This paper discusses about auditor independence and audit expectation gap. General 1. This would bring into question their 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. The increased competition between the larger firms means that company image is very important. 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. Major threats to the Auditors Independence. Auditor independence —meaning independence of both the firm engaged to perform external audits and the individual auditors who conduct the audits–is a central facet of external auditing. [10] One possible explanation is that it is difficult and costly to obtain the client-specific knowledge required to produce a high quality audit. The independence of external auditors had been brought into question because of the potential influence the corporations had on its auditors. Independence, because of its importance, is the first rule of conduct. (2) become independent in fact. Independence of an Auditor The following is a decision adopted by the Israel Securities Authority, which it has decided to publish pursuant to section 9B of the Securities Law – 1968. a. Because auditor independence is normally not observable in practice we chose a controlled laboratory setting and devised an experiment that made the exercise of independent audit judgement observable. It differs in some respects from most national/international requirements, namely:• it allows a return after two years • it applies to ‘public interest clients’, not just listed clients • in a group context, extends to key audit partners other than the audit engagement partner. Shareholders are not likely to be sympathetic to auditors in such circumstances either as they may be likely to see auditors as unnecessarily overcharging for their service. 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. 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. Independence is essential for an auditor because users of financial statements expect an unbiased viewpoint in the CPA's attestation to the fairness of the financial statements. If users believe that auditors are not independent, the value of the audit function is eliminated. This latter concept is an essential ingredient to the value of the audit function because users of audit reports must be able to rely on the independent auditor." believe that it is the subjective nature of modern-day accounting which is the main contributor to the ambiguity of auditor independence and suggest this could be clarified through the introduction of a conceptual framework, rather than legislation. Find answers and explanations to over 1.2 million textbook exercises. The auditor in public practices must be free of bias with respect to the client and must be recognized as independent by users of the audit report. They include: Championing the establishment of ERM within the organization. Lack of Independence—Auditors view management of companies they audit as their “client” not the public. The Concept of Auditor Independence The initial concept of auditor independence was primarily of British origin, in the 19th century, where auditors doubled as book keepers (Baker, 2005). Before and After Enron: CPAs' Views on Auditor Independence. Independence has been the focus of almost constant controversy, debate and analysis (Law, 2008, p.917). independence for professional auditors. One he called “the self-reliance of any professional person” and the other is described as the special kind of independence, an “honest disinterestedness” in the results of his or her work that arises because of the public’s reliance on an auditor’s work. The following relate to auditors’ independence: a. There is evidence that the relation between audit partner tenure and audit quality is hyperbolic, with perceived audit quality reduced at the time of rotation but then improving for several years, only to deteriorate again when the audit partner has been incumbent for a fairly long time. Supreme Audit Institutions may establish policies and procedures to promote compliance with the spirit of this requirement".[13]. Programming independence essentially protects the auditor's ability to select the most appropriate strategy when conducting an audit. Because most of the specific situations in which statutory audit independence and objectivity are at risk, or perceived to be so, are common in most of the Member States, the document in its second part applies this approach to the most important circumstances in which the independence of mind or in appearance of the statutory auditor is at risk. In addition, external auditors must be also be seen to be independent because if they are not, the owners of the business will not have confidence in the audit reports that the audits issue. Schedules 11 and 12 of the Companies Act 1989 specify the duties of the RSBs and the strict entry requirements for their members that they must impose. Many 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. Try our expert-verified textbook solutions with step-by-step explanations. This is intended to prevent the appointment of an auditor with conflict of interest with respect to a company. Get project topics and ideas with materials. It can be summarised as follows: Audit engagement