Responsibility and Authority in Finance: The Auditor Independence - Research Paper Example

Auditor independence Introduction Auditor independence even though is a mindset includes the prevention of certain details and of affairs whichare very significant and reasonable to third parties. The well informed third party has knowledge of all the appropriate info which might include any precautions enforced and this would entail him/her to fairly reason out a firm’s or a member’s unity, detachment or professional independence had been endangered. Thus it is the duty of a member to prepare his mind to key out several threats and to utilise the precautions to nullify the same. Auditor independence for the major part of the past three years had a lot of issues. These issues cropped up even before the Securities and Exchange Commission, the Enron Corp. and the WorldCom Inc., took up the issues and took efforts to chart rules in this area. The result was that considerable changes were brought about in the rules of auditor independence. Severe restrictions on several non-audit services provided by audit firms to its clients were also the results of the efforts taken up by Securities and Exchange Commission, the Enron Corp. and the WorldCom Inc. But still these rules were not sufficient as was proved by the needs of the Sarbanes-Oxley Act of 2002. New risks keep on appearing in this globalised world endangering the independence of auditors especially in the post-Enron scenario, their independence has become a very important issue for the smooth operation and success of economic order. Thus it is left to the auditors to take care and to avoid landing themselves in such a position where conflict of interest and duty might arise. The perception of independence is also a forceful fact. To understand that fact, the committee on Ethical Standards and Unjustified Removal of Auditors (CESURA) has deliberately researched all the potential vistas of the issue. Meaning of Auditor Independence Independence is basic to the dependability of auditors’ reports. The reports of companies drawn up by these auditors would not be trusted by the investors and creditors and they would have lesser confidence in auditors if there was no independence of auditors in both concept and form. In reality the opinion of an auditor has to be based on an intended and impartial judgment. The judgment is with regard to the true and fair view of the financial statements which are prepared in conformity with the normally recognised accounting principles. The conception of auditor independence during the 19th century did not believe of auditors as counsellors for audited entities. British investors unambiguously prohibited auditors from investing or functioning in the business concerns which they audited. Simultaneously if the auditors proved that they were primarily loyal to the capitalists the reach of professional accounting services were practically liberal. For instance, auditors were allowed to keep the books and develop the financial statements for the business concerns which they audited (Richard Baker, 2005). Actually during the early parts of the twentieth century, terms/concepts like integrity, objectivity and honesty were familiar and deep-rooted. It was not necessary to have any other kind of formal independence rules. The AICPA Council in the year 1932 believed that limitations against auditors who served as officers/directors of clients were not necessary and so disapproved them. But as soon as the Securities Act of 1933 was ordained the However, the proposal indicated the first concerns over a need to preserve the appearance of maintaining objectivity, as well as being independent in fact. After the Securities Act of 1933 was enacted, the Federal Trade Commission released ordinances expressing that it would not conceive auditors who serve as officers or directors as independent. Even those officers or directors who had any direct or indirect interests in, public audit clients were also not considered independent.1 The reason was that the relationship between clients and the auditors might subconsciously mar the auditor’s impartiality. The blend of well-developed standards of accounting and independent audits has served and made the U.S. capital markets a national asset. The auditor’s detachment is vital to shareholder confidence. But when any actions impairing or appears to impair independence regulators and others become worried. Definition of Auditor Independence The IFAC rules of thumb on auditor independence states that- “When in public practice an accountant should both be and appear to be, free of any interest which might be regarded, whatever its actual effect, as being incompatible with integrity and objectivity”. According to the Council of the American Institute of Certified Public Accountants (AICPA), “Independence, both historically and philosophically, is the foundation of the public accounting profession and upon its maintenance depend the profession’s strength and its stature” (Carey, 1970, p 182). Auditor independence is the foundation to the auditing profession, as it is the basis for the public’s trust in the evidence function (Caswell & Allen 2001). McGrath et al. (2001, p 40) indicate that “when independent auditors render unbiased audit decisions, the broader goal of auditor independence, namely to support user reliance on the financial reporting process and to enhance capital market efficiency, is accomplished.” According to the Berkshire Hathaway Inc. Annual Report to Shareholders “Auditors annually certify the numbers given to them by management and in their opinion unqualifiedly state that these figures ‘present fairly’ the financial position of their clients. The auditors use their reassuring language even though they know from long and painful