Independence of External Auditor
By:- shubham kanchhal Auditor independence refers to the independence of the auditor from parties that may have a financial interest in business being audited. Independence requires integrity and an objective approach for the audit process. This concept requires the auditor to carry his work freely and in an objective manner. The purpose of an audit to enhance the credibility of a financial enhancements by providing reasonable assurance from an independent source that present a true and fair view in accordance with an accounting standard.
This objective will not be met if users of the audit report believe that auditor may have been influenced by other parties, more specifically company directors or by conflicting interests. In addition to the technical competence, auditor independence is the most important factor in establishing the credibility of an audit opinion. The role of an external audit is to ascertain that the financial statements that are communicated to external stakeholders are a ‘true and fair’ representation of both performance and their position.
In doing this, they provide comfort to external users of these statements that what they are reading has been prepared in accordance with all the accounting and other mandatory and professional requirements. The onus of being able to read and interpret the information contained in the financial statements rests with the users, and no interpretation of the information is required by the auditors. Independence of the external auditor means independence from the parties that have an interest in the results published in financial statements of an entity.
The support from and relation to the audit committee of the client company, the contract and the contractual reference to public accounting standards or codes generally provides independence from management, the code of ethics of the Public Accountant profession) helps give guidance on independence from suppliers, clients, third parties. The role of the external auditor in the supervisory process requires standards such as independence, objectivity and integrity to achieve.
Even though the regulator and the external auditor perform similar functions, namely the verification of financial statements, they serve particular interests. The regulator works towards safeguarding financial stability and investor interests. On the other hand, external auditor serves the private interests of the shareholders of a company. The financial audit remains an important aspect of the corporate governance that makes management accountable to shareholders for its stewardship of a company. External auditor may however, have a commercial interest too.
The debate surrounding the role of external auditors focuses particular on auditor independence. A survey by the magazine “Financial Director” shows that the fees derived from an audit client in terms of non-audit services are significant in comparison to fees generated through auditing. Accounting firms sometimes engage in a practice called “low balling” where they set audit fees less than the market rate and make up for the deficit by providing non audit services. As a result, some audit firms have commercial interest to protect too.
There is a concern that the auditor’s interests to protect shareholders of a company and his commercial interests do not conflict with each other. Sufficient measures need to be in a place to ensure that the external auditor’s independence is not affected. The new directive states that all firms listed on the stock market must have an independent audit committee which will recommend an auditor for shareholder approval. It also states that auditors or audit partners must be rotated but does not mention the separation of auditors from consultancy work despite protests that there is a link to compromising the independence of auditors.
However this may be because Brussels also shares the view that there is no evidence confirming the correlation between the levels of non-audit fees and audit failures and that as a result, sufficient safeguards are in place. There are three main ways in which the auditor’s independence can manifest itself. Programming independence is essentially protects the auditor’s ability to select the most appropriate strategy to conduct an audit. Auditors must be free to approach a piece of work in whatever manner they consider best.
As a client company grows and conducts new activities, the auditor’s approach will likely have to adapt the account for these. In addition, the auditing profession is a dynamic one, with new techniques which is constantly being developed and upgraded which the auditor may decide to use. The strategy methods which the auditors intend to implement cannot be inhibited in any way. While programming independence protects auditors’ ability to select an appropriate strategy, investigative independence protects the auditor’s ability to implement the strategy in whatever manner they consider it necessary.
Basically, auditors must have unlimited access to all company information. Any queries regarding a company business and accounting treatment must be answered by the company. The collection of audit evidence is an essential process, and cannot be restricted in any way by Client Company. Reporting independence protects the auditors’ ability to choose to reveal to the public any information that they believe should be disclosed. If company directors have been misleading shareholders by falsifying accounting information, they will strive to prevent the auditors from reporting this.
It is the situations when auditor independence is most likely to be compromised. The increased competition between the larger firms means that the company image is very important. No audit firm wants to have to explain to the press about the loss of a big client. This gives the directors of the large company a commanding position over its audit firm and they may look to take advantage of it in anyway. The audit team would feel pressurized to satisfy the needs of the directors and in doing so they would lose their independence.
There are two important aspects to independence which must be distinguished from each other: independence in fact (real independence) and independence in appearance (perceived independence). Together, both forms are essential to achieve the goals of independence. Real independence refers to the actual independence of auditor, also known as independence of mind. More specifically, real independence concerns the state of mind an auditor is in, and how the auditor deals with a specific situation.
An auditor who is independent ‘in fact’ has the ability to make an independent decision even if there is a perceived lack of independence present, or if the auditor is placed in a compromising position by company directors. Many difficulties lie in determining the fact that whether an auditor is truly independent, since it is impossible to observe and measure a person’s mental attitude and its personal integrity. Similarly, an auditor’s objectivity must be beyond question, but how can this be guaranteed and measured?
That is why perceived independence is of such importance. It is essential that the auditor not only acts as independently, but appears independent too. If an auditor is in fact independent, but one or more factors suggest otherwise, this could potentially lead to the public concluding that the audit report does not represent a true and a fair view. Independence in appearances also reduces the opportunity for an auditor to act otherwise than independently, which subsequently adds credibility to the audit report.