See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/46533998

CHALLENGES OF INTERNATIONAL STANDARDS ON AUDITING IN GLOBAL

CRISIS CONTEXT

Article  in  STUDIES AND SCIENTIFIC RESEARCHES ECONOMICS EDITION · December 2008

DOI: 10.29358/sceco.v0i13.9 · Source: RePEc

CITATION READS

1 3,265

1 author:

Daniel Botez
University of Bacau
20 PUBLICATIONS   33 CITATIONS   

SEE PROFILE

All content following this page was uploaded by Daniel Botez on 25 September 2014.

The user has requested enhancement of the downloaded file.

 Challenges of international standards on auditing in global crisis context 11

CHALLENGES OF INTERNATIONAL STANDARDS ON AUDITING

IN GLOBAL CRISIS CONTEXT

Botez Daniel, Associate Professor, PhD

UNIVERSITY OF BACĂU

Abstract:
The financial crisis that broke out in summer 2007 is striking in its sheer magnitude, the
speed of its contagion to the global financial sphere, as well as its persistence. These factors make
it on the most impressive and unprecedented events in recent financial history.

One of key points concerning the  Independence standards were tightened by

financial crisis looking statutory audit and placing stricter limits on the work done
statutory auditors. for audit clients.
The financial crisis in 2001 Though auditors have not attracted criticism
highlighted weaknesses in the statutory audit over the subprime crisis, there are continuing
process. challenges related to the auditing profession.
Working with the FSF and market Two widely use sets of auditing standards
regulators, the statutory audit profession exist side by side, i.e. International Standards
undertook a on Auditing (ISAs) and the US standards
series of spectacular reforms with four main adopted by the Public Company Accounting
thrusts : Oversight Board (PCAOB). Europe should
 Most countries moved from a system of adopt ISAs as soon as possible to reduce
self-regulation to one of shared regulation uncertainty and promote convergence, and
or outside regulation, most notably in the should call for convergence between ISAs
USA; and PCAOB standards.
 A new system of global governance was Countries continue to apply different
introduced with the creation of the Public independence rules, particularly those on
Interest Oversight Board (PIOB), which scope of services restrictions. Europe should
oversees the public-interest activities of seek to adopt or converge to the IFAC’s
the International Federation of independence standards when the current
Accountants (IFAC), particularly in the revision is complete.
areas of audit standard-setting Auditors may see their role evolving, as they
(International Auditing and Assurance report more fully on future risks faced by
Standards Board – IAASB) and ethics audited companies. However, auditors are
(International Ethics Standards Board for reluctant to report publicly more fully on risk
Accountants – IESBA); identification because of liability issues,
 The IAASB adopted an extremely which need to be solved. This situation may
stringent standard for internal control at create a serious gap between the information
audit firms. The new standard provides, on past events given in the audit report and
among other things, for a systematic expectations by the industry for a forward-
concurring partner procedure before an looking opinion on risks facing companies.
opinion is issued. The underlying National supervisors and inspectors, within
principle is that the review should make it and outside Europe, need to develop
possible to avoid large-scale audit failures mechanisms to cooperate more effectively at
by assigning a non client-facing partner to operational level in the external control of
review audit work (including the audit firms.
identification of macroeconomic and
microeconomic risks) as it is being carried For Europe, one of the most important
out; recommendation looking the process of
convergence audit standards. All national

Studies and scientific researches Edition: Economics, no. 13 (2008)

12 Challenges of international standards on auditing in global crisis context

auditing standards, including those issued by • The need to incorporate judgments

