THE AUDIT MARKET

Chapter 2
 LEARNING OBJECTIVES

1. Distinguish between different

theories of audit services including
agency theory.
2. Understand drivers for audit
regulation.
3. Understand the role of public
oversight.
4. Distinguish between different audit
firms.
5. Identify some current developments
in the audit market.
6. Portray the series of industry codes of
conduct and guidance.
INTRODUCTION
 The emergence of Auditor :

The Industrial Revolution in Great Britain around

1780

The emergence of large industrial companies with complex

bureaucratic structures and, gradually, the need to look for
external funds in order to finance further expansion : the
separation between capital provision and management.

Both developments resulted in demand for the

services of specialists in bookkeeping and in auditing
internal and external financial representations.
 Management Controls Operations
and Communications

 Communications to Stakeholders
– the Financial Statement
 THEORIES ON
THE DEMAND AND
SUPPLY
OF AUDIT SERVICES
 Policeman Theory
An auditor’s job is to focus on arithmetical accuracy and on the prevention and
detection of fraud.
Lending Credibility Theory
Audited financial statements are used by management to enhance the
stakeholders’ faith in management’s stewardship.

Theory of Inspired Confidence

The demand for audit services is the direct consequence of the participation of
outside stakeholders (third parties) in the company. These stakeholders
demand accountability from the management, in return for their contribution to
the company. Since information provided by management might be biased,
because of a possible divergence between the interests of management and
outside stakeholders, an audit of this information is required.

Agency Theory
A company is viewed as the result of more or less formal contracts, in which
several groups make some kind of contribution to the company, given a certain
price. A reputable auditor is appointed not only in the interest of third parties,
but also in the interest of management.
AUDIT REGULATION :
INTERNATIONAL
PERSPECTIVE
US Sarbanes-Oxley Act

The Sarbanes –Oxley Act of 2002 was passed almost

unanimously by Congress and signed into law by President
George W. Bush on 30 July 2002. It required the US Securities
and Exchange Commission (SEC) to create a Public Company
Accounting Oversight Board (PCAOB). The Board, at this point,
has decided the generally accepted auditing standards (GAAS)
set by the American institute of Certified Public Accountants
(AICPA) will only be used temporarily.
European Union Regulation

Several European Union Directives on the annual accounts and

consolidated accounts of financial and insurance corporations
require that the annual accounts or consolidated accounts be
audited by certified auditors.
 2.5
INDEPENDENT OVERSIGHT
The global oversight organization is the International Forum of
Independent Audit Regulators (IFIAR).

Similar boards are in :

➜Australia (Financial Reporting Council)
➜the UK (the Review Board)
➜the Netherlands Authority for the Financial Markets (AFM)
➜France Autorite des marches financiers (AMF), and
➜the USA (the Public Company Accounting Oversight Board).
The IFIAR was established on 15 September 2006, based on the
following activities :

To share knowledge of the audit market environment and

practical experience of independent audit regulatory activity.

To promote collaboration in regulatory activity

To provide a focus for contacts with other international

organizations which have an interest in audit quality.
 Core principles of IFIAR cover the following :

Comprehensive and well defined accounting and auditing principles and standards that are
generally accepted

Legal requirements for the preparation and publication of financial statements according to
those principles and standards

An enforcement system for preparers of financial statements to ensure compliance with

accounting standards

Corporate governance arrangements and practices that support high-quality corporate

reporting and auditing practice

Effective educational and training arrangements for accountants and auditors.

AUDIT FIRMS
Usually, audit firms are classified
into two distinct categories :
The Big Four firms; and
The Non-Big Four firms.
The Big Four Firms
These firms resulted partially from several major mergers in the
late 1980s. This group is made up of Deloitte, Ernst & Young,
KPMG and Pricewaterhuse Coopers (PwC).

