Posted: August 12th, 2013
International Accounting and Auditing
Many governments throughout the world experience various forms of fraudulent schemes that result into them losing considerable revenues, that would enable them carry out significant fiscal duties. One aspect of financial fraud that has been detrimental to majority of governments throughout the world is money laundering. According to Gilmore (36), money laundering involves the concealment of the source of finances that are usually obtained through illegitimate means. Typically, the procedures involved in money laundering are usually varied. This is because of the level of sophistication of the money launderer.
Because of the widespread nature of money laundering on a global scale, most governmental and regulatory authorities provide estimates that depict the amount of finances laundered per annum globally or locally. Gallant (176) asserts that more than two percent of the global economy incorporated money that was laundered. Consequently, money laundering has been connected to the facilitation of terrorism and organized crime hence presenting grave dangers to most governments.
For instance, one of the largest global banks, HSBC, has been accused of permitting the laundering of billions of dollars thus financing crimes such as drug trafficking (Protess and Greenberg, 2012). In order to understand the fight against money laundering, it is important to assess the International Standards of Auditing (ISA), their implementation and the effectiveness of the standards and other anti-money laundering regulations based on the role of the external auditor.
International Standards of Auditing (ISA)
According to Hayes (26), the International Standards of Auditing (ISA) are proficient standards specifically quoted for financial audit performance regarding financial information. This information pertains to the financial activities of a firm and is thus indicated and represented in financial statements. These standards deal with the responsibilities of an independent auditor during the conduction of a financial audit. The ISA is provided by International Federation of Accountants (IFAC) via the International Auditing and Assurance Standards Board (IAASB).
Based on the ISA, financial auditing is usually carried out by two categories of auditors. The first category of auditors includes external auditors. External auditors represent independent firms that perform financial audits based on the specifications of the client per the audit. These independent auditors express opinions regarding the financial statements of the firm. The views of the external auditor usually indicate whether there is the presence or absence of material misstatements arising from error or fraud. For public companies, external auditors express opinions regarding the efficacy of internal controls.
The subsequent category of auditors comprises the internal auditors. Internal auditors are usually employed by the firm they audit. The auditors are engaged in a variety of tasks such as performance of audit procedures, which are related to the efficacy of internal controls regarding financial reporting. The 2002 Sarbanes Oxley Act requires that internal auditors, as well as external auditors, analyze the efficacy of internal controls. Irrespective of the consideration that internal auditors are dependent of the firm, they are required to apply objectivity in their audit assessments and thus required to report their findings and conclusions to the Board of Directors or a sub-committee of the directors. They are also required to avoid reporting their findings to the management in order to restrict them from producing favorable assessments resulting from coercion.
Objectivity of the Auditor
One of the main fundamentals that auditors are required to exercise is the principle of objectivity. Objectivity is a mind state that eliminates compromise, bias and prejudice. It provides fair and unbiased consideration to every matter that is relevant to the activity at hand and disregards the irrelevant (Ouellet, 39). The necessitation for auditors to be impartial stems from the realization that most valid issues entailed in the creation of financial statements relate to judgment rather than fact. For instance, various choices require the board of directors to decide upon based on the accounting policies that are to be taken up by the financial entity.
Furthermore, several items incorporated in the financial statements are immeasurable and cannot be determined with absolute accuracy and certainty. Applying prudence in these areas requires directors, whether deliberately or inadvertently, to make a prejudiced judgment or if not, an inapt decision, which can lead to misstatements in the financial statements. Therefore, it is against these conditions that the auditor is obligated to convey a view regarding the financial statements.
The objectivity of the auditor requires that a neutral opinion be expressed in light of accessible audit evidence and the professional judgment of the auditor. Objectivity also necessitates the auditor to adopt a scrupulous and strong approach towards the directors’ judgments, which can involve disagreements where necessary (IIA, 132). Concerning the auditing standards, the meaning of objectivity is not different from the connotation expressed in accounting standards.
Therefore, the meaning of objectivity is not influenced in international auditing standards. This is because auditors are required to maintain an unprejudiced position in financial reporting. Moreover, the international auditing standards provide statutes that the exercising of objectivity in the process of financial auditing. For instance, there is assessment regarding the objectivity of auditors. Auditors are usually encouraged to assess objectivity by examining past information acquired from experience with audit function.
Factors That Affect an Auditor’s Objectivity
Regardless of the major role of the auditing standards in the security of an auditor’s objectivity, various factors exist that play a role in threatening and diminishing the objectivity of auditors.
Undue Dependence on the Audit Client or Group of Clients
Regardless of the difference between objectivity and independence, an auditor requires to incorporate independence in the exercising of objectivity. Concerning undue dependence on the audit client, there are various factors that can lead to the auditor relying on the client or group of clients. Overdependence on the clients will lead to the loss of objectivity since the auditor will be coerced or persuaded to conform to the opinions of the client regardless of the misstatements discovered in the financial statements.
Thus, dependence on the audit clients threatens the principle of objectivity that the auditor is required to exercise in order to point out the error or fraud that may be invisible in a company’s financial statements. One factor that can propagate dependence on clients by the auditor is when the percentage of the audit client’s fee to the projected practice fee exceeds 15 percent. Millichamp (46) further asserts that undue dependence will affect objectivity and independence if the client fees exceed 10 percent of the practicing income regarding publicly listed companies.
Other factors can also induce the threat of undue dependence on the client. One such factor is the auditor’s desire to sustain a prominent client. For the auditor, gaining a prestigious client increases the commission the auditor receives after performing his or her duties. Thus, in order to ensure that the prestigious client is retained, the auditor will exercise strategies that will ensure the stay of the client. This threatens the objectivity of the auditor. This is because of the vulnerable nature of the auditor in becoming manipulated in fulfilling the client’s wishes in order to ensure retention of the client.
However, the auditor can use specific strategies to combat the effects of undue dependence on clients. Regarding the issue of the practicing fee, the appropriate safeguard that the auditor can use is increasing the gross practice income fee. The auditor can perform this by increasing the customer base. The auditor can also decrease the auditing fee that is imposed on the client. To avoid depending on prominent clients, increasing the client base can also be applied which will enable the auditor to focus on other clients and thus reduce dependency on a few prestigious customers. Moreover, the auditor can separate recurring assignments and non-recurring assignments in order to avoid the lure of the difference in fee incomes between the two.
Financial Interests in Audit Clients
Another factor that can threaten the objectivity of an auditor is the financial interests on the respective audit client. These financial interests can be expressed by the staff, the partners or the audit firm. Such financial interests result into self-interest whereby the audit firm and its elements seek to amass financial gains by maintaining a relationship with the client undergoing auditing. For instance, clients engaged in money laundering will need concealment of their activities. This can propagate the auditing firm to maintain its relationship with the client in order to gain financial profits by designing the findings received from the audit of the client’s financial statements.
Financial interests in the client can be in the form of interests in the client’s shares and investments. Through auditing, an auditor can view the shares of publicly listed companies and therefore possess knowledge of the current wealth in assets the respective client possesses.
Financial interests can arise whereby the auditor, the audit firm, the staff or the partners have an indirect interest in the entity connected to the client. For instance, the client can possess a financial entity such as a mutual fund, an estate, an investment vehicle or a trust (Russell, 78).
The material-indirect financial interest in the client’s financial interests can also lead to expression of a self-interest threat by the audit firm, staff or partners. Furthermore, financial interests can also arise where the company, the staff or the partners hold direct financial entities. These financial interests can be assets that owned by the firm or the auditor directly, assets that are under the control of the partners or the firm or assets that are beneficially owned through financial investments such as trusts and estates.
In order to safeguard the auditor from engaging in securing financial interests with the client, the auditors or the audit firm can report the illegalities expressed by the clients or fellow unethical auditors, partners or staff to the relevant oversight authority in charge of auditors in the country. Additionally, the same strategy can apply in the instance where the auditor is threatened or intimidated by a senior member of the audit team or the client. The auditor has the power of the law behind him or her, and can therefore act as a whistleblower and report to the relevant authorities regarding the financial interests and the intimidation instances from the staff or the client.