the Public Company Accounting Oversight concerning significant assumptions that
Board (PCAOB), and should converge to may be made by others such as experts
International Standards on Auditing (ISAs). employed or engaged by the entity or
Statutory auditors need to report more the auditor;
extensively about risk identification. This will
require addressing the question of auditor • The availability (or lack thereof) of
liability, which in many jurisdictions appears information or evidence and its
to be a major constraint to expanding the reliability;
auditor’s risk reporting. Convergence should • The breadth of assets and liabilities to
also be a goal for independence standards. which fair value accounting may be, or
is required to be, applied;
Among the recommendations of the Financial • The choice and sophistication of
Stability Forum (FSF) was that “The IAASB, acceptable valuation techniques and
major national audit standard setters and models; and
relevant regulators should consider the
lessons learned during the market turmoil and, • The need for appropriate disclosure in
where necessary, enhance the guidance for the financial statements about
audits of valuations of complex or illiquid measurement methods and uncertainty,
financial products and related disclosures.” especially when relevant markets are
illiquid.
The IAASB had already established a task
force in February 2008 to consider whether Of the above, in the current environment
additional guidance on fair values was obtaining reliable information relevant to fair
necessary and that task force was also asked values has been one of the greatest challenges
to develop a response to the FSF faced by preparers, and consequently by
recommendation. The task force includes auditors. The nature and reliability of
representatives of auditors and regulators. A information available to management to
wider group of interested parties, including support the making of a fair value accounting
preparers and investors, has also been estimate vary widely, and thereby affect the
consulted to inform the discussions of the task degree of estimation uncertainty associated
force and provide feedback on activities that with that fair value. If markets become
the IAASB could pursue in developing inactive, market price information becomes
possible auditing guidance on fair value unavailable and estimates need to be made on
accounting estimates. The task force the basis of other information, often using
recommended that a reminder of relevant models, some of which incorporate inputs that
material in ISAs should be issued. This alert are “unobservable.” The degree of estimation
has been prepared in response to that uncertainty therefore increases and affects, in
recommendation. turn, the risks of material misstatement. What
may in the past have been a routine valuation
One of the important challenges regarding problem may become the source of a
Fair Value Accounting Estimates. significant risk. In such circumstances there
are limits to the information that management
The following matters are particularly possesses or can obtain and that therefore may
important for preparers and auditors in be available to the auditor as audit evidence.
considering fair value accounting estimates: Nevertheless, whether inputs are observable
• The measurement objective, as fair or not, preparers need to have evidence to
value accounting estimates are support them, and auditors need to obtain
expressed in terms of the value of a sufficient appropriate audit evidence
current transaction or financial recognizing that the evidence may be
statement item based on conditions different from what has previously been
prevalent at the measurement date; available.

Studies and scientific researches Edition: Economics, no. 13 (2008)

 Challenges of international standards on auditing in global crisis context 13

Experience to date has suggested that, while requirements in other ISAs to the audit of fair
estimation of fair values has proved to be value; in particular, those dealing with
extremely difficult in light of market understanding the entity and its environment
uncertainty, it has not proved impossible to and assessing the risks of material mis-
obtain sufficient information to record these statement, responding to assessed risks, using
fair values in financial statements. the work of an expert, obtaining management
While fair values are commonly thought to representations, and communicating with
relate primarily to financial assets and those charged with governance.
financial liabilities, the use of fair value is ISA 300 requires the auditor to establish the
more widespread. Depending on the financial overall audit strategy for the audit. Part of the
reporting framework, the impact of fair value establishment of the overall strategy involves
accounting may be seen with regard to determining the characteristics of the
management’s determination of pension engagement that define its scope, such as the
liabilities, the value of goodwill and financial reporting framework used and
intangibles acquired in a business industry-specific reporting requirements. In
combination, real estate, endowment funds, the case of audits of the financial statements
share-based payments, non-monetary of banks or where there are derivative
exchanges and other classes of assets and financial instruments, in addition to the ISAs,
liabilities. the auditor may also look to IAPS 1006 or
IAPS 1012 for further guidance.
ISA 545 is the principal standard that is
directly relevant to auditing fair value ISA 500 establishes standards and provides
accounting estimates. It establishes standards guidance on what constitutes audit evidence,
and provides guidance on auditing fair value the quantity and quality of audit evidence to
measurements and disclosures contained in be obtained, and the audit procedures that the
financial statements. Fair value measurements auditor uses for obtaining that audit evidence.
of assets, liabilities and components of equity Unless management is able to support its
may arise from both the initial recording of valuations, it will be difficult for the auditor
transactions and later changes in value. to obtain sufficient appropriate audit
Further, those financial instruments and other evidence. However, as evidence about
assets recorded at historical cost, but not assumptions and the validity of models is
required to be re-measured at fair value, may necessarily less reliable than evidence of a
nevertheless require fair value consideration, market price taken from an active market, it
depending on the financial reporting may be necessary to look at more sources of
framework, for supplementary disclosure or evidence to accumulate sufficient appropriate
for estima-tion of provisions or impairment evidence, as the quantity of audit evidence
losses. Changes in fair value measurements needed is affected by the risk of misstatement
that occur over time may be treated in (the greater the risk, the more audit evidence
different ways under different financial is likely to be required).26 For example, an
reporting frameworks. For example, some auditor, or an auditor’s expert, may use an
financial reporting frameworks may require independent model to compare its results with
that such changes be reflected directly in those of the model used by management in
equity, while others may require them to be order to evaluate whether the values deter-
reflected in income. mined by management’s model is reasonable.
The ISA deals with the overarching In addition, the auditor may consider whether
requirement for the auditor to obtain external sources provide audit evidence to
sufficient appropriate audit evidence that fair which the auditor could benchmark an
value measurements and disclosures are in entity’s practices. For example, sources that
accordance with the entity’s applicable track provisioning by institutions may provide
financial reporting framework. Within the the auditor with evidence as to whether the
ISA, additional requirements tailor the

