Why is it important for external auditors to be independent?
In various business ventures there is a need for owners to effectively evaluate the performance of its management, investors need pointers to help them in decision-making concerning the sale and purchase of securities and bankers need to make wise decisions on loan provisions and other services. In order to carry out the activities mentioned above, financial statements are needed. Accounting ensures the communication of information about a business is done to those involved; shareholders, and management.
According to Elliot and Elliot (2004), this is done through financial statements which indicate the resources that are controlled by the management. There is a need for the analysis and verification of the financial statements and this is where the auditors come in. For the auditors to carry out their role effectively, independence is needed in order to ensure the highest possible level of objectivity and integrity is maintained.
The external auditor’s analysis of financial statements is dependent on the laws and rules set by that particular company, governmental organization or legal entity, (Elliot and Elliot, 2004). Through the support of Audit Committee of the client company, independence from the management, suppliers, clients or any other parties is made possible.
Independence can be exercised in three main ways. In Mautz and Sharaf’s view, Programming Independence is the first important means (1961). This ensures the auditor is not subject to interference from the client managers who may try to restrict or change the processes; the auditor intends to carry out during the audit. The auditor should be able to decide on the most effective strategy to undertake in the audit process. These strategies should however change in line with changes that may occur in the company in form of development and upgrades.
Subsequently, Investigative Independence provides the auditor with the ability to access the relevant records and materials required for the audit process. The management should be ready to cooperate with the auditor. This is in relation to the implementation process through unlimited access to all company information.
As stated by Dunn (1996), we have the Reporting Independence. Auditors should ensure the full disclosure of the information obtained in the auditor’s report. This should not be affected by loyalty to the client or any other factor for that matter. Auditor’s judgment and report content should not be altered in any way. In a situation where the company is found to have been providing false information in the financial statements that misled the shareholders, terms should be set to ensure they don’t prevent disclosure.
This independence is important in a number of ways. First, it enables the auditors carry out an analysis on the information provided by the management in financial statements without interference from the management. In the analysis and determination of whether the content is correct and comprehensive, the auditor should not be in a position where they can be influenced. Rather, they should be objective and have knowledge in auditing, accounting and financial reporting issues in order to effectively evaluate the statement, (Appah, 2011).
This independence enhances the credibility of the financial statements. An independent auditor is able to effectively carry out the audit process and if the audit report shows there are no irregularities or misstatements of any kind, it builds the confidence of the owners, bankers and investors in the business. This would not be possible if the above mentioned parties believe the performance of the auditor may be under the influence of other parties. In order to access investments, mergers, acquisitions and the capital market, an entity needs to ensure its financial statements have no errors or fraud, (The Institute of Chartered Accountants in Australia, 2012).
This independence prevents the occurrence of accounting scandals. These often result from the irregularities caused by inconsistencies occurring during the accounting process and compiling of financial statements. Baker (2005) illustrates that auditor’s independence is necessary in the entire auditing process and gaining of public trust. Evidence from previous scandals shows the adverse effects such scandals have on public trust.
Carrying out an audit involves the collection of enough evidence to ensure that the amounts contained in the financial statements and the disclosures have no mistakes whatsoever. An independent auditor will ensure this process is done well and that no information is omitted or ignored due to the influence from other parties. This provided an assurance for the management and shareholders, (Chartered Accountants in Australia, 2012). This is however not entirely effective due to the fact that accounting errors and misstatements are likely to be hidden in the financial statements even before the auditing process. The auditor may not be able to detect them all.
It also ensures the evaluation process carried out on the information obtained during the audit is done sufficiently. The auditor is required to evaluate whether evidence retrieved creates any issues in the client’s going concerns in the future. If not interfered with, the evaluation will provide useful information. Conversely, we do not know what the future holds and thus an auditor’s report is not enough to guarantee success of the business venture, (Chartered Accountants in Australia, 2012).
In the preparation of auditor’s report, the auditor is supposed to show his assurance in relation to the financial statement. An auditor who is not under the influence of another party will be able to provide his honest views and opinions on the content and presentation of the financial status and operational results of the business. In a case where he has differing views, he is able to incorporate them in the report.
