Auditor independence refers to the independence of the internal auditor or of the external auditor from parties that may have a financial interest in the business being audited. It ensures that auditors do not have any financial interest in the firms in which they are auditing.
Independence requirements are founded on 4 major standards:
An auditor can not audit their own work An auditor can not participate in the role of management for their client Relationships that create a shared or opposing interests between client and auditor are not allowed An auditor is not allowed to advocate for their client.
International codes and regulations frame independence using a principles-based approach. The IESBA International Code of Ethics identifies five categories of threats to independence—self-interest, self-review, advocacy, familiarity and intimidation—and requires accountants to apply safeguards when threats are not at an acceptable level. In audits of U.S. public companies, PCAOB rules (e.g., Rule 3520) require the audit firm and certain associated persons to be independent of the audit client throughout the audit and professional engagement period, alongside SEC independence requirements.
It requires integrity and an objective approach to the audit process, and requires the auditor to carry out his or her work freely and in an objective manner.
Auditor independence is commonly referred to as the cornerstone of the auditing profession since it is the foundation of the public's trust in the accounting profession.Lindberg, D.L. & Beck, F.D., 2004. Before and After Enron: CPAs' Views on Auditor Independence. The CPA Journal Online. Since 2000, a wave of high-profile accounting scandals have cast the profession into the limelight, negatively affecting the public perception of auditor independence.
Types of independence There are three main ways in which the auditor's independence can manifest itself.Mautz, R.K. & Sharaf, H.A. (1961) ‘The Philosophy of Auditing’, American Accounting AssociationDunn, J., 1996. Auditing Theory and Practice. 2nd ed. Prentice Hall. Programming independence Investigative independence Reporting independence
Programming independence Programming independence essentially protects the auditor's ability to select the most appropriate strategy when conducting an audit. Auditors must be free to approach a piece of work in whatever manner they consider best. As a client company grows and conducts new activities, the auditor's approach will likely have to adapt to account for these. In addition, the auditing profession is a dynamic one, with new techniques constantly being developed and upgraded which the auditor may decide to use. The strategy/proposed methods which the auditors intends to implement cannot be inhibited in any way.
Investigative independence While programming independence protects auditors’ ability to select appropriate strategies, investigative independence protects the auditor's ability to implement the strategies in whatever manner they consider necessary. Basically, auditors must have unlimited access to all company information. Any queries regarding a company's business and accounting treatment must be answered by the company. The collection of audit evidence is an essential process, and cannot be restricted in any way by the client company.
Reporting independence Reporting independence protects the auditors’ ability to choose to reveal to the public any information they believe should be disclosed. If company directors have been misleading shareholders by falsifying accounting information, they will strive to prevent the auditors from reporting this. It is in situations like this when auditor independence is most likely to be compromised.
Independence within different audit firms Different firms have different independence guidelines, with some being more strict than others. The types of software used to detect independence breaches or compliance also differ, with each firm preferring to have their own software.
In different types of audit Independence varies by whether the audit being conducted is internal or external.
Internal audits Independence of the internal auditor means independence from parties whose interests might be harmed by the results of an audit. To maintain independence and neutrality, internal adjudicators should report directly to the Audit Committee and have unrestricted access to all applicable information and labor force within the association. Specific internal management issues are inadequate risk management, inadequate internal controls, and poor governance. The Charter of Audit and the reporting to an Audit Committee generally provides independence from management, the code of ethics of the company (and of the Internal Audit profession) helps give guidance on independence form suppliers, clients, third parties, etc.
External audits Independence of the external auditor means independence from parties that have an interest in the results published in financial statements of an entity. The support from and relation to the Audit Committee of the client company, the contract and the contractual reference to public accounting standards/codes generally provides independence from management, the code of ethics of the Public Accountant profession helps give guidance on independence form suppliers, clients, and third parties.