Studies and scientific researches Edition: Economics, no. 13 (2008)

14 Challenges of international standards on auditing in global crisis context

entity’s valuations are reasonable if it has may require urgent action by the supervisor.
invested in similar instruments. In many countries, requirements concerning
the auditor’s communication to banking
supervisors are established by law, by
ISA 620 establishes standards and provides supervisory requirement or by formal
guidance on using the work of an expert as agreement or protocol. In situations where
audit evidence, whether the expert is used by there are no such requirements, agreements or
the entity or used by the auditor. When using protocols, the auditor encourages the bank’s
the work performed by an expert, the auditor management or those charged with
is required to obtain sufficient appropriate governance to communicate on a timely basis
audit evidence that such work is adequate for matters that, in the auditor’s judgment, may
the purposes of the audit. ISA 620 explains be of urgent interest to the banking
that when an expert is used, the supervisor.
appropriateness and reasonableness of
assumptions and methods used and their
application are the responsibility of the ISA 240 requires the auditor to consider the
expert. However, the auditor will need to risks of material misstatements in the
obtain an understanding of the assumptions financial statements due to fraud. At times of
and methods used to consider whether they market instability, unexpected losses may
are appropriate and reasonable, based on the arise through failure to protect the entity from
auditor’s knowledge of the business and the extreme fluctuations in commodity prices,
results of other audit procedures. This from unanticipated weakness in asset prices,
guidance is supplemented by ISA 545 which through trading misjudgments, or for other
includes guidance on the use of an expert and reasons. In addition, financing difficulties
on the auditor’s testing of management’s create pressures on management who are
significant assumptions. concerned about the solvency of the business.
Such circumstances may give rise to
incentives to engage in fraudulent financial
ISA 260 requires the auditor to communicate reporting: to protect personal bonuses, to hide
audit matters of governance interest arising management error, to avoid breaching
from the audit with those charged with borrowing limits or to avoid reporting
governance. ISA 545 draws attention to the catastrophic losses.
fact that because of the uncertainties
associated with fair value measurements, the Fraudulent financial reporting often involves
potential effect on the financial statements of manage-ment override of controls that
any significant risks may be of governance otherwise may appear to be operating
interest. For example, the auditor considers effectively. This may include inappropriately
communicating the nature of significant adjusting assumptions and changing
assumptions used in fair value measurements, judgments used to estimate account balances,
the degree of subjectivity involved in the for example using assumptions for fair value
development of the assumptions, and the accounting estimates that are inconsistent
relative materiality of the items being with observable marketplace assumptions. In
measured at fair value to the financial illiquid markets, the increased use of models
statements as a whole. In addition, the need and lack of market comparisons may present
for appropriate controls over commitments to opportunities for manipulation or override of
enter into financial instrument contracts and amounts calculated by brokers or experts.
over the subsequent measurement processes Even without fraudulent intent, there may be
are matters that may give rise to the need for a natural temptation to bias judgments
communication with those charged with towards the most favorable end of what may
governance. be a wide spectrum. What is favorableis not
always the position leading to the highest
Certain audit matters of governance interest profit or lowest loss.
are likely to be of interest to banking
supervisors, particularly when those matters