Lack of this independence causes a series of problems. In some companies there is provision of non-audit services which result in economic dependence. For instance, the fall of Enron in 2001 was attributed to the lack of auditor independence. Enron’s former auditor Arthur Andersen was seen as lacking independence due to the fact that the accounting firm received less revenue from audit services in comparison to non-audit services. This in turn changes an auditor into an internal advisor and decision-maker thus compromising his ability to independently audit. The negative publicity is harmful to the firm; soon after, Enron declared bankruptcy (Lindberg and Beck, 2009). The clients often influence the auditor’s work at given circumstances. Deloitte seconded employees to client firms and this hindered the firm’s ability to be objective in the analysis of financial statements according to the International Auditing and Assurance Standards Board.
An auditor’s work is dependent on the client’s fees. This reliance on the client affects independence in that higher fees lead auditors to ignore responsibilities in auditing thus mislead shareholders. There are cases where the audit firms quote low prices in order to ensure repeated business and acquisition of new clients. The audit is not comprehensively performed due to the low income to carry out audit investigation. The reports are thus of poor quality and lack evidence. At KPMG, the auditor’s report was signed off before the work was completed. This wasn’t done once but at least three times (Accounting Web, 2010). It was also criticized for providing audit services to customers for more than seven years contrary to the need for rotational appointments.
According to Moizier (1991), the independence can be enhanced through a variety of ways. The first he recommended was the need to establish legal prohibitions of financial interests in client companies. This prevents the auditor from having any kind of financial interest in the client. Clear rules should be set to expose financial interests that may exist in relation to professional employees and any individual that may be related to them.
Auditors should only be allowed to provide audit services to a client for a specific period of time before a rotation of appointments is carried out and they provide services to a new client. This is however not popular with most auditors who claim the constant change may interfere with their performance.
A peer review should be done. This is essential and entails bringing in another auditor to analyze the workings of an audit firm to establish their effectiveness and quality of their service provision. An independent body in charge of appointment of auditors should be set up. This heightens the possibility of selection of auditors who operate effectively. This body should also be in charge of deciding on the audit fee.
In conclusion, the success of any business is dependent on the efforts of various parties. The management has the responsibility of ensuring all activities and transactions are appropriately done and indicated in its financial statements. The accountants need to ensure these transactions are compiled and recorded in financial statements which can be analyzed by the auditors. Successful audits and presentation of audit reports builds confidence in the business thus its success is certain. It will be able to attract investors and other parties. The auditor’s independence is crucial and should be upheld no matter what. Interference with the independence has far reaching consequences the business may not be able or ready to deal with.
References
Accounting Web, (2010) Lack of professional skepticism pervades Big Four audits says FRC, Available: http://www.accountingweb.co.uk/../449246
Appah, E. (2011) ‘Non-Audit Services and the Impairment of Auditors’ Independence’, Medwell Journals, vol. 8(1): Pages 100-107. Available:
Baker, R. (2005) ‘The Varying Concepts of Auditor Independence Shifting with the Prevailing Environment’, The CPA Journal Online, Available: < www.conference.cbs.dk/../653.pdf > [Accessed January 11th 2013]
Dunn, J. (1996) Auditing Theory & Practice, 2nd edition, London: Prentice Hall.
Elliot, B. and Elliot, J. (2004) Financial Accounting and Reporting, Prentice Hall: London.
Lindberg, L. D. and Beck, F. D. (2009) ‘Before and After Enron: CPA’S Views on Auditor Independence’, The CPA Journal. New York: Society of CPAs, Available: http://www.nysscpa.org/../p36.htm
Moizier, P. (1991) ‘The Image of Auditors’, Auditing and the Future, Institute of Chartered Accountants in Scotland, England and Wales, Available:
Mautz, R. K. and Sharaf, H. A. (1961) The Philosophy of Auditing, Florida: American Accounting Association.
The Institute of Chartered Accountants in Australia, (2012) Chartered Accountants Auditing and Assurance Handbook, Australia: John Wiley and Sons, Available:
