2.A public declaration of approval. For example, the manufacturers of clothes washing machines and of washing powders may endorse one anothers’ prod- ucts to mutual advantage. 3.A clause in an *insurance policy that excludes an item from the terms of the policy.
engagement See *audit engagement.
engagement letter A *contractual document that confirms the terms, condi- tions, and costs of an *audit engagement. An engagement letter usually sum- marizes the rights and responsibilities of both the auditor and the *auditee.
Enron® A U.S. *multinational corporation that filed for Chapter 11 bankruptcy reorganization in December 2001. At the time, it was the largest bankruptcy in U.S. corporate history. The uncovering of false accounting and fraud forced Enron to make a write-down of stockholder *equity of more than $1 billion in its *financial statements in 2001. One of the contentious accounting mechanisms used by Enron was a web of *Special Purpose Entities. Some of these semi- independent, off-balance sheet investment partnerships were used to mask debts and losses. These investment mechanisms skirted some of the looser acceptability frontiers of *Generally Accepted Accounting Principles and many were essentially elaborate accounting hoaxes. Enron’s problems exploded in late 2001 and last-minute attempts to arrange for the corporation to be acquired by a rival failed. Following its collapse, Enron has been described as representing
“greed and hubris, deceitful accounting, and Wall Street favors” (Fox, 2003, v).
The importance of Enron in the history of auditing was the effect of its fall from grace. First, it was a major contributory factor in the demise of the *Big Five external auditing firm *Arthur Andersen (AA). A perception of collusion between the senior management of Enron and AA led to a hemorrhage of AA’s audit clients, the secession of some of AA’s international practices, and the firm’s criminal indictment. Most notoriously, AA’s shredding of literally tons of
entrepreneur •103
Enron-related auditing documents left its reputation in tatters. Even worse was to follow, as the Enron accounting scandal was followed by an even larger one at *WorldCom, another AA auditing client. Arthur Andersen itself col- lapsed in 2002.
The second way in which Enron is important to auditing is the effect of its accounting scandal on public opinion. The Enron affair changed the entire climate of auditing, and it led to shifts in the parameters of business legisla- tion and *corporate governance. Words like *Enronitis entered the English language. The most tangible post-Enron changes to corporate governance crys- tallized in the *Sarbanes-Oxley Actof 2002.
Further reading: Baker (2003); Bryce (2002); Fox (2003); Hala (2003);
Schwartz and Watkins (2003); Toffler and Reingold (2003) Web site: www.enron.com
Enronitis An ironic adjective referring to a loss of investor faith in corporate financial reporting and corporate governance. The term was coined by the media following the *Enron corporation’s accounting scandals. For example,
“Wall Street began talking regularly about Enronitis infecting stocks, as pundits ascribed various declines in the broad market to worries about corporations’
accounting” (Fox, 2003, 294).
Further reading: Vinten (2003)
enterprise 1.A *profit-seeking undertaking or activity. See also *entrepreneur.
2.A display of initiative and *risk-seeking attitudes.
enterprise risk management (ERM) The identification, analysis, and man- agement of the entire range of an organization’s *risks. Enterprise risk man- agement (ERM) is essentially the holistic and integrated application of *risk management principles, and it has been described as “a systematic and disci- plined approach to managing risk throughout [an] organization” (Funston, 2003, 60). At the time of this writing, in 2003, an ongoing project of the
*Committee of Sponsoring Organizations of the Treadway Commission is the development of an *enterprise risk management framework.
Further reading: Chapman (2001); Funston (2003)
entity A separately identifiable economic unit that can be subjected to auditing.
An entity in this sense does not necessarily have a separate legal identity: it can refer to a *corporation, *partnership, or *public sector body, or to an activity or department within an organization.
entrepreneur An individual who uses the *factors of production to create
*wealth. In classical economic theory, a *profit-seeking entrepreneur operates in
104• entry
the *private sector, taking *risks to achieve *income. The term is taken from the French, and it literally means “an individual who undertakes an *enterprise.”
entry The recording of an accounting *transaction in a *general ledger or *sub- sidiary ledger. Under the conventions of *double entry bookkeeping, entries take the form of *debit entries and *credit entries.
environmental auditing The auditing of an organization’s adherence to environmental laws, regulations, and best practices. This branch of auditing assesses the impact of an organization’s activities on the environment, in areas such as the following: (i) pollution levels, (ii) the handling of waste, and (iii) health and safety considerations for employees and the wider community.