Studies and scientific researches Edition: Economics, no. 13 (2008)

 Challenges of international standards on auditing in global crisis context 15

In auditing fair value accounting estimates, including ISA 540, “Audit of Accounting
therefore, the auditor may need to consider Estimates” (ISA 540). The similarity in the
whether the circumstances give rise to audit approaches to estimates and fair value
increased fraud risks. In reviewing the judg- measurement led to a decision to combine
ments and decisions made by management in ISA 540 with ISA 545, “Auditing Fair Value
the making of fair value accounting estimates, Measurements and Disclosures” (ISA 545),
the auditor may identify indicators of possible thereby revising both standards. The IAASB
management bias; if this is the case, the believes that the combination enhances the
auditor may need to consider the implications distinction between estimates involving fair
for the rest of the audit. value measurement and other types of
estimates because it draws upon the
similarities between the two while contrasting
ISA 700 requires the auditor to evaluate the their subtle differences. The revised ISA, ISA
conclusions drawn from the audit evidence 540 (Revised and Redrafted), places more
obtained as the basis for forming an opinion emphasis on areas of higher risk, accounting
on the financial statements. Forming an judgment, and possible bias, thereby assisting
opinion as to whether the financial statements the auditor to form appropriate conclusions
give a true and fair view or are presented about the reasonableness of estimates in the
fairly, in all material respects, in accordance context of an entity’s financial reporting
with the applicable financial reporting framework. These are also areas of particular
framework also involves evaluating the fair importance in the context of fair values.
presentation of the financial statements. In
doing so, the auditor considers whether the The revised ISA also includes expanded
financial statements, including the note guidance on auditing fair value accounting
disclosures, faithfully represent the underly- estimates as compared with extant ISA 545,
ing transactions and events in the context of including audit considerations relating to the
the financial reporting framework. proper application of the requirements of the
financial reporting framework relevant to
In certain circumstances, the auditor may such estimates and the use of models in
determine that there is a need to draw the valuations.
reader’s attention to a significant uncertainty
by adding an Emphasis of Matter paragraph to ISA 540 (Revised and Redrafted) highlights
the auditor’s report. ISA 701 describes the matters such as the auditor’s evaluation of the
manner in which this would be done. ISA 701 effect of estimation uncertainty on risk
describes an uncertainty as “a matter whose assessments, management’s methods for
outcome depends on future actions or events making estimates, the reasonableness of
not under the direct control of the entity but assumptions used by management, and the
that may affect the financial statements.” adequacy of disclosures. Such matters are
This, strictly, does not describe the type of relevant to estimates in general, but are also
estimation uncertainty that affects fair value particularly important in the context of fair
measurements. Nevertheless, as indicated values.
above, in times of uncertainty the disclosures ISA 540 (Revised and Redrafted) will be
about fair values in the financial statements effective for audits of financial periods
may assume particular importance. However, commencing on or after December 15, 2009,
any such emphasis is not an alternative to the date when all the standards redrafted
modification of the auditor’s opinion if the under the IAASB’s Clarity project become
auditor is not able to obtain sufficient effective.
appropriate audit evidence or disagrees with This may particularly be the case, for
the treatment of fair values in the financial example, when auditors are faced with
statements. circumstances in which the financial
instruments the entity has invested in have
In conjunction with its Clarity project, the relatively high estimation uncertainty. These
IAASB revised a number of its standards may include fair value accounting estimates

Studies and scientific researches Edition: Economics, no. 13 (2008)

16 Challenges of international standards on auditing in global crisis context

for complex financial instruments in general, model is used or for which there are
derivative financial instruments not publicly assumptions or inputs that cannot be observed
traded, and fair value accounting estimates for in the marketplace.
which a highly specialized entity-developed

References:
[1]. www.ifac.org

Studies and scientific researches Edition: Economics, no. 13 (2008)

View publication stats