What is Auditor Independence & Why is it Important?
In October 2001, the world was shocked by the single biggest audit failure in the modern era. Known as the Enron Scandal, the repercussions following its lawsuit and bankruptcy are still talked about today, 20 plus years ahead. The Enron scandal generated much debate as well as legislation designed to improve accounting standards and practices today.
The accounting firm responsible was Arthur Andersen, then one of the “Big Five” accounting firms in the world (now Big Four). They were accused of unfair accounting in the wake of Enron’s bankruptcy, and it was asserted that they had confirmed Enron’s accounting practises to maintain their clients.
In response to the scandal, countries around the world started to propose and enact laws to ensure better bookkeeping and auditing, including the Sarbanes-Oxley Act that increases penalties for fabricating records or attempting to defraud shareholders.
Why are we discussing a case from over two decades ago? Because it is as relevant and important to learn about the need for independent auditing today. Here, we will talk about auditor independence and its importance to uphold the integrity of businesses.
What is Auditors Independence?
An independent auditor is a certified public accountant (CPA) or chartered accountant (CA) who is not affiliated with the business they are auditing. The independent auditor must be free from external influence or bias to be able to maintain integrity, make objective judgements and exercise appropriate professional scepticism when they examine the company’s financial documents and business operations. The inability for auditors to remain objective and independent will hamper an accountant’s ability to provide an honest opinion about a company’s financial information. Therefore, objectivity and independence are important ethical values for auditors.
Independent auditors are commonly used—or even required—to protect shareholders and potential investors from the occasionally misleading or misrepresentative financial assertions made by public corporations.
There is a code of ethics adopted by the Malaysian Institute of Accountants (MIA) and Institute of Singapore Chartered Accountants (ISCA) via their respective by-laws in Section 600 respectively (ISCA code-of-ethics, page 131).
To summarise, para 600.2 states that “Providing non-assurance services to audit clients might create threats to compliance with the fundamental principles and threats to independence”.
In addition, para 600.3 prohibits a firm or network firm from providing certain services to an audit client in certain circumstances because the independence threats created cannot be addressed by applying safeguards.
Under subsection 601 – Accounting and Bookkeeping Services, providing accounting and bookkeeping services to an audit client might create a self-review threat. Unless it is demonstrated that the audit firm provides accounting services that:-
- a) cover transactions or entries which are routine or mechanical in nature which require
little or no professional judgement; AND
- b) the firm addresses any threats that are created by providing such services that are
not at an acceptable level;
then a self-review threat may not exist.
Why does Auditor Independence Matters?
The idea and concept of auditor independence have long been promoted and upheld by professional auditing bodies around the world. An organisation’s compliance and transparency as well as many of its stakeholders depends on honest auditing.
Auditing, in this case financial auditing, is an impartial analysis and evaluation of a company’s financial statements to make sure they fairly and accurately reflect the transactions they claim to represent. They, therefore, rely on the auditor’s impartial evaluation.
The trustworthiness of the judgments and reports provided by auditors regarding financial audits is a factor for shareholders and other stakeholders to make confident assessments and decisions, such as divesting, investing, contracting or lending with the company.
What can your company gain from an Independent Auditor?
The audit’s findings can be used by company managers to keep internal processes up to pace. The audit can eventually lead to financial savings because it identifies waste and areas where the company is losing money. Audits may also highlight areas that need better internal controls and inspections.
In addition, written assurance from an unrelated source gives the financial records of a corporation more credibility in the eyes of an independent audit. The accuracy and validity of the financial information and records can help business owners secure external financing from lenders and investors. Inaccurate accounting information can increase a company’s tax liability that may arise from overstating income, inventory value or other items which can significantly increase the amount of taxes owed by the company.
Auditor independence can be compromised when said auditor also performs services other than audit towards the same clientele. Non-audit services include bookkeeping, financial system design and implementation, actuarial services, internal audits, outsourced services, and more.
Independence can be compromised when the auditor misuses his or her rights and responsibilities towards being an auditor. It can also be compromised due to the familiarity threat, where conflict of interest can happen when there is a close or long relationship with a clientele. Familiarity threat can happen when an audit member becomes too accepting of the client’s work. For example, individuals who handle general accounting functions and then perform audits on the same information may compromise the objectivity and independent views of that individual.
Therefore, the best way to prevent these conflicts that will compromise auditor independence is to refrain from having the auditors’ firm and partners doing any services other than auditing for or on behalf of their audit clients.
There are now laws and regulations intended to improve the accuracy of financial reporting for publicly traded corporations and to prevent another Enron scandal. It is the duty of business leaders and accounting departments to ensure trustworthiness and transparency for the benefit of all stakeholders.
The best way is to work with a firm that offers accounting as a distinct service that will ensure independence from conflicts of interest. Firms such as Ledgen has been handling accounting procedures for a variety of clients, focusing only on core professional outsource services.