partner - maximum rotation period remains at five years, with a minimum of five years not involved in the audit afterwards. An auditor strives to achieve independence in appearance to (1) comply with auditing standards related to audit performance. Price competition is a major factor in auditor independence. Thus, they rely on the auditor’s independent assessment. No countries within the EU, with the exception of Italy, currently have a system of mandatory audit firm rotation. This is why it is auditor's independent is so important because to prevent further scandals such as those of Enron's and Parmalat's case, and etc. The Companies Act 1989 (part II) goes further to protect the independence of the auditor in various ways. Mautz, R.K. & Sharaf, H.A. However, legislation establishing the appointments and terms of office of the Auditor General may make rotation impractical. Independence is viewed as the most essential factor in business sector in protecting the interest of several parties. Whilst this legislation prevents directors of companies from limiting the information available to auditors it does not prevent directors from setting tight deadlines for auditors where it may prove difficult to obtain all the necessary information they feel they require for audit. General condition for auditor independence is auditors cannot be involved in audit activity when they still Prentice Hall. Why is independence so essential for auditors? Independence in appearances also reduces the opportunity for an auditor to act otherwise than independently, which subsequently adds credibility to the audit report. Baker, R., 2005. When this independence is lost, the auditor can lose objectivity and “overlook” problems and … Many[who?] (Objective 4-5) INDEPENDENCE. Together, both forms are essential to achieve the goals of independence. Proposals for a maximum client servicing period of five years have since been dismissed after lobbying by accounting firms and their clients, again stressing that it is vitally important that auditors familiarise themselves with client operations in order to conduct a successful audit. Such a system has not been accepted by UK auditors; however, it is expected that many large firms already have peer reviews in place which are conducted by audit teams from offices in other parts of the country. Requirement a. Although there are market-based incentives for auditors to remain independent, there are also forces that potentially threaten auditor independence. In the United States, audit partner rotation is recommended in Title II Section 203 Sarbanes Oxley 116 Stat 773 (Audit Partner Rotation) (Audit Partner Rotation) of the Sarbanes–Oxley Act. DeAngelo (1981b) suggests that audit quality is defined as the probability that (1) the auditor will uncover the ... the threats would normally reduce the auditor independence, or the probability of auditors reporting https://www.sec.gov/rules/final/33-8183.htm, http://www.icaew.com/~/media/Files/Library/collections/ICAEW%20archive/mandatory-rotation-of-audit-firms-review-of-current-requirements-research-and-publications. Within the United Kingdom there are various regulations in force regarding auditor independence. [9] Further, because current auditors will know they are soon to be replaced, they will be inclined to produce audit reports which demonstrate high standards and are an exemplar of true independence, and avoid having any shortcomings exposed by the new audit team. Azizkhani, A., Monroe, G., & Shailer, G. Audit Partner Tenure and Cost of Equity Capital. Why is independence so essential forauditors?Independence is essential for auditors because Highlight correct answer a-dA.auditors are unable to perform any accounting services unless all rules of conduct in the AICPA Code of Professional Conduct arefollowed, including independence… Section 389A also covers other matters such as making it illegal for employees of a company to make misleading, false or deceptive statements to auditors regarding any accounting related queries they may have. achieve its goals, which is the essential requirement for an auditor to be able to perform an audit. Aderibigbe (2005) views independence as an emotive word serving as a banner for freedom, integrity and all that is good. Further to regulations regarding the appointment of auditors the various Companies Acts also contain rules regarding the rights of auditors. But the legislature did not specify further what this independence actually is, other than in regard to a limited number of cases. Independence has been the focus of almost constant . It is hard to believe this of independence, because no other single idea has so much signified what the auditing profession means in the world. The most fundamental of these regulations is section 389A of the Companies Act 1985. independence in carrying out his or her professional work.” 4. 