auditing.doc

The Report of: Auditing Independence Issue in ChinaYitong Li S3251676Yi Zhao S3233242ZhaoyanXu S3222881Executive Summary：Now day, China is conducting an open market policy and Chinese firms are seeking reliable and independence audit services. But Chinese auditing system is operating in a unique environment from those experienced in Western developed countries. Therefore, there are some considerable issues about auditor independence in China. The motivation of this paper is to examine some factors that cause a lack of independence in Chinese auditing service, and how is them difference with western countries. The report is base on several article talks about the history and the current issue of auditing independence in China. Through the literature review, it shows all the possible factors that cause lack of auditing independence in China, and how are they differ with western countries. Factors include: central-control of the auditing profession, lack of satisfactory auditing standards, inter-relation between the government and auditor league, audit services is highly protected, lack of incentives to implement the law. Then, a questionnaire was implemental in order to get more valuable information about the auditing independence in china. The purpose is understanding the difference auditing environment in China, the current auditing independence issue in China, how is they different, and any suggestions. The Data issue parts mention about the limitation during the questionnaire, like sample limitation, methodology limitation, and the possible error regard reliable and validity of the answer due to these limitations. In conclusion, the paper summarizes some suggestion and implication conduct from the questionnaire, and how this suggestion works. Also provide some limitation of these suggestions. Introduction:Auditing independence is often regards as the cornerstone of all the auditing profession because its foundational role that keeps the publics trust in the attest function. Auditor independence is aim to ensure quality audits and keep financial statement users reliance on the financial reporting process. Without the reliable auditing independence, the auditing report will lost it value. Collapse of Enron in US has largely impact the perception of auditing independence. Another famous case in China which is a collapse of a A-Share listed company called “YINGUANGXIA” also had negative affect the auditing independence in China and caused a appeal to reform the auditing system in China. (Liu and Zhang, 2005). Recently. Chinese accountancy system expanded at a remarkable rate. The national government actively encourages foreign investors to participate in the domestic capital market, as a result, the credibility of the auditing system has become of fundamental importance (Yang, 2003). In order to analysis the auditing independence issue in China, we will review some literature to find the factor that affect independence in china. Then questionnaire will be adopted to find more detail information and suggestion about the auditing independence in china. The set of questionnaires was designed to identify and draw out the elements of the independence of auditing in different areas. The questions were divided into three different levels: (1) introductory questions, (2) Chinese auditing and independence generally, and (3) some suggestions on Chinese auditor independence. Broadly, the first part of question focused on broadly issue of accounting environment and impendence. There are some general question about the big picture, not some specifically area. The second set of questions deals with some key area of this report which is the auditing independence in china. The question ask why the independence was lack in china, and which factors affecting their independence with audit clients in financial report provided by respondent firms. The last group of question asked about the suggestions improving auditor independence depends on respondents experience according to the factors that affect auditing independence they talk about in last part. The sampling population in this report chosen are from different companies (4-big), different geographic area (Beijing, Shanghai, Guangzhou), and different level (from normal account to senior manager). All the samples come from 4-big accounting company which ensure the entire respondent have professional accounting background. Respondents not just choose from one region, but from three biggest cities in China, which is Beijing, Shanghai, Guangzhou, the reason is that these three cities biggest commercial region in china and 80% A-share list locate their head office there. Furthermore, different levels of position need to ensure comprehensive view from different level. The respondents include Accountant, Assistant Manager, Manager, and Senior Manager. Motivation:Auditing independence is a global issue among most country of the world because it is the foundation for a health and fair capital market. But china has the different problem compare to other western countries. Not just because China has a very short history of modern auditing framework that independence auditing is not exit in china before the economy reform in 1980s, but also China has a different mode of economy which is half planning and half market economy. Hence, there are two major reasons or motivation for our group to research the auditing independence in China. Firstly, due to the different history accounting system and economy, what factors in China will affect auditing dependence, how is there different. Secondly, auditing independence issues is one of the most important part that make sure China can keep the economy growth, and it is crucial to improve that Chinese government currently faced. Normally, there are total six factors that widely discussed affecting the auditing independence. They