Environmental auditing increased in importance in the late twentieth centu- ry, alongside a general increase in environmental awareness. A leading profes- sional organization in the field is the *Board of Environmental, Health &
Safety Auditor Certifications.
Further reading: Hillary (1998)
equilibrium A condition in a *market at which *supply and *demand are in harmony. An equilibrium point establishes a *price for a product or service, and it can be achieved in both the *short and *long terms.
equity 1.The ownership interest of *stockholders in a corporation. Under the conventions of *double entry bookkeeping and the *accounting equation, stock- holders’ equity is calculated as total *assets less total *liabilities. It is record- ed in the *balance sheet. 2.An alternative term for *common stock. 3.An alternative term for the combined value of *common stock, *preferred stock, and *retained earnings. 4.In a general sense, justice and fairness. 5.A legal right over an asset. 6.A body of English law distinct from (and which gener- ally prevails over) *common law. Equitable law derives in part from principles of natural justice, and equitable doctrines have entered legal systems through- out the English-speaking world.
equity method A means of accounting for *business combinations in contexts where an investment in an organization is too small to effect control. The equity method operates through (i) the inclusion of an appropriate proportion of the organization’s *income in the *income statement of the investor and (ii) the inclusion of the original amount invested (plus a share of *retained earnings) in the investor’s *balance sheet. See also *consolidation accounting techniques.
Ernst & Young® A global accounting, auditing, and professional services firm.
One of the *Big Four firms, Ernst & Young was established in its current form
European Accounting Review • 105
in 1989 with the merger of Ernst & Whinney and Arthur Young & Co. The firm traces its roots to the United States in the early twentieth century.
Web site: www.ey.com/global
error An inaccuracy, mistake, miscalculation, or misrepresentation. In general, the term error is used to refer to nonintentional inaccuracies or deviations from control, in contrast to deliberately *fraudulent actions. Systems of *internal control are intended to reduce the likelihood of errors.
escapable cost An alternative term for *avoidable cost.
ethical investment The restriction of investments to organizations that avoid unethical, immoral, or questionable activities. The concept of ethical investing is hotly disputed, owing to the subjective nature of the ethical judg- ments that underpin it. Criteria used to underpin ethical investing include (i) the nature of an organization’s activities (tobacco and armaments tend to be among disapproved activities), (ii) a record of good environmental prac- tices, and (iii) equitable treatment of employees. See also *Corporate Social Responsibility.
ethics Systematic moral judgments and principles of intrinsic value. High eth- ical standards are central to the credibility of *professions, and to the *corpo- rate governance standards of organizations, and they are often formalized in written codes of practice.
Further reading: Blank (2003); Dittenhofer (1983); Dittenhofer and Sennetti (1983); Preuss (1998); Shafer et al. (2001)
European Accounting Association (EAA) A European scholarly account- ing organization. Established in 1977 and headquartered in Brussels, Belgium, the EAA’s Web site states that it aims “to link together the Europe- wide community of accounting scholars and researchers, to provide a platform for the wider dissemination of European accounting research and to foster and improve research.” Its activities include an annual congress, workshops, and publication of the academic journal *European Accounting Review.
Web site: www.eaa-online.org
European Accounting Review A European scholarly accounting journal.
Established in 1992, the journal is published quarterly in English by Routledge on behalf of the *European Accounting Association, in both print and online formats. It focuses on academic research, and its notes emphasize
“its European origins and the distinctive variety of the European accounting research community.” The notes also draw attention to the journal’s “openness and flexibility, not only regarding the substantive issues of accounting
106• European Corporate Governance Institute
research, but also with respect to paradigms, methodologies and styles of con- ducting that research.” The journal frequently covers auditing topics.
Web link: www.tandf.co.uk/journals/routledge/09638180.html
European Corporate Governance Institute (ECGI) A European *corpo- rate governance body. The ECGI is based in Brussels, Belgium, and was launched in 2002 as successor to the European Corporate Governance Network.
Its primary objective, as stated on its Web site, is “to undertake and dissemi- nate impartial and objective research on corporate governance and undertake any other activity that will improve understanding and exercise of the highest standards in corporate governance.” The ECGI cooperates with other institu- tions in the field, like the *Global Corporate Governance Forum and the
*International Corporate Governance Network.
Web site: www.ecgi.org
European Federation of Accountants The English name of the *Fédération des Experts Comptables Européens.