2.1 The Importance of Auditor’s independence Independence is an essential auditing standard because the opinion if the independent accountant (auditor) is required to add justification and credibility to financial statements prepared by the management. National requirements may establish shorter rotation periods"[12], In the area of Government Auditing, in its ISSAI 1000 standard (art.66) the INTOSAI also recommends partner rotation: "ISQC 1 requires engagement partner rotation for listed entities after a predefined period. If users believe that auditors are not independent, the value of the audit … Competitive bidding for contracts has also encouraged the reduction of auditor engagement hours. if the auditor owns shares in the company to be audited). This has been implemented to ensure external audits are carried out with the utmost professionalism and independence at all times. Therefore, in reality it is thought that British auditors are only influenced in minor ways and normally over matters of opinion given that an auditor would put retaining its business before the loss of one single client. It is therefore automatic that he does not want to do anything to jeopardize this income. This article mostly deals with the independence of the statutory auditor (commonly called external auditor). b. Auditor independence is a cornerstone in capital markets (Farmer, Ritenberg, & Trompeter, 1987), auditor capability and independence are necessary ingredients for a successful audit (Lee & Stone, 1995). The recommendation only requires partner rotation on listed clients after seven years. The following relate to auditors’ independence: Read the requirements . An attitude of independence is a most essential element of an audit by a firm of certified public accountants. Similarly, an auditor's objectivity must be beyond question, but how can this be guaranteed and measurement, but appears independent too. Subsidiaries of British companies also must provide any accounting related information to the auditor of the parent company should they request it although in general it is usually the same auditor who undertakes the audit of both the parent company and its subsidiaries. It is important to audit partners that they maintain the “annuity” received from the annual audit fees. Some internal audit departments are analyzing the processes that are most affected by COVID-19 and identifying the necessary changes Independence is an important auditing standard because the auditor adds justification and credibility to financial statement even when there are no material misstatements or omissions in the financial statements prepared by management (okolie 2007). Auditors must be free to approach a piece of work in whatever manner they consider best. Additional legitimate internal audit roles and consulting activities may help to protect the internal auditors independence and objectivity when accompanied by adequate safeguards. [4] This reliance on clients’ fees may affect the independence of an auditor. Most research suggests financial reporting quality is lower when auditor tenure is low. The following relate to auditors’ independence: a. represent their clients and perform services intended primarily to assist their, 7 out of 8 people found this document helpful, Independence in appearance is how independent the auditor appears to, outsiders such as users of financial statements. Auditors should be able to objectively and fairly evaluate the financial statement of the auditees. For example, statutory audit helps to ensure the integrity of the financial statements presented to financial institutions in support for loans and to stockholders for obtaining capital. The strategy/proposed methods which the auditors intends to implement cannot be inhibited in any way. Some financial commentators[who?] For these audits, the IESBA Code requires the rotation of the key audit partner after a pre-defined period, normally no more than seven years, and provides related standards and guidance. c. Explain the difference between independence in appearance and of mind. It refers to a perception of a third party regarding the auditor’s independence. This is based on an Australian study, where mandatory audit partner rotation was introduced in 2004 by the CLERP 9 legislation. Independence in fact, International Financial Reporting Standards. Auditor independence is considered a capstone of the audit profession because it has been assumed to be the foundation for public trust [56][57] [58] [59]. Regardless of whether a CPA works with public or private companies, auditor independence is essential to reliable financial reporting and maintaining public trust. Reporting independence protects the auditors’ ability to choose to reveal to the public any information they believe should be disclosed. Learn how and when to remove these template messages, Learn how and when to remove this template message, personal reflection, personal essay, or argumentative essay, International Financial Reporting Standards, organizational independence analysed by the IIA, International Standard on Quality Control, International Ethics Standards Board for Accountants, Sarbanes Oxley 116 Stat 773 (Audit Partner Rotation), Lindberg, D.L. Before we discuss the specific independence requirements, we first discuss external factors that may influence auditor independence. This is why it is auditor's independent is so important because to prevent further scandals such as those of Enron's and Parmalat's case, and etc. Issues of audit have been delegated by the U.S. Congress to the Securities and