Family Relationships between the Auditor and the Client
If the auditor, the partners, the audit firm or the staff possesses family relationships with the client, the objectivity of the auditor is threatened. These family relations incur the familiarity threat, which can lead to the auditor exercising partial judgment on the client thus eliminating objectivity during auditing. If the auditor possesses family relations with key position holders in the audit client, it can lead to the auditor not being compliant with the objectivity of the principle (Russell, 57).
Additionally, family relations between the independent auditor and the client can lead to the expression of sympathy by the auditor to the client. The auditor will also be compelled to comply with the interests of his or her relatives, engage in bias reporting and create conflicts of interest and undue influence. In order to safeguard against such a threat, the audit firm, staff or partners can consider the review or opinion of an independent auditor. This is because of the unfamiliarity between the client and the auditor.
An independent audit firm will also be useful in maintaining objectivity because it will not be sympathetic towards the family members holding key positions in the firm under auditing. Eliminating the threat requires that the assignment on the respective client be subcontracted and even rejected to eliminate all possible forms of retraction.
Implementation of ISA on Money Laundering
According to Reuter and Truman (27), money laundering involves three distinct processes that are utilized in order to conceal the transaction of the illegal finances from the source to the recipient. These processes are the Placement method, the Layering method and the Integration method. According to Sharman (67), the processes involved in money laundering are distinct and they constitute the whole processes of the criminal activity such that if one process goes wrong, then it becomes simple to track the movement of the finances.
Simonova (347) defines the placement method as the process involved in the introduction of the finances to the respective financial system. The placement step describes the first and initial phase that marks the beginning of the process of money laundering. In the placement method, the illegal source can include the cash in the current financial system. Placement of the cash in the system requires the intervention of financial institutions such as banks, mortgage institutions and insurance companies (Verhage, 101).
The second step, layering, involves performing complicated financial transactions. In order to perform such transactions, financial institutions are required in order to facilitate the movement of the illegal finance. Additionally, by performing the transactions, the illegal source is hidden. The final process, integration, involves the acquisition of wealth produced from transactions intrinsic of the complex transactions. This step explains the reason why money laundered in the respective financial system is usually in large amounts (Simonova, 350-354).
As a classification of fraud, the International Standards of Auditing (ISA) have also been implemented in the reporting of money laundering. International organizations prominent in the fighting of money laundering schemes utilize the ISA in order to determine whether firms have been engaging in the fraudulent activity. One organization that engages in the fight against money laundering is the Financial Action Taskforce (FATF). The use of ISA has been effective against money laundering (Ping, 20).
The Anti-Money Laundering regulations (AML) are legal controls governed by international standards such as the ISA in the detection, reporting and prevention of activities that emulate money laundering. The regulations became prominent due to the creation of the FATF and a global structure that provided a set of anti-money laundering regulations. The standards have influenced the American legal system to incorporate possibilities of money laundering in the acts such as the Criminal Justice Act of 1993 and the 1994 Anti-Money Laundering Regulations (Moscow, 110).
These regulations have increased the risks involved in the committing of criminal offenses for auditors. For instance, failure to sustain apposite procedures for reporting or avoidance of money laundering, while carrying out performing appropriate business activities is a criminal offense (Murray, 10). According to Piccitto (37), the International Standards of Accounting (ISA) have also enabled the anti-money laundering regulations to allow for the reporting of suspicions that involve the act of money laundering.
In conclusion, the International Standards of Auditing play a fundamental role in the fight against money laundering. This is because they have provided principles and guidelines that require to be observed by auditors. Principles such as independence and objectivity are evident in auditing and they need to be followed in order to ensure that money laundering is curbed. Therefore, in order to ensure that the anti-money laundering regulations are implemented and performed to entirety, auditors require exercising objectivity to prevent unbiased judgments, especially in cases involving money laundering.
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