experience that the numbers so certified are likely to differ dramatically from the true earnings for the period.” (Berkshire Hathaway Inc. Annual Report to Shareholders 1985) Auditor independence serves to check quality audits and adds to financial statement users trust on the financial coverage process. Quite a lot of major instances of wrongly stated earnings propelled the SEC in 2000 to assume rules forbidding non-audit services discrepant to auditor independence (Deborah, 2004). These misstatements led the way for many to question the efficiency of different views of the audit operation, particularly auditor independence. Further, the SEC is conceiving extra measures to fortify actual and apparent auditor independence, particularly in light of the Enron disaster. Since auditor independence is in reality a mental state, capitalists and other users of financial statements will not be in a position to precisely consider actual auditor independence. They can only measure the appearance of the auditor’s independence. Thus even if an auditor acts independently and issues in fact a balanced audit judgment, capitalist assurance is eroded if they feel that the auditor was not independent (Deborah, 2004). Types of auditor independence Auditor independence is the basis of the auditing profession as it is the base of the public’s faith in the accounting profession (Deborah, 2004). Since 2000, a wave of high profile accounting scandals has cast the profession into the limelight, negatively affecting the public perception of auditor independence. The manifestation of the auditor’s independence can be done in three main ways. They are according to Mautz & Sharaf (1961) as follows: 1. Programming independence 2. Investigative independence 3. Reporting independence Programming independence fundamentally defends the auditor’s power to pick the most suitable strategy when carrying on an audit. Auditors must be given the freedom to set about a piece of work in whatsoever manner they believe to be the best. The auditor may have to adapt to the situation when his client company develops and carries on new activities as he/she will have to account for these. Apart from this the profession of auditing is dynamic as there is constant development and up gradation of new techniques which the auditor may choose to implement. The strategy or even the purported means which the auditor specifies to enforce cannot be suppressed in any way (Mautz & Sharaf 1961). Investigative independence safe guards the auditor’s capability to put into operation the schemes in whatever manner they regard necessary. Essentially, auditors must have infinite access to all company info. Any queries with regard to a company’s business or its treatment of accounting have to be responded by the company. The compilation of audit proof is a crucial procedure, and cannot be controlled by the client company (Mautz & Sharaf 1961). Finally reporting independence defends the auditors’ aptitude to disclose to the public any info they think should be revealed. If the directors of a company have been misinforming shareholders by distorting accounting info then they will surely prevent the auditors from reporting such information. Under such circumstances the auditor can make use of his independence and according to his conscious (Mautz & Sharaf 1961). Market Changes Affecting Auditor Independence Jonathan Weil, (2004), proposes that during the 1970s and 1980s the demand for audit services and the mode of conducting audits changed. This change contributed to the fall in auditor independence. The first factor of alteration was price competition. Before the 1970s, the American Institute of Certified Public Accountants (AICPA) Code of Conduct disallowed auditors from advertising in public about their services, from constituting unwelcome appeals to competitor firms’ clients, and from taking part in competitor calling for audits. But due to threats of antitrust action from the federal government, the AICPA was forced to get rid of these bans against competitive practices. Consequently, competitive tendering in auditing turned into a commonplace and produced force to decrease audit employment hours. This made audits into a commodity product. To preserve overall revenues and firm gainfulness, accounting firms started to emphasise on non-audit services. The proportional decrease in audit fee revenues and proportional increment in dependence on revenues from non-audit services must have pressurised auditor independence (Richard Baker, 2005). The second change is with regard to conducting an audit with an altered stress on “risk-based auditing.” This type of risk based auditing is reasonable because the greatest amount of effort on audit is place on the largest areas of audit risk. This concept presumes that auditors are experts who can determine the most hazardous fields of a company’s operations. Regrettably, as Enron and other business collapses have evidenced, some auditors are not adequately talented to decide risky areas of a company’s operations. Additionally, auditors applying a risk-based approach may not be in a position to find out deceitful activities (Richard Baker, 2005). Following the accounting and auditing scandals during the early 2000s, and the enactment of the Sarbanes-Oxley Act of 2002, the thought of auditors as confidential consultants seems to have become more and more invalid. The arguments of a possible new concept of auditor independence are still opening, but the Public Companies Accounting Oversight Board appears to be emphasising a construct of auditor independence that underlines a greater level of detachment between cross-filed auditors and client management (Richard Baker, 2005). Does independence matter? Based on the Code of Conduct of ICAI, “Human nature as it is, a man often