cashflows generated as an annuity. In case of annuities we use the annuity factors rather than the individual yearly discount rates to calculate the present values of the cash flows. Whereas in the equal annual cashflow method the annuity factor is the total of all the yearly factors for the duration of the project and in this case the lifespan of the payroll system being put in place.
Equal annual cashflow = present value of costs/annuity factor for N years at R%
Therefore for option 1:
The equal annual cashflow = 916,454/2. 3299 ( Looking at the annuity tables)
i. e = £ 393,345 ( see appendix B for figures)
and for Option 2:
The equal annual cashflow = 1,453,231/2. 7967
i. e = £ 519,623
Therefore on the basis of the analysis we will chose the option 1 as it has the lowest equal annual cashflow. There are a few limitations with the calculations involving cashflows and capital costs. These cashflows do not take into account the fluctuation of the interest rate and assume it to be constant over the lifespan. In isolation from authority B’s proposal we will chose the first option as it has the lower equal annual cash flow. It is feasible on the basis of the calculations to select option 1 and put it into practice. Hoewever there are limitations to the equal annual cashflow method. This appears to be a nice idea however in reality it does not add value to what we can determine from the other methods. The other methods will also yield the same result and therefore adding no extra information for us to make a decision. The equal annual cashflow method can be used alone when other methods yield nothing and this is the last resort for carrying out an financial apprasial. As far as the aritheticinvolvedin this method it is no more complicated that the other methods and is no more advanced than the traditional methods. There are limitations to this methods which leave a lot to be desired. This method ignores the influence of inflation and fluctuation in the interest rate. However it is possible to overcome these limitations by adjusting for the these factors. The cashflows can be adjusted for inflation and the fluctuating interst rate in the real world. Firstly a discount rate shoul be selected that is already adjusted for the inflation and includes an allowance for the inflation. Secondly the cashflows can be expressed in real terms whereby meaning that the anticipated inflation rate can be excluded from the discount rate. In other words the first method provides us with the nominal cashflows while the second method gives us the real cashflows at a real discount rate. The second method excludes the anticipated inflation rate from the discount rate which follows the prudence concept of accounting where the costs are over estimated and the profits are underestimated so as to avoid disappoinmtment later and to cover for the contigencies.
Authority B’s proposal is to transfer A’s payroll function to B. The cost associated with this £380,000 for the next financial year. Evaluating on the cost basis only the Authority A should go ahead with the transfer because the cost proposed by authority B is less than the cost calculated for authority A which is £393,345 on the equal annual cashflow method. Authority B has also suggested that in fututre if more authorities join in the cost would be lowered progressively in the following financial years. Based on the calculation and authrotiy B’s proposal the authotiy A its payroll function to authority B. In order to carry out an investment appraisal of the proposal there will be a few items other than the cost. We would need the reduction in the cost due to the shifting of the payroll. We would also require the reduction in cost due to less staff being employed. Reduction in service and supplies costs. However we would also need to know the cost incurred due to the redundancy of a number of staff due to the payroll being transfered. The knowledge of all these costs would enable us to make a much better informed desicion on whether or not to transfer the payroll to authority B and whether it would be beneficial in the long run. These financial appraisals have a limitation which is that they donot incorporate inflation however inflation can be adjusted for when carrying out the financial appraisal. The net present value can be adjusted by two ways to take inflation into account. Firstly a discount rate can be used which incorporates inflation. secondly the discount rate can exclude the inflation rate and the cash flows acan be expressed in real terms.
The transferring of the payroll from one different authorities to a central one might result in too many job losses and redundancies which again will be against the government’s agenda. The government would certainly not like to contribute to unemployment. In this case this can be solved by spreading the unemployment over different authorities and not increasing the burden on one authority or for that matter a few authorities. The government should also try and create more jobs so as to accomodate these redundancies.
The cost for operating the payroll section is as follows:
Payroll costs: £216,000
Services and Supplies: £101,000
Accomodation:£ 45,000
Capital Charge:£228,000
Full Cost:£ 590,000
The charge to the Budget Holders is:
£590,000/2500 = £ 236/Transaction. (fig1)
The cost for the payroll after paying the Lump sum:
Payroll Costs: £196,000
Services and Sipplies:£ 98,000
Accomodation:£ 45,000
Capital charge:£ 228,000
Full Cost:£ 567,000
The charge now to the Budget Holders is:
£ 567,000/2500 = £ 226/Transaction(fig2)
1£ 830,000 830,000
2£ 33,000 28,290
3£ 36,300 28,815
4£ 39,930 29,349
TOTAL 916,454
1£ 1400,000 1400,000
2£ 22,000 20,369
3£ 24,000 20,575
4£ 24,000 19,051
5£ 24,000 17,640
6£ 24,000 16334
TOTAL 1,453,231
1. Mott, G. (1993) Investment Appraisal
2. Pike