This leads to the inability to compare financial statements reliably with each other (Seay & Ford, 2010). A second concern is that the income statement will reflect increased volatility due to fair market writeups or writedowns. The third concern is the inconsistency in valuing some assets and liabilities at the current exit price. The fourth concern is whether price reflects the intrinsic value of the asset. It is suspected that price and value will differ, particularly in a downward trending market (Seay & Ford, 2010).
These concerns will affect the acceptance of fair value accounting and its ability to restore trust in the transparency and accuracy of accounting statements. According to Seay & Ford, many blamed fair value accounting for the collapse of the banking industry. However, they remind readers that the accountant only reports the information and that they were not to blame in the banking industry collapse.
As one can see, legislative actions such as the establishment of the PCAOB and fair value accounting are limited in their ability to restore public trust in the accounting profession. This research suggests that the public does not have confidence in the ability of the legislation to provide the transparency for which they ask. They also do not feel that the proposed actions will result in consistency in the accounting statements. These measures are not being viewed as the answer to the dilemma.
Self-Policing Efforts by Accountants
Accountants realize the importance of their need to restore the confidence of the public in their profession. They also realize that the public is not entirely trusting of the methods being proposed to help restore their confidence by the government. Therefore, the accounting profession has developed several methods to help increase accountability, transparency and the faith of the public in their profession. These methods are being developed out of a feeling that that the government efforts will not be enough. The first of these methods is the establishment of audit committees. The second to be discussed is third=party audits and rotating auditing methods.
The concept of audit committees is not new. Audit committees have been around for nearly 40 years. However, recently recommendations and regulations propose extending their use and their responsibilities. The proposed measures are intended to strengthen their ability to restore public confidence (Bedard & Gendron, 2010).
The effectiveness of the audit committee is determined by their composition, authority and the resources that they are granted. These three elements have the greatest impact on investor's perceptions of their capabilities and ability to effectively police the accounting profession (Bedard & Gendron, 2010). Another factor the significantly influences confidence in the audit committee is independence. The committee must be free of any relationship that could be construed as having any association with the business that is being audited. Bedard and Gendron state that even if the relationship is not important to the committee member, it can still result in mistrust among the public.
Another characteristic that is important in the effectiveness of the audit committee to establish public trust is member competency. They must be familiar with best practices and regulations. They must have demonstrated ability in performing their job. Audit committees are not always composed of accountants. Having at least one or more committee members who is a financial expert can go a long way in building the trust of the public (Bedard & Gendron, 2010). The final recommendation for the audit committee is that it must have a minimum of three members. This number is considered important in discouraging unscrupulous decision making. The chance for misconduct is decreased as committee members police themselves (Bedard & Gendron, 2010).
Bedard & Gendron's review of various characteristics of audit committees and their perceived effectiveness found that all committees are not viewed with the same degree of trust by the public. In order to accomplish their monitoring jobs effectively and in a manner that encourages public confidence, they must be independent, experienced, competent in financial accounting and must be large enough to be considered self-policing.
Bedard & Gendron's study made an important point about the ability to restore public confidence in the accounting sector. It is not enough to simply establish measures and policies. These measures and policies must have certain characteristics in order to secure the confidence of the public. It is not enough that they exist, they must prove their competence in order to generate confidence. It can be concluded that the effectiveness of oversight committees is only as good as the individual committees themselves.
Audit firm rotation is another method that has been suggested to help restore confidence in the accounting profession. Under this scheme, auditors would be rotated so that each auditor would be held accountable for their decisions. There would be less chance for dishonesty out of fear of being caught by the next auditor. A recent study compared the effects of audit firm rotation and audit partner rotation on confidence in the honesty of the accounting reports. The findings of the study suggest that audit firm rotation increased confidence more than audit partner rotation (Gates, Lowe, & Reckers, 2007).
Familiarity between auditors and their clients can promote the formation of strong bonds and a sense of closeness. This closeness can lead to relationships that are considered too close and can lead to the inability of an auditor to be objective in their assessment of an accounting report (Gates, Lowe, & Reckers, 2007). It is possible for them to have too much inside knowledge about their client and that this can influence their ability to be objective on the accounting report. A key case in point is the Enron auditors who shared in office parties and were given permanent office space within the building. People thought that they were regular Enron employees (Gates, Lowe, & Reckers, 2007). This close relationship was found to be a key factor in their unwillingness to present negative information about their client.
The length of tenure of the auditor-client relationship has been suggested to affect the independence of the auditor. Obviously, having an office inside the client's building would also have an effect on the auditor. In absence of relationships with their own employees, the auditor would only form bonds with the client. Another scenario that might affect auditor independence is the low-balling of bids in order to get a client. The auditor might have a "need" to retain a client, which could have a negative impact on their impartiality. As one can see, many factors exist that could affect the impartiality of the auditor and their ability to deliver fair and accurate accounting information.
Rotation of audit firm and audit partner rotation were found to have a limited effect due to a lack of legislation requiring it. Mandatory auditor rotation was suggested as a means to increase public confidence in auditors and accountants. However, accountants have not received this notion well (Gates, Lowe, & Reckers, 2007). They have questioned whether the benefits outweigh the costs of such an endeavor. The results of this study indicate that firm relationships are an important factor in achieving greater confidence through auditor rotation. Firm rotation was found to instill greater confidence, as there was less of a chance for a relationship to develop between the auditor and the accountant (Gates, Lowe, & Reckers, 2007).
Accountants do not make the financial decisions that they report, but they are blamed when something goes wrong. When scandals are discovered, it is the auditor who must take the heat. Restoring public confidence in the auditing profession has become a major issue. This research explored several different approaches to restoring public confidence in the auditing profession. Several themes emerged as consistent with the ability to restore public confidence.
The first factor is that the public wants mandatory, not voluntary compliance with programs. The general consensus is that those who volunteer are not the ones to worry about. The second theme that emerged is that the public wants independence and a lack of relationship that could jeopardize the objectivity of the auditor. They also demand competence and knowledge in regards to the auditor.
In order to achieve what the public wants in order to restore public confidence in the accounting profession, a multi-faceted approach is necessary. First, legislation must support the rotation of auditors and the establishment of audit committees. These laws need to set forth the minimum requirements and general operational procedures that must be followed. Third-party auditors must work to gain the confidence of the public. They must be seen as having a certain amount of integrity and concern for what they are doing in order to gain the public trust. Auditor rotation and the establishment of auditing committees can work to restore public trust, but only if these measures are established under clear guidelines and policies to ensure the quality of these programs.
Bedard, J. & Gendron, Y. (2010). Can audit committees deliver? CA Magazine; Sep 2010; 143 (7). 50-53.