The Non-Big Four Firms

These firms can hardly be treated as a homogeneous group. At
one extreme there are a very large number of small local firms,
with only a handful of professionals. At the other extreme are a
small number of second-tier firms, which also have an
international network, although not quite as extensive as the
Big Four network. In between, there are a large number of
medium sized national or regional audit firms with several
offices. As of 2011 the second-tier firms in the US included
Grant Thornton, BDO Seidman, McGladrey & Pullen, Moss
Adams, and Myer Hoffman & McCann.
LEGAL LIABILITY
➜Legal liability of the auditor to each stakeholder varies from country
to country, district to district. This liability can generally be classified
as based on one or more of the following: common law, civil liability
under statutory law, criminal liability under statutory law, and liability
as members of profesional accounting organisations.
Liability under Common Law

Liability to Clients

Liabilities to Third Parties

Ultramares

Caparo

German Liability
Civil Liability under Statutory Law

Most countries have laws that effect the

civil liabilities of auditor. Securities laws,
for example, may impose strict
standards on professional accountant.
In the USA, the Securities Act of 1933
not only created the Securities and
Exchange Commission (SEC), it
established the first statutory civil
recovery rules for third parties against
auditors.
Criminal Liability under Statutory Law

A professional auditor may be held

criminally liable under the laws of a
country or district that make it criminal
offence to defraud another person
through knowingly being involved with
false financial statements.
 Liabilities as Members of Professional Accounting
Organizations

Nearly all national audit professions have some sort of diciplinary court.
In most countries, anyone can lodge a complaint against an auditor,
regardless of one’s involvement with the auditor. The disciplinary court
typically consists of representatives of the audit and legal professions,
and sometimes representatives of the general public.
Having heard the arguments of the plaintiff and the defendant, the court
makes its judgment and determines the sanction – if any – against the
auditor. The sanction may vary. It may be :
-A fine
-A reprimand
-A suspension for a limited period of time
-A lifetime ban from the profession
 Suggested Solutions to Auditor Liability :

A limit or cap on claims is known in advance and limits settlements.

In some countries, a system of proportionate liability is under study.

To make insurance of all liability risks compulsory using new legislation

was one of the recommendations of a EU commission.

Exclude certain activities with higher risk profile from the auditors’
liability.

In order to protect the personal wealth of audit partners, some audit

firms are stuctured as a limited liability partnership.
 SOME DEVELOPMENT
IN THE AUDIT MARKET
Auditors’ Duties and the Expectatios of Audit Services Users
Expectations were found with regard to the following duties
of auditors in giving an opinion on the :

A. B. C.
Fairness of Company’s Company’s internal
financial ability to control system
statements continue as a  Barings bank
going concern. example
 Reporting on
D. Effectivenees of
Occurrance of fraud. internal control
 Famous fraud
 Object of an audit one hundreed E.
years ago Occurrence of
 Fraud- a responbility not assumed ilegal acts
 Fraud back in the spotlight
 Fraud in planning, evaluating, and
reporting
 EXAMPLE OF
LANDMARK STUDIES
AND LEGISLATION
THAT INFLUENCED
THE INTERNATIONAL
AUDIT MARKET
 Harmonising the
definitions
regarding internal
control and is
components

Creating internal control

benchmarks, enabling Helping management
management to compare
COSO in assesing the
the internal control in Report quality of internal
their own company to the control
state-of-the-art

Creating a basis for the

external reporting on
the adequacy of the
internal controls
 The Cadbury Report, Combined Code and Turnbull Report
 Cadbury Report
The Cadbury Report was published in the UK by the Commitee
on the Financial Aspects of Corporate Governance. Cadbury deals with the
responbilities and duties of the executive and non-executive members of
the board of directors.
Turnbull Report/Combined Code
Internal control : Guidance for directors on the combined
code, called the “Turnbull Report” after nigel turnbull, chairman of the
comittee which wrote the report, provides guidance to assist London stock
exchange listed companies t implement the requiremnents in the combined
code relating internal control.

 The Sarbanes-Oxley Act of 2002

 New Requirements for Audit Firms and Audit Commitees
The act has new requirements for audit firms and audit
commitees.
Thanks!