INTERNATIONAL AUDITING

LECTURE 11
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Objectives

Discuss important factors influencing the quality of the accounting and auditing profession. Discuss the nature of global audit services and examine the challenges of auditing across borders. Describe the structure of the audit industry and the strategies of the global public accounting firms in servicing clients worldwide.
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Introduction

Auditors are increasingly practicing internationally, both as individuals and as firms. The main reason is due to globalization of business in recent years. As enterprise became multinational, they asked that their financial advisers be equally multinational. As a result, professional accountants have organized themselves into global organizations, providing a wide range of services throughout the world.
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The Audit Profession

Messier et al. (2006), auditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.

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The Audit Profession

Therefore, the successful auditing has three important requirements: an objective (independent), competent person; quantifiable (and verifiable) information; and established criteria (or auditing standards) The quality of the auditing profession in each country based on the following factors: reputation of the accounting and auditing profession, the quality of the educational system and the certification process.

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The Quality of Audit Profession

Reputation is important because it determines whether or not the profession is able to attract competent people. 2. Education systems vary with respect to the specific training they provided potential candidates for the accounting in the respective country. In the US, a high value is placed on the university experience of students, and the firms that recruit at the universities are familiar with the backgrounds students will have when they graduate. In some developing countries accounting education may not that important as accounting is often viewed as a discipline within economics. As a result this type of education systems may not prepare students for careers in accounting. 3. The certification or licensing process is also a function of several factors, such as the identity of the candidate, educational requirements, experience requirements, an examination and the issue of reciprocity or the ability of a certified accountant in one country to practice in another 6 BAC3694 Intenational Accounting country.
1.

Global Audit Services

The services provided by the global audit firms include: 1. Audit/ Attestation and Assurance Services 2. Tax Advisory and Compliance Service 3. Consulting / Management Advisory Services
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Global Audit Services

Attestation Result Written conclusion about the reliability of the written assertions of another party Assurance
Better

Consulting/Tax
Recommendations

information for decision makers Recommendations might be a by-product

based on the objectives of the engagement. Tax documents for the government. Tax advice Better outcomes Not required Recommendations; not measured against formal criteria

Objective Independence Substance of Auditor Output

Reliable information Required by standards Conformity with established or stated criteria

Better decision making Included in definition

Assurance

about reliability or relevance of information. Criteria might be established stated or unstated. Some form of communication

Form of Auditor Output

Written

Written or oral

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The International Auditing Challenges

1. 2. 3. 4. 5. Local Business Practices and Customs Foreign currency Language and culture Interaction of home country and local law Distance and organization for providing audit services 6. The supply of auditors 7. International differences in training of practicing auditors 8. Reciprocity
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The International Auditing Challenges

Local Business Practices and Customs

Local business practices and customs can create challenges in simply confirming what has happened as well as in assessing future risks. Examples of such challenges include:

Predominance of cash - Japan Inability to confirm accounts receivable

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The International Auditing Challenges

Foreign Currency

Foreign currency restrictions and transfer requirements should be known for each country in which the auditor works. The auditor must be aware of corporate procedures for translating financial statements and recording foreign currency transactions so that reports sent to the parent in its own currency are prepared properly. Translation method must be determined by management, and the auditor needs to determine if the choice is based on the right criteria, using the appropriate accounting standard.
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The International Auditing Challenges

Language and Culture

If the auditor works in foreign country, he may not get the full story if he only relies on a translator. Therefore knowing the language is very essential. Sometimes, knowing the language can be useful for getting information in a sensitive situation. For example why commission and entertainment expenses are high.

