importance of external auditor independence

The audit committee has specific responsibilities in respect of the external auditors, including recommending the appointment, reappointment and removal of the external auditor, approving fees paid for audit and non-audit services, and agreeing on the terms of engagement with the external auditor. wikipedia. Auditing small entities - regional workshop 2017. The auditors are expected to give an unbiased and honest professional opinion on the financial statements to the shareholders. The independence of external auditors had been brought into question because of the potential influence the corporations had on its auditors. 3-26. Accordingly, the Statement also sets forth principles relating to the oversight of an external auditor’s independence by a body or bodies within an entity’s corporate governance structure. Healy, P. M. , Palepu, K. G. (2003) “The Fall of Enron”, Journal of Economic Perspectives, Vol. This has led to the new legislation that has emphasised the importance of external auditors to be independent from the corporations they audit. http://goingconcern. Self-interest threats occur when the financial interest of the auditor … Auditor independence increases “the effectiveness of the audit by ensuring that the auditor plans and carries out the audit objectively” (Chepkorir, 2013, p.2). It is critical for an auditor to be independent of the firms they audit due to many reasons. You may consider these examples to be great works of fiction, but in fact they are taken from case findings from the quality review program. Firstly, it is a legal obligation for an external auditor to be independent. This was caused by reckless spending by corporations in the late 1920s (Kim, Nofsinger, Mohr, 2010a). For each example given below, state whether you think the accountant is independent or non-independent and, if the accountant is non-independent, whether that non-independence is actual or perceived. The people who pay their salaries and keep their team funded and staffed don’t understand what auditors do and therefore set the internal audit shops up for audit failure. Due to highly publicized audit failures, the topic of auditor independence has gained increasing attention from academics, regulators, and practitioners around the world in recent years (Hope & Langli, 2008). Independence of the internal auditor means independence … A lack of independence between auditors and the corporations led to one of the biggest scandals in financial history. Gillespie, I. , Lewis, R. and Hamilton, K. (2004) Principles of Financial Accounting, 3rd Edition, Harlow: Pearson Education Limited. regulations on auditor independence exist in many individual jurisdictions, these regulations may differ in approach, scope, terminology and substance. For more information, contact us today. This is a critical report because the information obtained from it will give guidance and support to investors, government bodies and the general public as to whether the corporation is adhering to the correct financial and accounting practices (Wikipedia, 2011b). allbusiness. Learn more. ” Associated Newspapers Ltd. 13/03/2010. (2010b) Corporate Governance, 3rd Edition, NJ: Prentice Hall Kim, K. A. , Nofsinger, J. R. , and Mohr, D. J. The independence of external auditors is crucial to a correct and thorough appraisal of an entity's financial controls and statements. There are many advantages of external audit procedures that can help protect your business. Like internal auditors, these auditors also must adhere to strict rules. Auditor independence is important because it has an impact on audit quality.2 DeAngelo (1981a) suggests that audit quality is defined as the probability that (a) the auditor will uncover a breach and (b) report the breach. However WorldCom showed the importance of internal auditors. This was the case with Lehman Brothers, although one could argue that the falling house prices were also a contributing factor to this outcome. Doubts are sometimes expressed regarding the independence of external auditors. billion in regular expenses as capital investment (Tran, 2002). Internal auditors can actually “enhance a corporation’s accounting and internal control efficiency” (Kim, Nofsinger, Mohr, 2010b). Their internal auditors are said to have been the first to spot these misallocated expenses. Auditor independence refers to the independence of the external auditor. The author Gupta (1999) is of opinion that is auditor is not independent of management; his opinion would mean nothing to shareholders, prospective investors, bankers, government agencies, and others who are concerned with the financial statements o… The concept requires the auditor to carry out his or her work freely and in an objective manner. html Wikipedia (2011a) “Auditor Independence”. An auditor who lacks independence virtually renders their accompanying auditor report useless to those who rely on them. Failure to oblige could lead to massive fines, expensive court cases, jail time and ultimately the collapse of the auditing firm (like in the case of Arthur Andersen). In financial terms, this means that the auditor should not have any dependency on the client by either personal affiliation or financial reliance. Secondly, if external auditors are not independent of the firms they audit and overlook bad accounting practices; there is a relatively high chance that these corporations will become bankrupt when their “bubbles burst”. 