Web site: www.fee.be
evaluation 1. The assessment of evidence. Evaluation skills are central to auditing, in both the assessment of *audit evidence and the reasoning used to arrived at *audit opinions. See also *assurance. 2.A *quantitative or *quali- tative measurement. For example, qualitative evaluations of staff performance are common in most large corporations.
event 1.A *transaction or significant happening in an organization that can influence an *audit opinion. 2.In *critical path analysis, a point that repre- sents the start or end of an activity or series of sequential activities. 3.In
*probability analysis, an outcome of an activity to which a probability estimate can be applied.
event after the balance sheet date A *material *event that can poten- tially affect *financial statements despite its occurrence after a *balance sheet date. An event of this type may lead to *disclosure in the notes that accompany financial statements, or to adjustments to financial statements. See also *con- tingent assets and *contingent liabilities.
evidence See *audit evidence.
examination 1.The inspection or investigation of a matter. The examination of records and procedures is central to the gathering and *evaluation of *audit evidence. An 1888 editorial of the *Accountantmagazine described an audit as “an intelligent examination of the *books” (quoted in Chambers, R. J., 1995,
executive remuneration • 107
73). 2.A formal test of competence or knowledge. Along with supervised work experience, examinations are central to the certification of auditors by *pro- fessional associations. 3.An archaic term for *audit.
exception An item that does not follow a general pattern. For example, an organization’s *internal controls may specify that all *disbursements over a given threshold should be *authorized by a senior employee. If this procedure is not followed in only rare cases, the nonadherence to the internal control may be deemed to be exceptions. Auditors are required to apply judgment to *errors to decide whether (i) they are merely isolated exceptions or (ii) they indicate a systematic breakdown in procedures and internal controls.
exceptional item A *transaction separately reported or disclosed in an
*income statement on account of its *materiality, unusual nature, or infre- quency. Exceptional items arise from normal operating activities, and exam- ples may include the write-off of a significant *accounts receivable balance, or unusually large *reorganization costs. A material, unusual transaction arising from events beyond the scope of normal operating activities is usually referred to as an *extraordinary item.
exception report A report of errors or other *exceptions arising from an activ- ity or procedure. Exception reports are convenient mechanisms for focusing on potential breakdowns in *internal controls, and they are a common management tool. Auditors also frequently use the contents of exception reports as *audit evidence. Exception reports may be either manually prepared or generated by a computer program.
exchange The buying and selling of items in a *market. Simple exchange is effected through *barter transactions, but in modern economies *money is used as the main medium of exchange.
exchange rate 1.The rate at which one unit of a *currency can be exchanged for one unit of another currency. 2.The *value of a commodity, good, or serv- ice measured in terms of its ability to be exchanged for other items, without the intermediary of *money. See also *barter.
executive director The British term for *inside director.
executive remuneration *Compensation paid to an organization’s *directors and senior *management. Levels of executive remuneration are a sensitive topic, and they are subject to *disclosure in financial statements under most systems of *Generally Accepted Accounting Principles. Other *corporate gov- ernance measures in this area can include (i) the existence of *remuneration
108 • exemption
committees to determine executive remuneration, (ii) the linking of remunera- tion levels to individual and organizational performance (including changes in the *value of a corporation’s *common stock), (iii) internal audits of executive pay, and (iv) the releasing of executive remuneration details to the media in the interests of openness.
Further reading: Keasey and Wright (1999)
exemption 1.The releasing of an individual from an obligation or responsibility.
2.A permitted deduction or exclusion from computations of taxable income.
ex gratia The giving of an item, such as a gift* or a payment of *money, without any obligation intended to be placed on the recipient. The term derives from Latin, and it usually refers to an action that originates from a moral decision rather than from a legal requirement.
existence Objective, verifiable reality. The *verification of the existence of both
*tangible and *intangible items is a fundamental *audit objective.
expectations gap Discrepancies between the expectations of auditors and the expectations of *auditees, other parties interested in an audit, and public opin- ion. The term is normally used in the context of external auditing, and it tends to be painfully apparent when external auditors are perceived to have failed to detect a corporate *fraud or other *material *irregularity in a corporation’s financial statements. The expectations gap has been described as “the differ- ence between how financial auditors are perceived (responsible for the detec- tion of *fraud) and how they see themselves (primarily responsible for forming a professional opinion on the financial statements)” (Power, 1994a, 24) and “a representation of the feeling that auditors are performing in a manner at vari- ance with the beliefs and desires of those for whose benefit the audit is being carried out” (Humphrey, 1991, 7).
