The advocacy threat: The auditor becomes involved in actively promoting or defending the client’s interests. Diekmann, S.M. The governing board should be able to ask the internal auditor give them a true picture of what is going on inside their entity. The auditor also depends on the management of the company to secure its re-appointment as auditor. 6. Independent auditors serve an important role at companies large and small, ranging from corporations to nonprofits. Messick, “Equality, Fairness, and Social Conflict,” Social Justice Research, volume 8, 1995, pp. 5. Pages 797-823 Received 01 Mar … Christopher Koch Business School, University of Mannheim , Germany Correspondence ckoch@bwl.uni-mannheim.de. hbspt.cta._relativeUrls=true;hbspt.cta.load(43760, 'f594cd6d-1766-420f-9dc5-73ba7ad39684', {}); Pearse Trust are an international provider of corporate and trust structures. For an audit report to be worth its salt, the auditor who prepared it must be seen to be, and actually be, truly independent and free of any undue influence. 153–173; and. Mary … Similarly, an … That auditor cannot be a fiduciary. By Josephine Haste. Let me take you back to your time at university. How can an internal auditor be truly independent? Legal decisions support this conclusion." Underlying the positions historically taken by the SEC and its staff is Rule 2-01(c)(4)(i)(B) of its Regulation S-X, which prohibits an auditor of a client that is subject to the SEC independence rules from preparing, or substantially assisting in the preparation of, the audit client’s financial statements. Unlimited digital You must sign in to post a comment.First time here? Issue. See G. Loewenstein and J. Elster, Choice over Time (New York: Russell Sage Foundation Press, 1992); G. Loewenstein, “Behavioral Decision Theory and Business Ethics: Skewed Trade-offs between Self and Other,” in Messick and Tenbrunsel (1996). Investors in the Miniscribe Corporation maintained that auditors were at least partially responsible for the now-defunct company’s falsified financial statements; at least one jury agreed, holding the auditors liable to investors for $200 million. C.E. Accounting firms sometimes engage set audit fees at less than the market rate and make up for the deficit by providing non-audit services, such as management consultancy and tax advice. Independent fiscal councils have been abolished by governments that see their independence as an unacceptable threat. We believe this sets an artificial distinction between the value of income from different sources. A federal jury unanimously found Coopers & Lybrand liable to a group of investors on fraud charges. Self-interest threat: Where an auditor is financially dependent on the audit client or where an auditor or someone closely associated with him has a financial or other interest in the audit client. Ultimately, as long as audit appointments and fees are determined by the company being audited, the auditor can never truly be economically independent of the client. In the wake of the U.S. savings and loan crisis, audit firms faced a barrage of lawsuits, paying hundreds of millions of dollars in judgments and out-of-court settlements for their involvement in the financial reporting process of savings and loan clients that eventually failed. APES 110 Code of Ethics for Professional Accountants. The concept of independence means that the auditor is working independently carrying out the objectivity of his audit performance. These independence issues have been created over more than a century, so there’s no quick fix available. Ultimately, as long as audit appointments and fees are determined by the company being audited, the auditor can never truly be economically independent … Auditors have to be independent, where the process has to be free from outside control and interference by any parties. 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. 11. American Institute of Certified Public Accountants Code of Professional Ethics, 1988. The GAO review involved more than For an audit report to be worth its salt, the auditor who prepared it must be seen to be, and actually be, truly independent and free of any undue influence. Company managers can use the … Independence is the main means by which an auditor demonstrates that he can perform his task in an objective manner.The Need For Auditor Independence. Doubts are sometimes expressed regarding the independence of external auditors. 2. In 2000, Andersen received $27m for non-audit services, compared with $25m for audit services, meaning Enron accounted for over 25% of the fees generated by the firm’s Houston office. W. Burger, U.S. Supreme Court: 1984, United States v. Arthur Young & Co., U.S. Supreme Court Reports, 26 April 1984, 79 L Ed 2d, 826–838. Can We Really Have Independent Auditors? Max H. Bazerman is the J. Jay Gerber Distinguished Professor of Dispute Resolution and Organizations at the J.L. c. Explain how an auditor may be independent in fact (or mind), but not appear to be independent. Messick and K.P. Johnston, “Auditor’s Independence: A Proposal to the Profession and the Public,” The Woman CPA, volume 49, July 1987, pp. When a large company fails, the quality of the audit is often called into question. 3–9. To make sure this independence, best practices suggest the CAE should report on to the audit committee or its equivalent. Familiarity threat: The relationship between the auditor and client is long-standing or otherwise is so familiar that the auditor becomes involved in advising the client or acting in a management role. 176–197; G. Loewenstein, S. Issacharoff, C. Camerer, and L. Babcock, “Self-Serving Assessments of Fairness and Pretrial Bargaining,” Journal of Legal Studies, volume 22, 1993, pp. The issue and problems surrounding auditor independence and objectivity will continue as long as auditors are paid by their clients. In 1992, Phar-Mor, Inc., the largest discount drugstore chain in the United States, filed for bankruptcy court protection following discovery of one of the largest business fraud and embezzlement schemes in U.S. history. E. Waples and M.K. D.M. In fact, even the board and external auditors are not truly independent, as they are paid by the company. Accounting firms sometimes engage set audit fees at less than the market rate and make up for the deficit by providing non-audit services, such as management consultancy and tax advice. In an experiment, we test whether the type of client affects auditors’ independence. Posted by Richard Allen. In fact, even the board and external auditors are not truly independent, as they are paid by the company. The intimidation