places his personal gain above service. Therefore, persons who as individuals and as a class are willing to place public good above their personal gain have enjoyed respect and honour.” The above idea is no doubt lofty but the question is that will such words suffice to stimulate auditors to better their ethical standards? The answer can be hardly given and so in order that an auditor practices independence it is we who must be able to prove that it is only in their best interest. This issue can be considered from both economic and ethical perspectives (Swapan Bakshi, 2004). According to Stella Fearnley and Viven Beattie, (2004), it is not possible to well inform an investor as to what auditor independence in appearance actually demands. The Review Board states that audit firms must disclose the following, Management structures; management of economic dependence at firm and partner level, quality control procedures for audit and maintenance of independence, and financial information with regard to the relative profitability of audit. This would in the end increase auditor independence. Threats to independence (Swapan Bakshi, 2004) The current debacles underline the need to beef up the independence system. Quiet a lot of ways can have an impact of auditor independence and since it is not possible to list all areas of risk a few are as follows (Swapan Bakshi, 2004): 1 Financial interest with or in the matters of the client 2. Designation in companies as officer, member of the Board or even employee etc. 3. Involved in a family liaison with a client 4. Providing other services in addition to auditing to their audit clients 5. Depending solely on a client for fees 6. Contingent fees for professional service which depends on some particular info or results. 7. Accepting hospitality or any other welfare from client (Swapan Bakshi, 2004). Conclusion Auditor independence has thus been the field of study for a substantial number of research papers and debates out of which some have developed many suggestions for progress. Thus it can be seen that the present need is for a complete afterthought of the conception of auditor independence. Such reconsideration may sometimes lead to a new construct in which auditor independence could be instituted on confirming the accounting profession’s previous ethic of being an objective and unbiased exponent of accounting standards, instead of being an advocate for client positions. Because of the recent and in progress accounting and auditing outrages, it seems apparent that independent auditors cannot be advocates for client positions. Neither the Sarbanes-Oxley Act (SOA) nor the Public Companies Accounting Oversight Board (PCAOB) independence standards distinctively cover this issue. A second issue with regard to auditor independence which has not been sufficiently dealt with by SOA and the PCAOB rules is the scope of influence by client management with regard to audit fee and the range of the audit commitment. SOA section 301 defines the following: “The audit committee of each issuer, in its capacity as a committee of the board of directors, shall be directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm employed by that issuer (including resolution of disagreements between management and the auditor regarding financial reporting) for the purpose of preparing or issuing an audit report or related work, and each such registered public accounting firm shall report directly to the audit committee”. According to Richard Baker, (2005) “A new concept of auditor independence is required that specifically incorporates the propositions that 1) auditors should not be advocates for their clients, and 2) management should not be able to influence the audit fee and the scope of the audit. Without a transition to this concept, auditor independence standards will most likely be primarily cosmetic and will not provide sufficient assurance that auditors are in fact independent from client management”. Therefore it is time that some decision on which auditor independence has to be based should be taken and such independence should not hinder shareholder confidence. Shareholders are the most important elements of a corporation, since it is their money with which the company runs and so they will have to be taken into confidence. Their morale should not be marred. This will surely require auditor independence but with the limitations discussed in this paper. Reference 1. Berkshire Hathaway Inc. Annual Report to Shareholders 1985 2. Caswell, B. & C. Allen. 2001. “The engagement team approach to independence.” Journal of Accountancy 191 (2): 57-63. 3. John L. Carey, the Rise of the Accounting Profession: To Responsibility and Authority, 1937-1969, New York, 1970, p. 175-182. 4. Jonathan Weil, 2004, “Behind Ways of Corporate Fraud: A Change in How Auditors Work”, The Wall Street Journal, March 25. 5. Lindberg, Deborah L "Before and After Enron: CPAs Views on Auditor Independence". CPA Journal, The. FindArticles.com. 18 Mar, 2010. http://findarticles.com/p/articles/ mi_qa 5346/is_200411/ai_n21359407/ 6. McGrath, S., A. Siegel, T. W. Dunfee, A. S. Glazer & H. R. Jaenicke. 2001. “A framework for auditor independence.” Journal of Accountancy 191 (1): 39-42. 7. Mautz, R.K. & Sharaf, H.A. (1961) ‘The Philosophy of Auditing’, American Accounting Association. & Dunn, J., 1996. Auditing Theory and Practice. 2nd ed. Prentice Hall. 8. Richard Baker, August 2005. The Varying Concept of Auditor Independence Shifting with the Prevailing Environment, CPA Journal 9. Stella Fearnley and Viven Beattie, 2004 International Journal of Auditing, 8 pp.117-138 10. Swapan Bakshi, 2004 Safeguarding Auditors Independence: The Profession at the Crossroads the Chartered Accountant, February 2004 p.823 11. Sarbanes-Oxley Act of 2002, section 301 Read More