include non-audit services, regulation, audit reputation, competition, low-balling, and size of audit firms. (Hua, 2010) Most people claim that Non-audit service, competition and low-balling are regarded as the negative impact auditor independence (DeFond, 2000). For example, when the competition is so intense, in order to attract more customers, the customer (company) will have more bargaining power on which to adopt the framework. And when the average profit among auditing firms is lower, they will reduce some necessary procedure or minimized the data pool when doing the auditing in order to reduce their cost. The rest factors like Regulations, reputation and audit firm size are, on the other hand, regarded as positive that could improve auditor independence (Magee and Tseng, 1990) The above six elements have been analysis widely in most western countries. However, China has a quite different environment as we just mentioned. In China, factors like unique political, cultural and economic environment play the most important role affect auditing independence. It does not mean the other factors will be neglected, they still affecting auditor independence but not the crucial. Hence, research about Chinas auditing dependence should emphasis on its half planning market economy, one party government, unenlightened accounting frameworks, and incomplete law and regulation. This assignment tries to find the detail of these factors through a review of the associated literature to explore how they affect the auditing independence in china. On the other hand, as china is planning to open more its capital market to global and want to encourage more foreign investor. Therefore, the fair, stable, credible auditing regulation and service will be the most essential for encourage foreign company participant. If the third party independent auditing is not reliable, most foreign investor will not invest due to too much risky and uncertainty. Moreover, if china wants to further its market to encourage more foreign investor, not just the structure market need to internalized, and the accounting framework need to internalize as well that can make internationalized company more easier operation in China. It means china needs to harmonize with International Accounting Standards like IFRS. If the auditor independent is the problem in china, it is impossible to effective implementation of IFRS. This paper can provide some valuable suggestion and address the key factor that Chinese rule-maker need to consider priority Literature reviewAccounting profession backgroundBefore 1980, the Peoples Republic of China had not fully aware about the demanding for independence auditing, when sate-owned enterprises seek for the separation of ownership, stock exchange and control entity, it realized that the it is time to acknowledge the importance of independence auditing. In 1982, the Chinese Constitution started pursuing the relevant auditing approaches. There are Auditing Law and CPA law in China contains pieces of legislation regulating audit practice, the Auditing Law is concerned mostly with state auditing, the CPA Law deals with professional auditing. The Chinese Institute of Certified Public Accountants also known as CICPA, was established in 1988 which is responsible for the regulation of the profession, and accounting practitioners must be members. The connotative establishments of regulation departments and Law has set up the primary problem of harmonize to IASB which lead to the further issues in auditing independencyIn recent years, frequent auditor switching has drawn increasing attention from both government regulators and academic research. In 2003, the CICPA issued the Specific Standard for independent auditing (N0.28) to highlight the communication between predecessor and successor auditors, as well as to remind successor auditors of potential risks of auditing switching. Soon after, CICPA listed the auditor switching problem as one of its supervisory priorities of the year (Code N0. 9, 2004). As pointed out be CICPA, vicious auditor independence, and impair the development of Chinas capital market accordingly.What raises the auditors independence problem in China?The strength of independency is important to an auditor which is being regarded as the most fundamental principles when commencing auditors work. First, China is trying to develop its capital market and induce more and more investment from foreign people. (Australian Overseas Newspaper, 1 November 2000). In that case, for those companies whom like to take up shares in Chinese companies are not going to make a confident decision by involve too much risk, unless they get approval from a reliable independent third partys auditing. (Xing. 1998)Secondly, China has been struggling to apply to the International Accounting Standards for years, according to the new Chinese accounting standards, being consistent with their international counterparts, are more flexible than the previous form of accounting standards which are borrowed from Soviet Union, (Xing 1998) therefore without independent auditing, the effective implementation of IFRSs in China will depend so much on independent auditing. Third, China is conducting a campaign to further privatize state-owned enterprises. The government is now planning to cut down its shareholding in listed companies, and further retreat from small and medium-sized state-owned enterprises, it is proposed that the government retain control only in 35 very large key firms and retain dominate in 15 industries out of total 196 industries. How success of this campaign will reach is fully rely on the supply from the private investors, consequently, independent auditing is about to play a crucial role to help those private investors gaining enough confidence to do so. (Australian Chinese Daily, 2000).Why hardly achieve auditing