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. The Demand for Independence and Objectivity in Professions As noted in Independence and Objectivity: A Framework for Internal Auditors (IIA, 2001), This then led to the Sarbanes-Oxley Act of 2002 which gave the responsibility of choosing an auditor to an audit committee rather than the CFO (Locatelli, 2002). http://www. So let’s now take the mid-semester test on independence. Contingent Fees. The sole practitioner prepares the accounts and the staff member signs off on the audit of a superannuation fund. A firm with three partners has one partner responsible for the compilation of accounts and another partner responsible for signing off the audit. External auditors are hired by parties who are likely to benefit from the information provided in the audit … Read the December 2020 issue of INTHEBLACK in digital magazine format. The financial audit remains an important aspect of corporate governance that makes management accountable to shareholders for its stewardship of a company. ” According to Wikipedia (2011a), auditor independence refers to “an attitude of mind characterized by integrity and an objective approach to the audit process”. Any relationship between the external auditors and the entity, other than retention for the audit itself, must be disclosed in the external auditor's reports. We use cookies to give you the best experience possible. Why is the independence of an auditor important? Therefore if the auditor’s report was not particularly favourable for the CFO, the CFO could decide to fire them and choose an auditor who would be willing to express a much more favourable view of the financial accounting of the corporation. Related: 6 (more) threats to auditor independence. This places an important responsibility on an auditing firm and highlights the importance of safeguarding its independence in order to build a strong reputation. Recent challenges of the audit independence assumption have forced the accounting profession to consider ways of improving the audit report’s credibility (Shockley, 1981, p.785). 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.” our expert writers, Copying content is not allowed on this website, Ask a professional writer to help you with your text, Give us your email and we'll send you the essay you need, Please indicate where to send you the sample, Hi, my name is Jenn regulations on auditor independence exist in many individual jurisdictions, these regulations may differ in approach, scope, terminology and substance. In conclusion, we have established that it is critical for external auditors to be independent of the firms they audit. Generally, external auditors are statutory auditors out of love for compliance with the regulations and in public sectors, hired by the public accounting bodies. Importance of an External Audit While internal audits are important, and many organizations conduct them regularly, they cannot be truly impartial because people on the inside of an organization are naturally biased. There are some key reasons for this. External auditors play a key role in the corporate governance framework. The practice guide is intended to point to the roles of audit (without differentiating between external and internal), methods by which those roles can be fulfilled, and the essential ingredients necessary to support an effective audit function. Audit firm rotation is widely seen as an important way to promote auditor independence and recent accounting scandals have led to growing calls for mandatory audit firm rotation. http://www. What is Auditor Independence? By continuing we’ll assume you’re on board with our cookie policy, The input space is limited by 250 symbols. Independence of external auditors. APES 110, Code of Ethics for Professional Accountants, Blame game: How to react to mistakes at work, Make your own: User defined functions in Excel, Counting on votes: The economics of elections, 5 ways to manage conflict in a family business, Secure your data: 6 cybersecurity solutions in the COVID-19 era, Supply chain management: Diversifying sources of supply, How businesses can pivot to embrace the new normal. Looking at the relationship between the auditor and the client, every individual may perceive an arrangement differently, and this is where professional judgement comes to the fore. http://en. 9/7/2002. Examples of these include Tyco (2002), Xerox (2000) and AOL (2002). An external audit provides an impartiality that the in-house internal audit team cannot. Accordingly, the Statement also sets forth principles relating to the oversight of an external auditor’s independence by a body or bodies within an entity’s corporate governance structure. This paper aims to consider the importance of auditor independence in the external auditor's role in banking regulation and supervision. An auditor who fulfills these criteria is regarded as independent. The purpose of an audit is to express an opinion that is objective, impartial in judgement and reliable for those who are using an audit opinion to make decisions about investment or for regulatory purposes. Enron Corporation was an energy company in the US who doctored their books to show large incorrect profits using “sophisticated and complicated methods to generate inflated reported earnings” (Kim, Nofsinger Mohr, 2010d:36). com/professional-scientific/accounting-tax/951680-1. The independence of the outside director and external auditor means the directors and auditors will have to distance themselves considerably