Auditing: A Brief Synopsis

Auditing: A Brief Synopsis

Empire State College

Audit Beginnings

"The origin of auditing goes back to times scarcely less remote than that of accounting…whenever the advance of civilization brought about the necessity of

one man being in-trusted to some extent with the property of another, the advisability

of some kind of check upon the fidelity of the former would become apparent." As told by accounting historian Richard Brown (1905, quoted in Mautz & Sharaf, 1961). As far back as 4000 B.C. record-keeping systems were started by businesses and governments in the East to lessen their concerns about sufficiently accounting for receipts and disbursements and collecting taxes. The need for audits can be traced back to public finance systems in Babylonia, Greece, the Roman Empire, etc., all of which expanded a full system of checks and balances. These governments were worried about inept officials making bookkeeping errors, as well as corrupt officials who were motivated to commit fraud when they had a chance. Fraud cases throughout European history— such as the South Sea bubble of the 18th century, and the tulip scandal —provided the need for placing more control over managers.

In the period of a few hundred years, the European systems of bookkeeping and auditing were launched to the United States. As business activities started to grow in nature and complexity, an urgent need for a separate internal assurance unit that would authenticate the accounting information used for decision-making by managers materialized. There was a need to verify the honesty and efficiency of employees. Around the turn of the 20th century, the internal business function primarily consisted of protection against payroll fraud and loss of assets, internal audit's scope was quickly extended to the substantiation of almost all financial transactions, gradually moving from an "audit for management" emphasis to an "audit of management" approach (Reeve, 1986).

For most of the twentieth century the public accounting industry remained pretty stable. Many public accountants were in public-practice firms that provided tax and accounting services to businesses and a small proportion of private individuals with complex financial affairs. Most firms were local, with operations concentrated in one office servicing one city. Accountants were perceived by the public to have a reputation for ethical integrity. A short time before the Enron fiasco, a survey of attitudes within the business community done by the Canadian Institute of Chartered Accountants (CICA) revealed that accountants had the highest reputation for ethical integrity compared to other professional groups. (CICA 2001: 6) The severe contrast between the profession's reputation pre- and post-Enron is notable. What was it that caused this change?

The 1960s saw advances in the transportation and communications industries that let many businesses expand to the national level. As the accounting profession's major clients changed their geographical reach, it became inevitable that accounting firms also expanded from a local to a national level to reach their largest clients. The growth of national firms by a succession of mergers increased the concentration in the industry by merging national accounting firms into international companies. These mergers first produced the "Big Eight" accounting firms, then the "Big Six", followed by the "Big Five". The collapse of the merger of KPMG and Ernst and Young in 1997 stopped further consolidation to a "Big Four". The major change in public accounting in these decades was the surfacing of this small number of large global accounting firms that dominated the field. These varying mergers were probably one of a number of factors that reduced client loyalty in the 1970s and 1980s. (Magill & Previts, 1991: 123.) Eventually clients began to shop around, putting intense pressure on audit prices, affecting profits. And with this we begin to see the first small signs of conflicts of interest starting in the accounting profession.

LABOR PRESSURE

Price began to be the only variable to the audit companies. Since labor is the main cost of auditing, one of the ways to reduce the cost would be to reduce the total labor-hours of an audit or else reduce the cost of a labor-hour. Therefore, expensive senior supervision began to decrease and recent grads were being used, lowering the quality of audits. In the 1970s and 1980s, there was