Auditor Independence: Meaning And Importance In Essay.

Defining Auditor Independence

Questions:

1.What It Means For An Auditor To Be Independent?

2.How Can An Auditor Be Independent When Being Paid By The Client?

When it comes to conducting an audit of a client for which he or she is being paid, the theory of independence in the conduct of work plays a lead role. The auditor independence is crucial from the view point of an external auditor. An auditor’s independence is coupled with truthfulness and impartiality in the approach of the audit process. Thus the profession desires the professional to carry on the work of the audit in an independent manner thus ensuring that his work is not impacted by any such acts of the client which would bring disrepute to the profession. The said essay focuses upon the fact as to what does independence in the field of auditing mean and how can he or she carry on the work of an audit independently without any biasness, specifically when the client is paying him for the work. This is the area wherein the auditor’s independence is seen to be at risk as is rightly narrated by Reiter and Williams in their journal article named ‘The philosophy and rhetoric of auditor independence concepts.’ As is rightly said by them, the audit work should be conducted in a free manner is generally seen to be in trouble simply because of the financial arrangement that they have with the client. Thus the essay mainly emphasises upon this area, describing about how an auditor can behave and act independently in spite of being paid by the client (Kueppers, & Sullivan, 2010).

1. The first question that arises while conducting an audit is whether the same is being done in an independent manner or not. The main objective behind getting the audit of a company is to express an opinion which is impartial, unbiased and dependable in nature for those who are utilising the said opinion to take investment related decisions or regulatory decisions. Thus for an auditor to be independent in his opinion he is required to be independent from his mind as well as in his conduct (Elliott, & Jacobson, 2006). By the former it means that the auditor should have such a mind set that allows him to express an opinion in such a state wherein he is not being impacted by any undue influences that would compromise on his expert judgement thus giving room for an individual to perform his functions of an audit with integrity and objectivity. The latter defines that an auditor’s appearance plays a very important role in the independence. If he appears to be independent in his conduct to the client, then his chances of missing out on material information also minimises (Fearnley et.al. 2005).

As per AU 220 of AICPA defines the auditor independence as an auditor being unbiased and unprejudiced with regards the client else the professional would have to compromise on the impartiality which is a must for the dependability of his opinions irrespective of the technical proficiency that the auditor may possess (Fontaine & Pilote, 2012).  Further to this the International Federation of Accountants lays down a ruling that those who are part of the assurance team should always pursue to find out any possible conflicts and threats to independence, evaluate the same with regards the impact of the same on the conduct of the work and if the threats are very significant then the auditor should try to eliminate such threats so as to bring it down to an acceptable level. However if the same cannot be done so then the auditor should refuse to conduct the audit.

Types of Auditor Independence

The auditor’s independence can be of two types i.e. actual and perceived. As the word actual means definite, auditor independence in the actual sense means that the same is visible and is straight forward. If the auditor has any kind of a financial relationship with the client apart from the audit fees that he is to receive in lieu of the work he performs, then the auditor’s actual independence is said to be hindered (Almer, & Olazabal, 2001). However perceived independence is to arise when there are shades of grey creep in to the normally black and white world of audit. Thus it simply means that due to a linkage between the auditor and the audit client it may seem that there is an agreement between the two and thus it is in such a circumstance that the professional judgement plays a vital role (Haste, 2015).

It can be rightly said that the issue of auditor acting independently is very pivotal in nature and equally crucial for the profession as well. Independence has become an important auditing standard simply because the opinion stated by an auditor adds to the explanation and creditability of the financials of a company even if the company has not made any such statement which is false and misleading (International Organisation of Securities Commission, 2002). Due to corporate failures such as that of Enron that has occurred in the past, has made the standards related to auditor independence more comprehensive and rigorous. However after such failures also it is understood that the independence needs to be strengthened day in and day out due to the kind of mishaps and bankruptcies which have taken place specially the one which took place was the Global Financial Crisis in the year 2008 with the failing of Lehman Brothers (ASIC 2001).

2. The said issue with regards the fact that the auditor is being paid for the audit being conducted by the client may hamper the independence in his conduct is still unresolved. There have been several doubts with this issue specially with regards the external auditors. Due to the fact that they are being paid by the client for the conduct of their company’s audit, thus until and unless a strong corporate governance measure is not put in line, the firm of auditors may express such opinions that are influenced by the desire to maintain good relation with clients so that their work is not taken away. If this is the situation then the fact the opinion would be true and fair becomes questionable and the shareholders are unable to rely on the opinion (Icaew.com., 2016).