Further reading: Sikka et al. (1998); Wolf et al. (1999)
expected value (EV) The quantifiable, expected result of a course of action whose outcome is uncertain. Expected values are often used in *decision theory, and are calculated by multiplying the expected outcomes of decisions by the
*probabilities of their occurrence. See also *decision tree.
expediting payment An alternative term for *facilitating payment.
expenditure *Money spent to cover *costs and *expenses. See *capital expen- diture and *revenue expenditure.
expense 1.A *cost incurred in a specific time period. Expenses are deducted from revenues in an *income statement to calculate *net income for a defined
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time period. The cost of *long-term assets is expensed to individual time periods through the mechanism of *amortization. The terms cost and expense are often used synonymously. 2.[plural] Travel expenses incurred for a business journey.
expert-comptable A French term that approximates to *Certified Public Accountant. It is used in France and in a number of other francophone countries.
In France the *Ordre des Experts-Comptablesis the professional association for *public accountants, while the Paris-based Fédération Internationale des Experts Comptables Francophones is a forum for French-speaking public accountants around the world.
exponential increase A quantifiable increase that becomes increasingly rapid.
exportation The selling of goods and services to customers based in a foreign country. Contrast *importation.
exposure draft A draft *accounting standard or *auditing standard that is dis- seminated for public comment and discussion prior to being finalized and issued.
extended trial balance A mechanism for the preparation of financial state- ments from a *trial balance. The listing of *general ledger accounts in a trial balance is “extended” by the recording of adjustments (like *accrued expenses) and reclassifications, and by the identification of each account with the *balance sheet and *income statement.
external audit An *audit of *financial statements by *independent individuals or organizations. *Robert Khun Mautz has suggested that “the role of [external]
auditing in an advanced economic society can be and has been stated in very simple terms—to add credibility to financial statements” (quoted in Flint, 1988, 6), while *Tom A. Lee has described external auditing as a “technical process to independently *verify and attest the quality of externally reported. . . financial statements” (1993, 115). Another definition has been offered by the American Accounting Association: “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 parties”
(American Accounting Association, 1973).
Modern external auditing is the result of almost two centuries of continuous evolution. It emerged as a *professional discipline in the United Kingdom in the nineteenth century, when the creation of limited liability *corporations
110• external auditing
resulted in separation of the providers of *capital from the managers who administered it. To monitor that investments were appropriately managed and controlled, the external auditing profession offered providers of capital an inde- pendent and objective opinion on published financial statements, traditionally the primary record of corporate accountability. As has been suggested, “capi- talism is a complicated enterprise, and the system won’t work without referees”
(Fox, 2003, 313).
The early emphasis of external auditing was on the detection of *errors and
*fraud, but it gradually developed into an assessment of the *fair presentation of financial statements. With the establishment of the *American Institute of Certified Public Accountants in 1887, external auditing’s center of gravity shifted from the United Kingdom to the United States, where it has since remained.
A notable feature of the external auditing profession is the existence of pow- erful auditing firms of astonishing longevity. The auditing firms of nineteenth century London included the forerunners of today’s global auditing and accounting firms. Among the names of London auditing firms in 1886 were several that have survived, in various combinations, to the modern era: Price, Waterhouse, and Cooper Brothers (now *PricewaterhouseCoopers) and Deloitte, Dever, Griffiths (now *Deloitte Touche Tohmatsu). See also *agency theory and *internal auditing.
Further reading: Flint (1988); Lee (1993); Porter et al. (2003); Power (1997);
Schandl (1978); Wolnizer (1987)
external auditing The process or action of undertaking an *external audit.
Although the gerund auditing places greater emphasis on action than the simple noun audit, the two terms are largely interchangeable.
external auditor An individual who performs an *external audit. In most countries, external auditors are drawn from the ranks of *Certified Public Accountants, or are individuals of equivalent *professional standing.
external audit risk See *audit risk (definition 1).
external control 1.Aspects of *corporate governance related to the controls exercised by *stakeholders over their interests in an organization. Elements of external control include (i) the preparation of published *financial statements, (ii) the *external auditing of financial statements, and (iii) other mechanisms of *accountability for *boards of directors. 2.The monitoring of *internal con- trols in a *vendor or other outside organization. For example, some retail cor- porations seek to ensure the achievement of their objectives by monitoring the activities and internal controls of their major vendors.