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The International Auditing Challenges

Interaction of home country and local law

Home countries occasionally have laws that extend to subsidiaries of their domestic companies that operate abroad. These laws may contradict or conflict with laws in the host country. For example, the US Foreign Corrupt Practices Act states that the act does not only forbid most forms of bribes but also specifies what minimum accounting controls must be in place. The passage of Sarbanes-Oxley in 2002 introduced a significant complicating factor for foreign companies operating in the US as well as US companies operating abroad, especially for Section 404 (Management Assessment Control) which introduced annual certification of internal controls over financial reporting by the companys CEO and its external auditors.
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The International Auditing Challenges

Distance and organization for providing audit services

A major challenge of auditing outside the home base is distance. It is impossible to conduct pre-audit and post-audit visits, so most communication has to rely by telephone, email, fax, or mail. If let say, when post-audit problems arise, it may be impossible to get an answer quickly or to communicate adequately. The simplest way to cover clients in widely disperse areas is for an auditor to travel from the home office to service a client abroad.
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The International Auditing Challenges

Distance and organization for providing audit services

However, this approach is unsatisfactory in the long run because of the complexity of the international audit and tax environments and the increasing internationalization of most of the firms larger clients. Another way is to have a correspondent relationship with the local audit firm. This arrangement allowed for local knowledge plus global clients, but without the tight control of a single firm.
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The International Auditing Challenges

Distance and organization for providing audit services

For example Ernst & Young, used to be known as Ernst & Young in the US; Canada, Ernst & Young-Henry Martin; Lisdero y Asociados in Argentina; Ernst & YoungPunongbayan & Araullo in the Philippines. But the strongest presence for any global firm would be a single entity with common equity holdings. This can be achieved by expanding outward through branches of the original firm or by the merging of previously independent entities. Home office personnel often fill the important positions in foreign branches until domestic personnel can be trained to take over. As a result this concept provides a tighter control over firms services.
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The International Auditing Challenges

The supply of auditors

The number of accountants depends on the barriers to entry to the profession, such as strict educational and testing requirements. Emerging market countries such as Mexico and countries with a tradition of standards designed to service the government (code law countries) have a relatively smaller number of accountant/auditor compare to developed countries such as UK and US.

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The International Auditing Challenges

The supply of auditors
Country Accountants per Thousand 2.13 2.02 1.63 1.49 0.83 0.51 0.42 0.20 0.15 0.13 0.11 0.10 0.08 0.06 0.05 Certified or Chartered Accountants 69,157 40,159 98,283 437,333 13,513 21,856 2,248 16,129 7,169 3,009 14,235 110,256 570 6,186 61,225
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Population (2004) 32,507,874 19,913,144 60,270,708 293,027,571 16,318,199 42,718,530 5,413,392 82,424,609 48,598,175 23,522,482 127,333,002 1,065,070,607 7,517,973 104,959,594 1,298,847,624

Canada Australia United Kingdom United States Netherlands South Africa Denmark Germany Korea Malaysia Japan India Bulgaria Mexico China

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The International Auditing Challenges

International differences in training of practicing auditors

The training of potential audit professionals can vary considerably. In the US, a high value is placed on the university experience of students, and the firms that recruit at the universities are familiar with the backgrounds students will have when they graduate. There are three different models of accounting education leading to certification:

The apprenticeship approach, patterned after the British experience, which does not require specific university training in accounting. The university-based model for certification, similar to the approaches used in the United States and Germany. The Dual-track model, found in the Netherlands and France, which permits either approach.
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The International Auditing Challenges

International differences in training of practicing auditors

Each model has its strength, but auditors may be unfamiliar with the competence level of staff in all countries. One solution for the global firm is to concentrate on developing a stronger human capital base through common global training and internship of foreign residency programs. It is common to find accountants working in foreign offices to learn the challenges of audits in those countries and to train local accountants in the ways of the international firm. When these accountants return to their home countries, they can more effectively perform local subsidiary audits that comply with the requirements in countries where the clients parent company is located.