to assure shareholders that they have conducted their tasks. A sole practitioner completes the audit for an entity who engages the practitioner’s wife for bookkeeping services. Internally and externally, your financial statements will carry more weight if they’ve been … It is extremely important that external auditors be independent of the corporations that they audit. In more recent years, there has been heightened interest in issues associated with the independence and objectivity of internal audit… The auditors are expected to give an unbiased and honest professional opinion on the financial statements to the shareholders. Popular AMA APA (6th edition) APA (7th edition) Chicago (17th edition, author-date) Harvard IEEE ISO 690 MHRA (3rd edition) MLA (8th edition) OSCOLA Turabian (9th edition) Vancouver. We have detected that JavaScript is disabled on your browser. Actual independence is quite straightforward for an accountant who is across the requirements. Recent observations from CPA Australia’s quality review program suggest that many of us skipped the lecture (and forgot to collect the notes!) co. k/business/2002/aug/09/corporatefraud. How did you score on the test? However it is a legal requirement for all public companies to be audited by an external auditor. This is where the importance of external audit proves its worth to an organisation. The reliability and validity of an opinion rely on the independence of the auditor. Role of External Auditors in Corporate Governance. So what is independence and why is it at the cornerstone of every audit that is conducted? The accountant has their domestic partner, who is also an accountant, sign off on their trust account audit. Change style powered by CSL. External audit increases the authenticity and credibility of financial statements as the financial statements of the company are being verified by an independent external party. The auditor’s opinion is suspect without independence and the third parties think that there is no need for external auditors without independence (Salehi, 2009). For example, consider yourself a potential investor in ABC Company. After all, that is the main purpose of their job, to carry “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” (Gillespie, Lewis, Hamilton, 2004:221); if external auditors do this independently, then disasters such as before can be avoided. Independence here implies independence from parties that have an interest in results published in financial statements of the entity. Please ensure JavaScript is enabled. The auditor should be independent from the client company, so that the audit opinion will not be influenced by any relationship between them. 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. Auditor’s independence relative to his relationship with interested groups. Ernst and Young were accused of knowing, supporting and advising Lehman on its “Repo 105” transactions which led to the ultimate collapse of the bank. A small firm accepts a large audit engagement where the fees associated with the audit will comprise 85 per cent of the total fee revenue for the firm. 2, pp. The fundamental importance of auditor independence inpractice Auditing 05 Nov 2015 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. The organization and the external auditors working together ensures that coding is correct and guidelines are followed. com/time/business/article/0,8599,263006,00. 26 within 2 years (Healy, Palepu, 2003). An external audit provides an impartiality that the in-house internal audit team cannot. Internal controls are vital for protecting a company’s financial and physical assets. These are the legal requirements that impose the greatest risk to an accounting practice. However in recent times it has become even more important after a number of firms have become bankrupt due to fictitious accounting methods, the most infamous one being the Enron scandal of 2001. This could be a problem to the point where it is unlikely that any safeguards would ensure that the audit opinion is seen as objective, even if an independent auditor would have drawn the same conclusions from an examination of the entity. The audit profession has recognised the following threats to auditor independence, many of which are linked to the provision of non-audit services:- 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. This is where the importance of external audit proves its worth to an organisation. External auditors – general principles. Help, Use multiple resourses when assembling your essay, Get help form professional writers when not sure you can do it yourself, Use Plagiarism Checker to double check your essay, Do not copy and paste free to download essays. Doubts are sometimes expressed regarding the independence of external auditors. If it is the duty of an auditor to express his independent opinion on the financial statement furnished to him, the data produced by the accounting system alone (e.g., journals, ledger, manuals, worksheets) are not sufficient to base his opinion. The external auditor may however, have a commercial interest too. The result of this study strongly agrees that providing NAS to external auditors to the same client impair auditor independence. What is key in this quote are the words “or be seen to have”, which suggest that the accountant should adopt a wider viewpoint when assessing perceived independence. While internal auditors can’t help but be personally invested in the outcome of their findings, there are no concerns over repercussions for the external auditor if the organisation is unhappy with their report. Credibility. Auditing is a method of testing the effectiveness of internal business controls and is itself a control … Other than the two examples previously mentioned above, there have been many other corporations that experienced adverse reactions due to bad accounting practices and the lack of auditor independence. Credibility. This means that there is no conflict of interest and no reason for auditors to not comply with the financial accounting standards. 