independency in ChinaThe factor is put primarily in the paper to give out issues and emphasize the importance of independence auditing. China will suffer in processing economy transition and reforming of business structure without a reliable auditing work. Why it is so important and it is very hard to make a change in China? There are several explanations as follow.To start with a well-known idea which assumes that the lack of auditors independence in China is attributable to the lack of satisfactory auditing standards which is a set of internationally wellbeing standards? However, China has already associated international auditing practice with its own standards as much as possible in recent years and its auditing standards are now quite similar to International Auditing Standards. Xiao. 2000)Second, the government central-control of the auditing profession actually appears to underpin the problem relating to auditor independence. At the national level, the Chinese profession is not self-regulated, but government regulated. The profession monitoring organization, the CICPA, is a government controlled body, and refers to the situation that every decision made by CICPA needs ratified by the Ministry of Finance, under such a relation which suggests that the CICPA is an agent of the MOF department, although the CICPA does not handle clients in direct link, also its association with the MOF, and its quasi-governmental status is potentially influencing the magnitude of professional industry independence. (Xing, 1998) A thirdly reason for recognition of a lack of independence is the inter-relation between the government and auditor league. Initially, all CPA firms include both accounting plus auditing firms were formed by the government, statistically speak government-affiliated firms are still in dominant position, with over 75% of the audit market in terms of the number of clients, meanwhile, the controlling shareholders in virtually all listed companies and overwhelming majority of unlisted companies are government entities. This broadly government ownership of both clients and their auditors leads to underlying conflicts of interest in auditing work. In addition, there is also lack of incentive of auditors themselves to maintain independence, such associations protect auditors from market competition and external litigation, and make them more likely to compromise to a state-support clients pressure and therefore issue unqualified audit reports.(Yang, 2001)Fourth, the consequence of government control and huge influence over the entire profession is that the market for audit services is highly protected. There are two types of government ownership of CPA firms which name respectively industrial and regional, which trigger to the protectionism of both. For instance, a government department may possess the necessary authority to require business entities under its control to be audited be a CPA firm also under its control. Regional protection can arise through provincial or local governments exercising authority to dictate that entities located within its territory are to be audited by a certain CPA firms in the same area. (Liu and Zhang, 1996) Market protectionism provides strong incentives for individual CPAs and CPA firms to perform audits services with the interest of the controlling government body in mind, in result severely impairing their independence. What is more, Government control and influence over CPA firms may also protect firms form the threat of litigation and may explain why until recent years there has been little cases of litigation against auditors. Without the danger of costly shareholder litigation, auditors have less incentive to avoid audit failures. (Palmrose, 1994)The last but not the least, although it reveals that so many problems related to auditing practice arise, not only because lack of relevant legislation, but mainly due to a lack of incentives to implement the law. By reviewing some audit failure scandal cases (Shenzhen Yuanye Industrial Corporation Case, 1992; The Great Fund Raising Case, 1993), it is suggests that prevailing behavior and reporting was a breach of existing laws and regulations. The clients in these cases committed illegal act, such as the forgery of accounts to mask true financial positions, evade tax, embezzle state revenue, and appropriate state assets, the auditors involved in these cases were found to be materially negligent of fraudulent, guilty of intentionally helping clients to falsify accounts, or guilty of providing false certificates of capital contribution verification and unqualified audit reports. Such auditors were obviously acting at their own interest in terms of only caring about money, absolutely paying few attentions to the quality of its jobs, and totally regardless to the ethics, but some times they can protected be the local government and corrupt official. (CPA Law, 1993)By all of above, it can be revealed that many of our results are strongest among the relations within the government-affiliated auditors. In addition, audit firm associations with the government can strongly impair auditor independence, and that severing this connection is the first and crucial step towards the creation of a truly independent Chinese auditing profession. (Yang, Qing, Hong, 2001). Auditors in China are expected to face stronger incentives to act independently in response to the new standards.Research methodologyThe previous parts has adopt literature review demonstrated that four major factors in China affect the auditing independence. In order to find more valuable, reliable information about the currently auditing system in china, how it works, how to improve the auditing independence. The methodology questionnaire will be adopted. The research used a self-administered quantitative survey, Saunders pointed out that the quantitative survey “is a