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The International Auditing Challenges

Reciprocity

The number of accountants available in any particular country varies significantly. Therefore, it would be naturally that if international business activity grows in a country with relatively few accountants, auditors would move from relative surplus countries such a the US and the UK to countries in need. Even between surplus countries, it would often seem to be reasonable conclusion that such intracountry flows would speed up the global audit process. Reciprocity has varied in practice over time. At one time, British accountants could and did have a valid global certificate to practice. In the 1989, the free trade agreement signed between the US and Canada initiated a closer degree of economic cooperation between these two countries.
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The International Auditing Challenges

Reciprocity

The EU issued a series of directives that must be incorporated into national law in each country. The Eight Directive, as adopted by the Council of Ministers of the European Union in 1984, deal with the qualifications of statutory auditors. Within the EU auditors from one country are allowed to practice in another member country if two conditions are met: The conditions are: The auditor must have obtained qualifications that are deemed to be equivalent to the reviewing authorities in the host country. The auditor must demonstrate that they understand the laws and requirements for conducting statutory audits in the host country.
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The International Auditing Challenges

Reciprocity

For example, In the Netherlands, the Ministry of Economic Affairs may issue a license to a foreign accountant on the grounds of proof of suitable qualifications obtained aboard and satisfactory moral standing. The French recognized foreign diplomas from countries that grant reciprocal treatment once the candidate has passed an oral examination administered by the Ministry of Education covering French law, tax and accounting, and ethics.
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International Diversity in External Auditing

1. 2.

3.
4.

External auditing is the first line of enforcement of legal and professional requirements concerning financial reporting. Variations are due to: Purpose of Auditing Audit Environments Regulation of Auditors and Audit Firms Audit Reports
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International Diversity in External Auditing Purpose of Auditing Primary concern of external auditor is whether the financial statements are free of material misstatement. Due to numerous financial scandals due to financial accounting irregularities, auditors being questioned their professionalism. The roles of auditors are different in different countries.
1)
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International Diversity in External Auditing

In Germany The role of auditor is wider compared to his counterpart in UK or US. In addition to auditing the financial statements, auditor also should examine management report of large and medium size corporation. In UK and US auditor audit financial statements of large and medium firms. Auditor reports to shareholders whether the financial statements give a true and fair view report to shareholders.
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International Diversity in External Auditing

A countrys corporate governance structure also become a factor that determines the purpose of external auditing. In Germany limited liability companies are required to appoint a supervisory board to oversee the management board. The German Commercial Code establishes a duty for a supervisory board to conduct audits. The major issue faced by the board is about accounting valuation. As a result, the board started to use external auditors to fulfill their audit and control duties.
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International Diversity in External Auditing

2)

Audit Environments
Accounting infrastructure such as producer of information, final users of information, laws and regulations that govern the production, legal entities that monitor and implement the laws and regulations affect auditing issues. The primary source of finance in a country affect the audit profession in that country. Countries in which primary source of capital is shareholders and creditors require sophisticated audit procedure. Country in which state-controlled banks require less sophisticated audit procedure.
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International Diversity in External Auditing

Different legal system also influence auditing. A codified Roman law Germany and France require more reliance on the stated legal objectives of the auditing profession. A Common Law system US and UK allow audit characteristics to develop more freely or rely more on the auditing profession to set a general tone for the profession.

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International Diversity in External Auditing

3)

Regulation of Auditors and Audit Firms

The difference ranges from those that leave the task largely in the hands of the profession to those that rely heavily on the government. For example, in the UK there is no qualification requirement in order for someone to practice as an accountant. The Auditing Practices Board was responsible for setting and developing auditing standards in the UK. There are 4 professional bodies conduct their own examinations. On the other hand, in Germany, the examinations for the prospective auditors are set by the Ministry of Economics, and self-regulation of the auditing profession takes place within the strict boundaries of the law.
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International Diversity in External Auditing

4)

The Audit Report

There are significant differences in audit reports across different countries and sometimes across different companies within the same country. The companies will state that their audit work has been conducted in accordance with various audit standards either local audit standard or international audit standards.
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Structure of the Audit Industry

The audit profession is characterized by a few very large public accounting firms that conduct the audits of the most of the worlds largest corporations. These firms, known as the Big Four are: Deloitte, Ernst & Young, PricewaterhouseCoopers, and KPMG. The statistics of the Big Four: audit 97% of all public companies in the US with sales over $250 million, more than 80% of public companies in Japan, 2/3 of those in Canada, all of Britains 100 biggest public companies, and they hold over 70 % of the European market by revenue
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Structure of the Audit Industry