As is said by Reiter and Williams in the article ‘The philosophy and rhetoric of auditor independence concepts’, the metaphor Independence Is Separation has come due to the existence of the separation model which details about the independence of auditors. It says that the various threats which an auditor faces has lead to the requirement of separation so that independence in the conduct of an auditor can be achieved successfully. One such threat is the self interest threat which is said to arise due to the audit fees which an auditor receives from a client for the work being done by him. Secondly, another metaphor used for defining the independence of an auditor with regards the audit fees they receive is Independence As A Matter Of Interest, which states that the financial interest of an audit firm would provide an assurance with regards apt behavioural conduct. There lies an assumption that the independence is widespread simply due to the supremacy of financial inducements for intention auditing even after considering the potential prejudice of receiving audit fees, the auditor at the same time also has a dominant attention  towards safeguarding the reputation of the audit firm as well. As per the two authors, these principles are basically based on the financial concepts such as materiality and the cost/benefit analysis.

Importance of Auditor Independence

The auditing firms at times agree to receive such audit fees which is less than the actual market rate simply to secure the work and further cover up the deficit by conducting various non-audit services for the client. One of the most eminent example which showed the influence of the auditor with regards the audit fees being charged is the case of Enron, when in the year 2000, Anderson had received a fees of $27m for conducting non-audit services in comparison to $25m for the audit conducted. Due to this the company fell down and the reason was the fact that the auditor failed to perform his duties independently and it was proved that the professionals had compromised with the accounting simply to ensue that the work is not given to someone else (corplaw.ie., 2014).

Further to this, it is true that the auditors always try to ensure that they are able to retain their clients but the same should be done not by compromising with the audit independence but by extending good service to the client (Franzel, 2014). Thus if the audit fees is significant to the total revenue of a CPA then he would ensure to go out of his way to retain which would also mean compromising on the independence as well.

Conclusion

Thus on a concluding note it can be rightly said that an auditor should conduct an audit independently, so as to ensure that the profession is not disrespected and the external shareholders are being able to take informed decisions with regards the company’s actual performance. Such a reliance is what increases the creditability of both the firm as well as the company. One major threat to auditor independence is the audit fees which has led to various crisis in the past. Thus in order to be independent with regards the audit fees that an auditor receives, he or she should ensure that the fees does not form a significant part of the total earnings of the audit firm. However an auditor should act in a professional manner as without performing the audit function independently, the main reason for such an appointment gets defeated.

References:

Almer,E.D., & Olazabal,M., (2001), Independence and Public Perception : Why We Need to Care, Journal of Accountancy [Online], Available at https://www.journalofaccountancy.com/issues/2001/apr/independenceandpublicperceptionwhyweneedtocare.html (Accessed 06th May 2017)

ASIC., (2001), Auditor Independence and audit quality, Available at https://asic.gov.au/regulatory-resources/financial-reporting-and-audit/auditors/auditor-independence-and-audit-quality/ (Accessed 06^th May 2017)

Corplaw.ie., (2014), Importance of Auditor Independence, Available at https://www.corplaw.ie/blog/bid/369348/Importance-Of-Auditor-Independence (Accessed 06th May 2017)

Elliott,R.K., & Jacobson,P.D., (2006), Auditor Independence concepts, The CPA Journal, 68(12), Available at https://raw.rutgers.edu/docs/Elliott/06Audit%20independence%20concepts.pdf (Accessed 06^th May 2017)

Fontaine,R., & Pilote,C., (2012), Clients’ Preferred Relationship Approach with their Financial Statement Auditor, Current Issues in Auditing, vol.6, no.1, pp. 1-6, Available at https://aaapubs.org/doi/pdf/10.2308/ciia-50116?code=aaan-site (Accessed 06^th May 2017)

Franzel,J.M., (2014), The Importance and Positive Impact of Independent Audit Oversight, Available at https://pcaobus.org/News/Speech/Pages/11192014_FranzelIARI.aspx (Accessed 06th May 2017)

Haste,J., (2015), The fundamental importance of auditor independence, Available at https://www.intheblack.com/articles/2015/11/05/the-fundamental-importance-of-auditor-independence (Accessed on 06th May 2017)

International Organisation of Securities Commission, (2002), Principles of Auditor Independence and the Role of Corporate Governance in Monitoring an Auditor Independence, Available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD133.pdf (Accessed 06th May 2017)

Icaew.com., (2016), Auditor Independence Approach, Available at https://www.icaew.com/en/technical/ethics/auditor-independence/auditor-independence-approach (Accessed 06th May 2017)

Fearnley, S.,Beattie, V.& Brandt, R. (2005) Auditor independence and audit risk: a reconceptualisation. Journal of International Accounting Research 4(1):pp. 39-71.

Kueppers,R.J., & Sullivan,K.B., (2010), How and Why an independent audit matters, International Journal of Disclosure and Governance, 7(4), pp.  286-293, Available at https://link.springer.com/article/10.1057%2Fjdg.2010.22 (Accessed 06^th May 2017)