Abstract
The question on the moral issues surrounding companies and their decision makers has been there for a long time. This has become even more critical given companies’ ever-increasing urge to outdo their competitors. It has consequently, led to the development of decision-making models that incorporate ethical values to describe processes that decision makers should follow when dealing with issues containing ethical dimensions. That, therefore, creates and maintains a corporate culture that is ethics-oriented. Many problems and solutions have been attributed to the corporate practices that constitute an organization’s culture. That definitely makes it an important determinant of the behavior of people in an organization (Graham, 2015).
The role played by the management team as prescribed by corporate culture is also of equal importance. The management can directly improve the performance of the organization through influencing the behavioral culture within the organization in addition to acting as a role model.
Introduction
Ethics can be described as the philosophy that studies what is wrong or right. They provide a set of regulations and ideas that give guidance to individuals when making situational decisions of varied natures. It can be said that every business entity or company usually possesses its unique ethical climate. An ethical climate is described as an individual perspective on the different perceptions of what does, or does not constitute good behavior. However, it is not characterized by the ethical standards of an individual, but rather the whole business entity perceives the individual’s ethical standards. An ethical climate works as a prediction of organizational norms and practices that might elicit certain moral aftermaths. It also functions as a psychological means to manage the ethical issues (Graham, 2015).
In general, it can be said that an ethical climate influences decision making within a company and the behavioral responses that can be exhibited towards ethical issues. These behavioral responses can be later observed in the work outcomes. Therefore, in a workplace (business) environment, ethics, as well as the ethical environment, are tailored to gel with the tasks that management and their subordinates undertake. In a nutshell, organizational perceptions and behavior are governed by three core factors: ethic legislation (which is part of the institutional factors), moral growth and development (personal factors), and ethics program (organizational factors) (Graham, 2015).
Ethics in Auditing
The core of running many companies involves financial reports. That means that the financial reporting process should be done as effectively and efficiently as possible. Here is where auditors and mechanisms of auditing come into place. Auditing involves detection and deterrence of frauds through evaluation of accounting systems for weaknesses, design and monitoring of internal controls, determination of the degree of risk of organizational fraud, interpretation of financial records to check for unusual trends, and following up on the fraud indicators discovered.
The ethical issues surrounding auditing have led to widespread debates concerning audit tenures. Audit tenures refer to the longevity of the relationships between audit firms and the companies being audited. That is because it is believed that a prolonged relationship between an auditing firm and the company it is auditing might compromise the independence and objectivity of the auditors.
The Financial Reporting Council in the UK
The Financial Reporting Council (FRC) seek to promote high-quality corporate governance and efficient reporting of finances. They have argued that for high standards of the audit to be maintained, it is advisable for a company to retain the services of the audit firm that it believes to have the best capability to undertake its audit. The FRC disregards the concept of mandatory audit firm rotation and instead suggests tendering as an alternative.
Tendering is the process of choosing the best company to perform a particular job based on the remuneration they would require and the quality of service it plans to deliver. Through tendering, companies can examine and choose the best auditor available. The company can as well reappoint the incumbent audit firm if the audit firm has proved to be the best to undertake the audit. Tendering also nurtures the potential for simulation of audits on the way audits are done as audit firms strive to find ways to demonstrate the quality of their audit tenders. The FRC has implemented the idea by establishing a provision that requires listed companies to put out their audit to tender every ten years.
Auditing in the US and other parts of the world
Outside the UK, the rest of the world is employing the provision of mandatory rotation of audit firms in a bid to improve independence, objectivity and professional skepticism. The United States, for example, requires its companies to rotate their engagement partners every five years. There is, however, no requirement to change audit firms. That prompted the four biggest audit firms and other large accounting firms to stand up against the rotation requirement. The firms believed that rotation of audit firms would come at great expense to audit quality. On the other hand, the United States government believed that long-term relationships between companies and their audit firms always creates problems concerning the audit objectivity and independence.
In countries like Qatar, companies are also required to change the entire audit firm every five years.
Given the lack of unanimity concerning the rotation of audit firms, further research into the issue is being conducted to prove the impact of mandatory rotation on the quality and reliability of financial reporting for any company. Many still insist that there are more effective ways to reinforce the independence, objectivity and professionalism of auditors without having to rotate audit firms.
Effect of the Debate on Stakeholders
The stakeholders involved are mainly the audit firms and the companies hiring the audit firms. The auditing firms face the prospect of losing firms due to the mandatory rotation policy. A reduction of clients might lead to unprecedented losses in profits as well as loss of the status quo. The positive side is that audit companies will strive to improve the quality of their audits.