Internal and external concerns are convoluted when nominally independent divisions of a firm provide auditing and consulting services.Bob Vause: Guide to Analysing Companies, Fifth Edition; Bloomberg Press, 2009 The Sarbanes-Oxley Act of 2002 is a legal reaction to such problems. Real independence and perceived independence There are two important aspects to independence which must be distinguished from each other: independence in fact (real independence) and independence in appearance (perceived independence). Together, both forms are essential to achieve the goals of independence. Real independence refers to independence of the auditor, also known as independence of mind. More specifically, real independence concerns the state of mind an auditor is in, and how the auditor acts in/deals with a specific situation. An auditor who is independent 'in fact' has the ability to make independent decisions even if there is a perceived lack of independence present, or if the auditor is placed in a compromising position by company directors. A number of difficulties lie in determining whether an auditor is truly independent, since it is impossible to observe and measure a person's mental attitude and personal integrity. Similarly, an auditor's objectivity must be beyond question, but how can this be guaranteed and measurement, but appears independent too. If an auditor is in fact independent, but one or more factors suggest otherwise, this could potentially lead to the public concluding that the audit report does not represent a true and fair view. Independence in appearances also reduces the opportunity for an auditor to act otherwise than independently, which subsequently adds credibility to the audit report.
Relationship with the client An auditor earns a living from the fee he is paid. It is therefore automatic that he does not want to do anything to jeopardize this income. This reliance on clients’ fees may affect the independence of an auditor. If the auditor feels this client income is more important than their responsibilities to shareholders he may not perform the audit with the shareholders' interests in mind. The larger the fee income the more likely the auditor is to shirk his responsibilities and perform the audit without independence. This could lead to the manipulation of figures and exploitation of accounting standards. By performing the audit without independence the shareholders may get misled, as the auditor is now reliant on the directors. To encourage auditors to maintain their independence they must be protected from the director's board. If they were able to challenge statements and figures without the risk of losing their job they would be more likely to work with complete independence. Ultimately, as long as the client determines audit appointments and fees an auditor will never be able to have complete economic independence.Auditor Independence - General
In most cases it is the directors that negotiate an audit contract with the auditors. This may cause problems. Audit firms on occasions quote low prices to directors to ensure repeat business, or to get new clients. By doing so the firm may not be able to perform the audit fully as they do not have enough income to pay for a thorough investigation. Cutting corners could mean the audit team would be reporting without all the evidence required which will affect the quality of the report. This would bring into question their independence.
Under what conditions an auditor is dependent on the client is an open question.
It is common for the audit firm of a company to provide extra services as well as performing the audit. Helping a company reduce its tax charges or acting as a consultant for the implementation of a new computer system, are common examples. Having this additional working relationship with the client would result in questions being asked of the independence of the audit firm. If non-audit fees are substantial in retaliation to audit fees suspicions will arise that auditing standards may be compromised. The firm would no longer be unbiased, as it would want the company to perform well so it can continue to earn the addition fee for their consultancy. This would mean the audit firm would be dependent on the directors and they would no longer be working with independence.
The AICPA defines a covered member as the following:
“an individual on the attest engagement team. an individual in a position to influence the attest engagement. a partner, partner equivalent, or manager who provides 10 or more hours of non-attest services to the attest client within any fiscal year. Designation as covered member ends on the later of (i) the date that the firm signs the report on the financial statements for the fiscal year during which those services were provided or (ii) the date he or she no longer expects to provide 10 or more hours of non-attest services to the attest client on a recurring basis. a partner or partner equivalent in the office in which the lead attest engagement partner or partner equivalent primarily practices in connection with the attest engagement. the firm, including the firm's employee benefit plans. an entity whose operating, financial, or accounting policies can be controlled by any of the individuals or entities described in items a–e or two or more such individuals or entities if they act together.”
Immediate family members of covered members (spouses, dependents) must comply with the same independence rules as the covered members. There are various situations in which independence could be impaired as a result of a covered member. For example, financial interest (direct and indirect), family relationship, employment, and consulting relationships (Vermeer, 2021).
By country Issues of audit have been delegated by the U.S. Congress to the Securities and Exchange Commission (SEC). As part of the Sarbanes-Oxley act the SEC has issued Requirements Regarding Auditor Independence.U.S. Securities and Exchange Commission: Strengthening the Commission's Requirements Regarding Auditor Independence; Title 17 CFR PARTS §210, §240, §249 and §274, final rule, 27 March 2003, https://www.sec.gov/rules/final/33-8183.htm Recently the SEC has followed up on cases where auditor independence is questionable William F. Sullivan, Thomas A. Zaccaro, and Adam D. Schneir (Paul, Hastings, Janofsky, & Walker LLP): The SEC's View of Auditor Independence; Bloomberg Law Reports -- Risk and Compliance, Vol.2 No.1, 2009.
United States