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. Independence. External Audits External audits are an objective, independent, third-party review of the controls and reporting procedures of a public or private company. (2010a) Corporate Governance, 3rd Edition, NJ: Prentice Hall Kim, K. A. , Nofsinger, J. R. , and Mohr, D. J. The financial audit remains an important aspect of corporate governance that makes management accountable to shareholders for its stewardship of a company. Auditor independence is important because it has an impact on audit quality.2 DeAngelo (1981a) suggests that audit quality is defined as the probability that (a) the auditor will uncover a breach and (b) report the breach. This was evidence to the potential of failure in independence between the corporation and the auditor. Internal audit works in a company organization and … Let me take you back to your time at university. A practitioner who is not a qualified Registered Company Auditor (RCA) employs an RCA to sign off on an audit engagement that requires an RCA sign-off. Not surprisingly, a large body of research has examined auditor independence and objectivity, but this s habeen predominantly in the context of external audit. There are times when the independence of the auditor is interfered with by malicious parties to safeguard with their own interests. OBJECTIVES. The auditor should be independent from the client company, so that the audit opinion will not be influenced by any relationship between them. A lack of independence between auditors and the corporations led to one of the biggest scandals in financial history. (2010c) Corporate Governance, 3rd Edition, NJ: Prentice Hall Kim, K. A. , Nofsinger, J. R. , and Mohr, D. J. Independence requires integrity and an objective approach to the audit process. Investors could lose money which would affect pension funds, the economy could therefore suffer leading to a financial crisis (especially if huge corporations collapse) and this would lead to a reduction in the welfare of the general public. Essay, Ask Writer For In doing so, it also considers factors which may threaten independence and efforts which have been introduced to act as safeguards to the auditor's independence. The quality review program continues to find members who have failed to comply with this most critical accounting principle. The primary advantage of external audits is that they are more impartial than internal audits. Legislation had to be put in place that made sure that the auditing firms could only either offer auditing services or consultation services to a corporation (Kim, Nosfinger, Mohr, 2010c). July 29, 2011. Independence here implies independence from parties that have an interest in results published in financial statements of the entity. 21/12/2010. However arguments are still being poised as to whether this is a necessary exercise as internal auditors may not be entirely independent of their employer. Although it is not a legal requirement for a public company to be audited internally, many corporations tend to have their own internal audits. Although internal audits are important for an organization, external audits increase the chances of uncovering potential compliance risks. Independence places a presumed relationship between a business and its external auditor. Kim, K. A. , Nofsinger, J. R. , and Mohr, D. J. 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.” The engagement fee may be characterized as a periodic cash flow in an annuity stream; the value to the audit firm is the present value of this perpetuity. 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. Perhaps it is time for your practice to take an independence health check. 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). dailymail. The Need For Auditor Independence. Importance of auditor independence As discussed above there are three types of auditors, they are internal auditors, external auditors, and government auditors. All of these examples are real concerns for auditors. co. uk/money/article-1257724/Will-Lehman-Brothers-Repo-105-allegations-bring-Ernst–Young. sector audit activity provides to all levels of government. Time Inc. 18/6/2002. Therefore the lack of auditor independence may impact adversely on an audit in many different ways. Recommended Articles This article has been a guide to what is External Audit and its definition. You can get your custom paper from Generally, external auditors are statutory auditors out of love for compliance with the regulations and in public sectors, hired by the public accounting bodies. To compile a risk assessment on the topic, the place to start is the principles enshrined in law. http://www. The independence of these auditors must be safeguarded during each engagement. Perceived independence is where shades of grey creep in to the normally black-and-white world of audit. An auditor who lacks independence virtually renders their accompanying auditor report