Auditor’s independence; Reality or an illusion?

//Auditor’s independence; Reality or an illusion?

Auditor’s independence; Reality or an illusion?

Independence is perceived to be an important corner stone in auditing theory. A little consensus is there on the notion that an auditor can maintain independence when the client is paying for the audit job. Certain threats are identified to coup with, in order to ensure the independence of an auditor. The purpose of this essay is to outline the independence of an auditor, the threats to the independence of an auditor and some suggestions to create an environment that would minimise these threats and bring back users reliance on the integrity of financial statements.

Independence occupies an important attribute of external auditors. As the financial statements needs to be reliable for use by investors, creditors, financial institutions and public at large, much reliance is placed on auditor opinion. This reliance becomes more important when it is perceived that audit has been done in an independent fashion. The adverse can leave negative impact on the financial statements reliance.

Auditor independence is always debated as questionable because it is the client who pays the auditor for expressing his/her opinion. Logically speaking an auditor will not go against its own client by giving a negative opinion. This phenomenon raises queries by the users of financial statements. However, independence can be ensured with compliance of a legislative framework. This along with other measures can minimise, to certain extent, the doubts about the auditor independence.

 What is independence?

Independence refers to state of integrity, honesty and objectivity. A man can be held to be independent only when his higher or rational self, or his ideal personality, determined his actions. “Independence” means independence of mind and independence in appearance.

(Reiter, SA & Williams, PF 2004, “The philosophy and rhetoric of auditor independence concepts”, Business Ethics Quarterly, vol. 14, no. 3, pp. 355-376)

What is auditor independence?

Independence concept associated with professional man is the concept of independence in fact. The term independent auditor was first used in the sense of independent contractor – to distinguish the auditor offering his services to the public generally from an auditor employed by a company. (Reiter, SA & Williams, PF 2004, “The philosophy and rhetoric of auditor independence concepts”, Business Ethics Quarterly, vol. 14, no. 3, pp. 355-376)

Independence is the way an auditor demonstrates that his job has been done in an objective manner. The need for independence arises because users of financial statements do not have sufficient information or knowledge to understand what is contained in a company’s annual accounts. (Importance of auditor independence. www.corplaw.ie/blog/bid/369348/importance-of-auditor-independece)

An auditor’s independent is important because the financial statements are believed to be reliable after the audit has been done. Users of financial statements will only rely on the auditor’s opinion if that is given independent of the entity and management of the client being audited

How an auditor can be independent when paid by the client?

In the literal sense it is unrealistic to assume that anyone can attain absolute independence. No human being can free himself from all outside influences – from his environment. (Reiter, SA & Williams, PF 2004, “The philosophy and rhetoric of auditor independence concepts”, Business Ethics Quarterly, vol. 14, no. 3, pp. 355-376)

It is an open secret that audit firms are active rivals in audit pricing and competency for undertaking an audit, but there are very few occasions when they compete with each other in respect of independence. In fact they always try to increase their revenue target by offering multiple services on top of audit service.

A high profile example would be the relationship between Enron and their auditors, Arthur Andersen. In 2000, Andersen received $27m for non-audit services, compared with $25m for audit services, meaning Enron accounted for over 25% of the fees generated by the firm’s Houston office. In the aftermath of Enron’s demise, the accounting firm was accused of not acting independently and suggestions were made that they had gone along with the accounting practices in Enron in order to retain their work. (http://www.corplaw.ie/blog/bid/369348/Importance-Of-Auditor-Independence)

Hence keeping in view the financial incentives and a fear of being fired makes an auditor’s role less independent because the auditors is paid by the client and giving an adverse audit report means losing the client. This is the basic question and assuring the independent is so complex because auditor is the focal person both, by the management and by the third parties who are taking financial statements along with the audit report as the reliable documents because an independent auditor has audited these.

Threats to auditor independence

The following lines shall describe some of the main threats an auditor’s independence face today.

(6 key threats to auditor independence; https://www.intheblack.com/articles/2015/01/06/6-key-threats-to-auditor-independence)

  1. Self-Review threat – these occur when the auditor has also prepared some of the accounting for the client.
  2. Self-interest threat – an auditor has only one client or one client represents a significant proportion of their business. Their independence is threated because they’ll likely to want to issue qualified audit opinion or something that will cause an issue for the client because they’re worried about losing the client.
  3. Multiple referral threat – this arises when an auditor receives a large number of referrals from the one client, which can also be characterized as self-interest threat. Issuing a qualified report could impact on that referral relationship an in turn impact on their business.
  4. Ex-staff and partner threat – this happens when a staff member or partner leaves their own business and performs audits for their former employer.
  5. Advising threat – this threat occurs when the auditor provides non-audit services to the same client.
  6. Relationships threat – relationship threats are broad and generally cover anything that involves the auditor knowing the client staff, directors at personal level. If an auditor has close family relationship within the client business, independence can be doubtful.

The above-mentioned threats give us an idea how the independence of an auditor is under threat. Keeping in view the importance of this job, some checks and hurdles are required to off set these threats. Described below are some.

Ways and means to ensure auditor independence

An appropriate accounting framework and professional code of conduct can enhance the independence of auditors. A corporate governance framework and/or professional bodies rules can be a good check to maintain independence of an auditor.

Most of the auditors perform non-audit advisory and consulting services, that is a big threat to auditor independence. A complete ban or restrictions on provision of non-audit advisory services can be a solid check on the auditor conflict of interest. In Australia a complete ban was rejected when CLERF 9 Act reforms were introduced, because this creates some other issues besides assurance of auditor independence. (Australian Auditor independence requirements, a comparative review)

A restriction on employment of former audit partners and/or senior audit personnel within client is a good measure. However, in case of employment a minimum of cooling-of period is mandatory as in Australia this period is 2 years, Sarbanes Oxley Act suggests one year.

Section 324CK of the Corporations Act 2001 restricts employment of multiple former audit partners. This in conjunction with above measure will restrict the former audit partner or key audit personnel to seek employment in the client.

Rotation of auditors is another effective measure to protect the auditor independence because when an auditor already knows the retirement after certain period of time his/her work will be more neutral and transparent as opposed to a situation when the job is being done indefinitely.

Another proposal was tossed to create an independence board, that will watch the independence of auditor after having reviewed the quality of audit, relations with client, provision of other services like non-audit advisory etc. this board established should work under the auspices of a professional body or a consortium of multiple professional bodies.

Auditor independence is a pre-requisite for the financial statements for these to be reliable. Different circles raise question about auditor independence as the client pays him. In such a situation how can an auditor go against the client by expressing a negative opinion to maintain his/her independence? The severance of this question can be minimised by:

  • Ensuring a proper legislative framework to govern corporations and audit proceeding
  • Restrictions and regulation on some non-audit duties by the auditors
  • And a watchdog role by the professional bodies in conjunction with legal regulations and Government regulatory bodies like ASIC.
By | 2017-10-09T03:46:27+00:00 October 9th, 2017|Categories: Assurance|Tags: |0 Comments

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