In recent years, the corporate scandals of Enron, Worldcom and other large firms have produced dramatic changes in the accounting profession. Although most these changes occurred in the US, they have had the most impact on the large international accounting firms. The fall of Arthur Andersen was the first of such changes. Andersens license was revoked by US regulators in 2002 after the firm was indicted for obstruction of justice in the investigation of the Enron scandal. The indictment harmed the firms reputation so much that clients and the public lost confidence in Andersens integrity, and the firm disintegrated soon after. That same year, Sarbanes-Oxley Act was enacted in the United States.
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Structure of the Audit Industry

The Act established the Public Company Accounting Oversight Board (PCAOB) to regulate the accounting profession and monitor the work of public accounting firms. The Act also prohibits accounting firms from providing several nonaudit services to audit clients, including bookkeeping, financial information systems design and implementation, internal audit outsourcing, and legal and expert and expert services (such as consulting) unrelated to audit service. As a result, in 2002 PricewaterhouseCooper sold its consulting practice to IBM. The events of 2002 have had a major impact on the international auditing profession in the sense that firms auditing large MNEs must be careful to maintain their reputations while trying to remain profitability. Another trend for public accounting firms is to organize around industry. For example, KPMG is organized around four industryspecific lines of business: consumer and industrial, communications and entertainment.
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Audit Standards

Focus factors on sources of audit guidelines and audit requirements, differences in audit standards, and audit opinion. The development of auditing standards in a given country is a complex dynamic of cultural, legal-political, and economic variables, so one would not expect total uniformity. Auditing standards come from the public (government) sector, the private sector, or a combination of the two. In developing country, where accounting profession is not well developed yet, the government often takes the lead by incorporating audit requirements.
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Audit Standards

In the US, the AICPA, a private organization was responsible for setting audit standards. However, the massive corporate frauds of the past few years caused the auditing profession to come under fire, with the loss of confidence in the auditors work. Later, the Congress passed the Sarbanes-Oxley Act, which created the PCAOB. The PCAOB was charged with responsibility for setting and enforcing audit standards for audit of public companies listed in US stock exchanges. The PCAOB responds directly to the SEC, a government entity, so audit standards now are in effect set by the public sectors.
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Audit Standards

However, the UK and Canada still maintain private bodies to set audit standards. Another source of audit requirements is the Fourth Directive of the EU.
It

requires that firms (public companies) that fall under the guidelines of the Fourth Directive be audited.

There are many reasons why audit standards vary from country to country.
In

some countries, for example the US, audit profession is regulated by government whereas, in the UK, it is regulated by private sector.
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International Harmonization of Audit Standards

The organization that plays a big role in harmonizes the audit standards is International Federation of Accountants (IFAC). IFAC was established in Munich in 1977 at the international congress. IFACs membership comprises representatives of 163 national professional accountancy bodies from 113 countries, representing more than 2.5 million accountants employed in public practice, industry and commerce, government, and academe. The International Auditing and Assurance Standards Board (IAASB) has developed: International Standards on Auditing (ISAs), which deals with the audit and review of historical financial statements. International Standards on Review Engagements, which deals with assurance engagements other than the audit or review of historical information.
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International Harmonization of Audit Standards

The major benefits of developing and enforcing internationally acceptable auditing standards:
1. The existence of a set of ISAs will give readers of

audit reports produced in other countries justifiable confidence in the auditors opinion. 2. ISAs will reinforce the benefits that are already flowing from the existence of international accounting standards by providing readers with greater assurance that the accounting standards are being adhered to. 3. Adding strength to ISAs will assist readers in making international financial comparisons.
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International Harmonization of Audit Standards

ISAs will provide further incentives to improve and extend the set of standards. 5. The existence of ISAs will aid in the flow of investment capital, especially to developing economies. 6. The development of an international set of standards will make it easier for developing countries to produce domestic auditing standards.
4.
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THE END
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SERIOUS WARNING!
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