The companies hiring audit companies in the UK face the challenge of having to go through a tendering process for a new audit firm every few years. The tendering process is often a tedious process, and many companies would rather keep their audit firms than go through the process.
The dilemma over the rotation process has also led to many lawsuits being filed against the government by companies, audit firms, and accounting firms. That cuts into the finances of these organizations. It also takes away time and energy that would have been used to accomplish organizational goals and objectives.
Alternative Ways of Reinforcing Auditor Independence, Objectivity and Professionalism
One alternative way of reinforcing auditor independence could be through additional rules or legislation on auditor independence. To achieve this, an extensive system detailing independence prerequisites and an active program committed to enforcing these systems are required. The combination of these two factors serves to provide the appropriate safeguards to investors. These safeguards shield investors from incurring any losses as a result of auditor conduct, and especially so for auditors that lack independence from their clients. These independence rules and interpretations would focus on and guard relationships that often create the perception of an existence of a conflict of interests between the auditor and the client. These rules will also have to be kept up to date due to constantly changing the business environment (Public Oversight Board, 1994).
Strengthening the relationship between the board of directors and the independent auditor might also aid in reinforcing an auditor’s professionalism. That might seem like a definite way to compromise an auditor’s objectivity and independence, but it is not. A board of directors’ main challenge is to stay up to date with the organization’s performance and to be concerned with the future. It is therefore up to the board to stay sufficiently independent to make the necessary changes at the right time. By enhancing the independence of the board, accountability to shareholders also rises. The presence of an accountable board strengthens professionalism within the outside auditor, and thus enhances the credibility of the independent audit (Public Oversight Board, 1994).
Establishing an audit committee to report and give formal evaluations of the independent auditor can also help reinforce audit independence. That will allow the committee to probe the degree of objectivity and skepticism reflected by the auditor. The committee can also investigate the relationship between the auditors and the management of the client company to establish if there was any form of conflict of interest that compromised the integrity of the audit. If there are any non-audit services provided by the audit firm, the committee is allowed to investigate in case those services had any influence on the audit firm’s independence (Floyd and Amanda, 2013).
The audit firms can also strive to serve the public interest and honor the public’s trust by maintaining utmost objectivity, independence, and professionalism in audits. To do that, the firms need to emphasize to their professional staff that auditing is a special service that involves a public responsibility that transcends any other employment relationship with the client. Focusing on further enhancing the audit function within the organization can also help improve audit quality. That would require the management of audit firms to restructure their organizational structures and strategies. Other mechanisms that the firm could adopt to enhance audit quality are ensuring that:
Their offices remain independent of the partners that are subjected to direct pressures from client companies.
The standards that office personnel observes when advising partners, and which they are obliged to observe, are not just “what practices are acceptable” but also “what is the most appropriate action in the circumstance.”
Full information about facts and circumstances are made available to the national office.
A better legal environment can also help improve auditor professionalism. Litigation has a detrimental effect on the auditing profession as well as on the public it serves by:
Discouraging those who seek to get into the auditing profession.
Focusing business strategies and management efforts within large firms on non-audit services that entail lower risks of litigation.
Encouraging an increase of detailed standards meant to serve as a protection against second-guessing by litigants. In this way, audits get more compliant and rule-book oriented.
Creating an atmosphere in which auditors are reluctant to express their independent professional opinions and judgment.
A better legal environment permits auditors to express professional judgments to boards of directors without any fear of exposure to unwarranted or excessive liability. A more, enabling legal atmosphere would also allow the members of the auditing profession to analyze, correct and learn valuable lessons from past failures (Public Oversight Board, 1994).
Conclusion
Regarding the debate over mandatory audit firm rotation, the best course of action could be a collection of views and opinions from all the main stakeholders. These views can then be compared and analyzed to come up with solutions that will suit everyone. Those audit firms against the mandatory audit firm rotation should provide alternatives that would be equally or more efficient in maintaining audit independence and objectivity. The most important thing is to find a common baseline from where all the shareholders in the audit industry can work together to tackle ethical issues that may arise.
References
Floyd, Bill and Amanda Leech. "Auditor Independence: Mandatory Auditor Rotation And The Increased Burden For Audit Committees". Financier Worldwide. N.p., 2013. Web. 28 Apr. 2016.
Public Oversight Board. "Strengthening the professionalism of the independent auditor." Stamford, CT: POB (1994).
Graham, J. O. H. N. "The Role of Corporate Culture in Business Ethics." (2015).