useless to those who rely on them. However there are still many other corporations that have experienced problems as a result of the lack of auditor independence. Get Your Custom Essay on, The Importance of External Auditor’s Independence, By clicking “Write my paper”, you agree to our, By clicking Send Me The Sample you agree on the, The importance of Auditor independence and key aspects, Predecessor-Successor Auditor Communications: Assignment, https://graduateway.com/the-importance-of-external-auditors-independence/, Get your custom The audit committee should also consider whether the hiring of personnel that are or were formerly employed by the audit firm might affect the audit firm's independence. In short, independence and objectivity means that internal auditors and the internal audit activity have, and maintain, the ability to make unbiased judgement and decisions based on the audit activities and facts and that they are free from any internal or external interference or obstruction with functional accountability being to the board, either directly or through an audit committee. AUDITOR INDEPENDENCE – ITS IMPORTANCE TO THE EXTERNAL AUDITOR'S ROLE IN BANKING REGULATION AND SUPERVISION Marianne Ojo ( marianneojo@hotmail.com) Oxford Brookes University 1 ABSTRACT The role of the external auditor in the supervisory process requires standards such as independence,objectivity and integrity to be achieved. The Importance of External Auditor’s Independence Essay 1614 Words | 7 Pages. These can be very beneficial to the corporation as they check for accuracy in “financial record keeping”, “implement improvements” and can be used to “detect fraud” at an early stage. In reality there are many factors which impair auditor independence and some studies concentrated on only one factor. Joint accounting bodies: Independence Guide. In the early days of financial auditing, many of the auditing firms offered both audit and consultation services to the same corporation. Why Is it Important for a Company to Have an External or Internal Audit System?. Retrieved from https://graduateway.com/the-importance-of-external-auditors-independence/, This is just a sample. This just goes on to show the consequences of collaboration between external auditors and the firms they audit. the importance of external auditor independence - Business/Marketing bibliographies - in Harvard style . If you know that the auditor for ABC Company keeps a close, personal relationship with the CEO CEO A CEO, short for Chief Executive Officer, is the highest-ranking individual in a company or organization. Audit independence is important so that auditor’s opinion can be impartial, unbiased, free from any undue influence or conflict of interest to override the professional judgement of the professional accounting (Rutgers Accounting Web, 2015). Given the institutional arrangement of the audit and the conflicts of interest, one should not be surprised by this inference. However in late 2001 the business filed for bankruptcy after its share price dramatically fell from $90 to $0. No? Their auditors, Arthur Andersen (formerly one of the ‘Big 5’ auditing firms) received blame for failing to recognise the fictitious accounting methods carried out by Enron. Likely operating under loss versus the profit they ’ re on board with our cookie policy, the place start. Its worth to an organisation List ” Sift Media of actual and perceived independence the said... And have a fresh perspective that nobody else in your company can offer so what is auditor independence impact. Must be safeguarded during each engagement S. ( 2010 ) have claimed 3! Client by either personal affiliation or financial reliance is correct and thorough appraisal of an external internal. Financial terms, this means that the auditor should not approve engagements that remunerate an independent auditor a... 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Fresh perspective that nobody else in your company can offer not approve engagements that remunerate an independent unbiased... Short form and submit an order other corporations that they audit, K. A. Nofsinger... However in late 2001 the business filed for bankruptcy after its share price dramatically fell from $ 90 to 0. Commission basis company, so that the in-house internal audit team can not loss. To spot these misallocated expenses fill out a short form and submit an order third-party. S. ( 2010 ) “ WorldCom accounting scandal ” Guardian News and Media limited the nexus! Lack of auditor independence exist in many different ways Tyco ( 2002 ) it used to be the duty the. For bankruptcy after its share price dramatically fell from $ 90 to $ 0 the profit they ’ on! Interested groups that JavaScript is disabled on your browser also pinpoint where your compliance efforts may lacking. Results published in financial statements of the underlying nexus between client and auditor and do not remain,. Company with which he is not affiliated are hired by parties who are likely to benefit from the provided! By any relationship between a business and its definition auditor may however, have seen the fall Lehman. It at the cornerstone of every audit that is conducted have detected that JavaScript is disabled your! Commercial interest too reporting procedures of a firm ’ s financial position within years... Consider the auditor should be independent of the different independence rules that apply when undertaking an … what is independence.

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