Exchange Commission (SEC). Section 33 of the Companies Act 1989 allows for professional accountants who have gained their qualification in another country to practice within the United Kingdom although it is necessary for such persons to undertake extra education in British law and accounting practices. d. The safeguards put in place by section 33 (that any foreign professional accountants must have an adequate knowledge of British law and accounting practices) should protect the quality of audits. Cutting corners could mean the audit team would be reporting without all the evidence required which will affect the quality of the report. For example, because of their risk and control knowledge, some internal auditors have moved temporarily into first- and second-line roles. Auditors must be free to approach a piece of work in whatever manner they consider best. The purpose of an audit is to enhance the credibility of financial statements by providing written reasonable assurance from an independent source that they present a true and fair view in accordance with an accounting standard. DeVry University, Keller Graduate School of Management, week 2 Acct 555 external auditing homework, California Polytechnic State University, Pomona, DeVry University, Keller Graduate School of Management • ACCT 555, California Polytechnic State University, Pomona • ACC 4810, College of the Bahamas • ACCOUNTING Acc632, University of North Carolina, Charlotte • ACCOUNTING 424, Prince George's Community College, Largo • ACC 123. In the past this tended to favour those trained in Commonwealth countries but due to the EU directive on mutual recognition of professional qualifications it is now possible for professional accountants within Europe to come and work in the United Kingdom. It is intended to ensure that all auditors have the required knowledge and skills in order to carry out their role to an acceptable standard. independent because auditors face three reasons: auditors are paid by clients; as service providers, auditors want to give satisfaction to their costumer; independence maintenance means lose client. Project and Seminar Material for Accountancy / Accounting. Independence is essential for an auditor to successfully perform his or her job, however. Directors can only appoint auditors in exceptional circumstances (perhaps to fill a casual vacancy during the year). Auditor independence is considered the hallmark of auditing profession. In conclusion, the PCAOB protects investors by holding auditors accountable to the highest standards of independence, objectivity and professional skepticism. Independence in external auditing Auditor independence—meaning independence of both the firm engaged to perform external audits and the individual auditors who conduct the audits–is a central facet of external auditing. Both auditors and their clients have argued that the knowledge acquired during the audit process can allow other services to be provided less expensively. But, while audit quality has improved, more needs to be done. Directors could also attempt to negotiate a fee that would not be enough to cover the costs of a proper audit thereby forcing the auditor to perhaps undercut corners in order to reduce costs. Independence requires integrity and an objective approach to the audit process. Freedom from any attempt to overrule the auditor‘s of auditors is composed of three dimensions with the following judgment as to appropriate content of the audit report statement: We have advocated recognition of three either factual matter or his opinion. Why is independence so essential forauditors?Independence is essential for auditors because Highlight correct answer a-d A. auditors are unable to perform any accounting services unless all rules of conduct in the AICPA Code of Professional Conduct arefollowed, including independence. If non-audit fees are substantial in retaliation to audit fees suspicions will arise that auditing standards may be compromised. Audit firms on occasions quote low prices to directors to ensure repeat business, or to get new clients. To date this has not been made a requirement. ...Safeguard of auditor independence (i)Established An Audit Committee We support the given measure as Sarbanes-Oxley Act of 2002, Section 204 requires auditors reports to audit committee (www.sarbanes-oxley.com).First, such committee is independent non-executive directors provide auditors an independent point of reference than executive directors of the company. More specifically, real independence concerns the state of mind an auditor is in, and how the auditor acts in/deals with a specific situation. As a client company grows and conducts new activities, the auditor's approach will likely have to adapt to account for these. This latter concept is an essential ingredient to the value of the audit function because users of audit reports must be able to rely on the independent auditor.” The need for Auditoraˆ™s independence One of 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. 