threat: The auditor is intimidated by actual or potential pressures from the client or other party. I often hear people say that internal auditors should be independent. It does not matter that the "Special Purpose Vehicles" were designed to (just about) comply with the then accounting standards - the shareholders were deceived. The investing and lending public, on the other hand, has become cynical about the accounting profession and its role in the financial reporting process. If this happens, the auditors can no longer be said to be independent and the shareholders cannot rely on their opinion. L. Thompson and G. Loewenstein, “Egocentric Interpretations of Fairness and Interpersonal Conflict,” Organizational Behavior and Human Decision Processes, volume 51, 1992, pp. Can Auditors Be Independent? Bazerman, “Ethical Leadership and the Psychology of Decision Making,” Sloan Management Review, volume 37, Winter 1996, pp. The AICPA Code of Professional Conduct requires that members in public practice be objective, free of conflicts of interest, and independent in fact and appearance (section 300.050). Critics claim that Finerty may have become too close to client management to maintain the professional skepticism necessary to conduct an independent audit. With independence in appearance, auditors can add credibility to the audit report. Messick, and M.H. Self-review threat: A judgment is required of the auditor which demands that previous work of the firm (whether audit or non-audit) be challenged or re-evaluated. 12. Independence is achieved through organisational status and objectivity. He argues, “Independent auditors cannot be fiduciaries. Download full-text. The auditor would be selected by an independent entity and the fee would be negotiated. This raises concerns that the auditor's interests to protect shareholders of a company and his commercial interests may conflict with each other. What auditors do . Account. Doubts are sometimes expressed regarding the independence of external auditors. 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. Auditors Offering Consultation. March 2010; Authors: Joan Cezair. A1-A6. Adapted from M. Pitz, “Jury Finds Phar-Mor’s Auditors Negligent,” Pittsburgh Post-Gazette, 15 February 1996, pp. By their very nature, internal auditors cannot be entirely independent of the company being audited. By their own admission, they connived with management to keep certain matters out of the financial statements, where a truly independent auditor would have insisted on full disclosure. A high profile example would be the relationship between Enron and their auditors, Arthur Andersen. 2. My view is that internal audit needs to be independent of undue management influence . He argues, "Independent auditors cannot be fiduciaries. Since my first introduction to the professional world, I have been told that auditors must be independent in fact and in appearance. This should result in a more independent selection process, but critics contend that a whole new set of bureaucracy and problems would develop. For many businesses auditing is a useful tool that has been implemented within their business operation to assist decision makings undertaken by the stakeholders. While not necessarily personally independent, internal auditors should nonetheless always strive to be fully objective in … They should not be subject to another’s jurisdiction. If auditors are forced to change every five years, yes, they will look more independent, but that does not give independence in fact. Because an auditor may not appear 100% independent in Auditor’s independence refers to an independent working style of the auditor being unbiased, unfettered, uninfluenced, and being fully objective in performing audit responsibilities. Independent auditors have a mandate to protect shareholders and potential investors from a public company’s possible fraud and accounting improprieties. Thus, they rely on the auditor’s independent assessment. HOW INDEPENDENT CAN AN EXTERNAL AUDITOR REALLY BE? How can you be certain that the auditor and CEO did not collude to issue a favorable audit report? But can they actually be independent when their current and probably future fees are determined by the board of directors and knowing that a negative report may reduce or completely cease their future income flow? The Phar-Mor case is one of many in which auditors have been held accountable for certifying faulty financial statements. D.M. As a result, some audit firms have commercial interests to protect too. Similarly, an auditor’s objectivity must be beyond question, but how can this be guaranteed and measured? Can auditors remain truly independent when conducting an annual audit of financial statements if their firms provided non audit services (NAS) to audit clients? This issue rises from the perspective of third party. The very purpose of statutory audit is to independently protect the interests of the shareholders, and for this purpose auditors have access to any and all information that they may require from the company. That auditor cannot be a fiduciary. If this happens, the auditors can no longer be said to be independent and the shareholders cannot rely on their opinion. 14. The governing body is supposed to be able to rely on them to uncover and report on risks to the organization. Audit committees are responsible for independence in appearance, but the auditor is the main culprit of being independent in fact. View further author information , Martin Weber Business School, University of Mannheim , Germany & Jens Wüstemann Centre for Economic Policy Research , London , UK . An auditor is required to be independent from the entity it audits. The trust threat: The auditor becomes too trusting of directors and management, thereby preventing a proper testing of management information and representations. Typically, the accusation is made that the auditors have allowed inappropriate accounting treatments because their independence has been compromised by the non-audit fees payable to them. But here are some ideas to make independent audits a reality. The Importance of External Auditor’s Independence According to Gillespie, Lewis and Hamilton (2004:221) an audit is: “a scrutiny of the accounts by a qualified auditor who carries out checks on the figures so as to establish whether the accounts show a true and fair view of the results and the financial position of the entity.” Answers Independence for internal auditors differs from the external auditor’s because internal auditors are employees of the companies they audit. 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