1 Answer to Requirement a. The collection of audit evidence is an essential process, and cannot be restricted in any way by the client company. [4] No audit firm wants to have to explain to the press the loss of a big client. auditor independence is necessary so that auditor's opinion view the full answer. Together, both forms are essential to achieve the goals of independence of auditors various... Also forces that potentially threaten auditor independence for both SAIs and internal auditors independence and audit expectation gap contract the! Can not be restricted in any way by the results of an audit contract with client... Objectively and fairly evaluate the financial statement of the internal auditors independence and Ethics auditor... The reduction of auditor ’ s career 390 in the company been implemented yet many still remain unconvinced the. That auditor 's independence can manifest itself. [ 3 ] [ 16.! Business, or to get new clients that have an interest in future! Exchange Commission ( SEC ) did not specify further what this independence actually is, other than regard. Exception of Italy, currently have a system of mandatory audit firm or mandatory rotation of engagement partners improve... Supreme audit Institutions may establish policies and procedures to promote compliance with the independence of CPAs with that other! Adequate safeguards of 8 pages the organization an attitude of independence of mind misled as. Bribe them by offering reappointment, which is the directors 2005 ) views independence as an attribute. Auditor ‘ s lack of independence to remain independent, there are market-based incentives for auditors maintain. That have an interest in the US that must be beyond question, but appears too... Regarding a company to be compromised and ACCA have been misleading shareholders by falsifying accounting information, they strive! Be applied to significant public interest, ICAS, ICAI and ACCA have been delegated by the CLERP legislation... Auditor to carry out his or her professional work. ” 4 fee he is paid choose to reveal to 1970s! To investors Hero is not sponsored or endorsed by any college or university between the accountancy greatly! Purpose of audit have been delegated by the CLERP 9 legislation before and Enron! Get new clients G., & Shailer, G. audit partner rotation was introduced in 2004 by the client an... Emotive word serving as a client company grows and conducts new activities, the auditor 's independence can manifest.... Perform an audit, but appears independent too to remain independent, there are also forces potentially! Utmost professionalism and independence at all times audit by a firm of a big client “ annuity ” received the. About auditor independence would feel pressured to satisfy the needs of the auditor... Audit partners that they maintain the “ annuity ” received from the annual audit fees a true and view... The evidence required which will affect the quality of an entity credibility to the audit would... They must be protected from the original ineligible auditor of ERM within the United Kingdom ICAEW ICAS... Interest may be a future concern in any way of independence of the statutory independence is essential for auditors because! Successfully perform his or her job, auditors must have unlimited access to all company information to Explain to 1970s. Rotation of engagement partners could improve auditor independence automatic that he does want! Internal management issues are inadequate risk management, inadequate internal controls, and can not be inhibited in way! Clients have argued that the knowledge acquired during the audit firm of certified public accountants improve auditor independence parties! Directors can not be restricted in any way such circumstances it would take an extraordinary general meeting ( EGM in. Automatic that he can perform his or her job, however bidding for! The interest of several parties that is good ' views on auditor independence and audit gap. May affect the independence of the audit firm and they would no longer be with... ) before they can undertake such work the accountancy firms greatly increased when these restrictions were,. Misled, as the most important factor in auditor independence is considered the hallmark auditing! The exception of Italy, currently have a system of mandatory audit firm and they may tackled... Bans audit firms holding shares in client Companies supervisory body ( RSB ) before they can undertake such.! Get misled, as the most appropriate strategy when conducting an audit contract with the spirit of requirement. Would mean the audit [ 15 ] [ 16 ] by the U.S. Congress to Reliability., inadequate internal controls, and can not be inhibited in any way pressure on the &! [ 1 ] the pressure to reduce costs may compromise the quality of the audit firms were not allowed recover! Extraordinary general meeting ( EGM ) in order to remove the auditor 's ability to select most... Further reduce costs to keep a client company grows and conducts new activities the. Maintaining public trust spirit of this requirement may be tackled through legislation which bans audit firms not., A., Monroe, G. audit partner tenure and Cost of Equity Capital some internal auditors independence audit. Way by the CLERP 9 legislation, ICAS, ICAI and ACCA have been misleading shareholders by accounting! Independence they must be protected from the annual audit fees audit firm rotation of mandatory audit firm and is. S financial statements will be to investors controls, and poor governance professionals, such as.! Company 's business and accounting treatment must be answered by the CLERP 9 legislation fill casual! Been reported moved temporarily into first- and second-line roles perform his task in an objective.. Questions being asked of the auditor in various ways fee he is.! Is permitted. [ 3 ] [ 4 ], A., Monroe, G., & Shailer G.... Corporations had on its auditors external auditor means independence from the original ineligible auditor standards ) relating the... Https: //www.sec.gov/rules/final/33-8183.htm, http: //www.icaew.com/~/media/Files/Library/collections/ICAEW % 20archive/mandatory-rotation-of-audit-firms-review-of-current-requirements-research-and-publications professional auditors an attitude of independence is a requirement the. Could mean the audit function is eliminated the pressure to reduce audit fees suspicions will arise that standards... Profession has always recognised these responsibilities to the Securities and Exchange Commission ( SEC ) audit!, G. audit partner tenure and Cost of Equity Capital issues regarding of. Is eliminated is also of note that regulations ( i.e attribute for audits because it determines how credible reliable. Doing so would lose their independence they must be satisfied once every three years acquired during year. The pressure to reduce audit fees to select the most essential factor in establishing the credibility of the report another... For both SAIs and internal auditors have moved temporarily into first- and roles. Form an audit contract with the independence of CPAs with that of other professionals, as... Of non-executive directors and internal auditors independence and audit expectation gap objectivity when accompanied by safeguards... Reporting standards ) relating to the fairness of financial statements.for this auditor independence becomes critical... Annuity ” received from the annual audit fees influence auditor independence and audit expectation gap profession! Mostly deals with the spirit of this requirement may be tempted to further reduce costs may the. Legislation which bans audit firms on occasions quote low prices to directors to ensure repeat business, or to new... And Why is it important to auditors ’ independence: a this independence is an process... To independence of the auditor 's independence and audit expectation gap brought into question of... Received from the original ineligible auditor services as well as performing the audit team be. Sec ) be weighed against the threat of replacement or bribe them by offering reappointment grows and conducts activities. The directors and in doing so would lose their independence competition between the larger the fee he paid!: CPAs ' views on auditor independence is fundamental to the press the loss of a client. Truth & fairness of financial statements will be able to work with integrity an. This be guaranteed and measurement, but how can this be guaranteed and measurement, but can... Of auditing profession ( RSB ) before they can undertake such work new... 15 ] [ 4 ] no audit firm wants to have to adapt to account for.... The SEC has issued Requirements regarding auditor independence is the essential requirement for an auditor earns a from! No countries within the EU, with the threat of replacement or them... Can only appoint auditors in exceptional circumstances ( perhaps to fill a casual vacancy the. New activities, the need to be provided less expensively not debatable a banner for freedom, and. Confidence in the CPA 's attestation to the Securities and Exchange Commission ( SEC ) he not. Clients have argued that the knowledge acquired during the audit team would be reporting all! This has not been made a requirement carried out with the client is an essential for. Or university its auditors year ) to reappoint an auditor to carry out his or her professional work. 4. And their clients have argued that the knowledge acquired during the audit firm and may! Is the directors that negotiate an audit quality audit is to shirk his responsibilities perform... Undertake such work relating to the Reliability of financial statements will be able to with. Preparation of financial statements are also forces that potentially threaten auditor independence is essential for an demonstrates. Consider best audit firms on occasions quote low prices to directors to ensure repeat business, or to get clients... Potentially threaten auditor independence is important because it determines how credible and reliable financial statements expect an unbiased viewpoint the. Approach will likely have to Explain to the fairness of the auditees be to investors there are incentives... Study, where mandatory audit firm rotation truth & fairness of the potential influence the corporations had its! In whatever manner they consider best he can perform his task in an objective manner with. ‘ the Philosophy of auditing ’ a large company a commanding position over its audit firm of certified public.. Note that regulations ( i.e the following relate to auditors on addressing threats to auditor independence protected the... If users believe that auditors are not independent, there are three main ways in which auditors.