Why is it important for external auditor to be independent? Throughout the years, banks, shareholders, possible investors and creditors always relied on the financial statements produced by a company. Since the management of a company is producing these documents it has been assumed that the managers may act dishonestly so that their performance looks better. To monitor the company’s performance better the directors along with the shareholders employ external auditors to check all these financial statements for both intentional and unintentional errors.
Therefore, external auditors have no motivation to produce dishonest reports, ence they are regarded as being truly independent. 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? What if there is built-up loyalty or some personal relationships between the auditors and the audited company? What is the primal role of external auditors?Order now
Before proceeding further, it is important to note that an audit has any value to the financial statements’ readers, so long as the auditor is both echnically competent (qualified enough to uncover significant errors) and truthful (All mistakes are corrected and presented to the public). For all the further contemplation, auditors are assumed technically competent. First of all, the primal role of an audit body is monitoring and examining financial statements. It is to serve to all financial statements readers as a reassurance on the truthfulness and reliability of these documents.
Hence the external auditor has to act in an independent honest fashion. But even if he is economically independent, why should the auditor act honestly? Independence is an attitude of mind, it is the person’s independent viewpoint that protects him from being influenced and pressured by his clients. There are two groups of auditors, concerning ethical reasoning: These who take into consideration the consequences of their actions (consequentialists) and these who analyse the moral quality of the action, no matter how dreadful the consequences can be (deontologists).
The latter will always be honest, while the consequentialists may occasionally produce dishonest reports. However, when economic dependence is taken into consideration (since the clients are the one who ay) the consequentialist becomes rational self-interested auditor, who tries to maximize his own economic wealth and minimize the risk related to this future income (there is a risk of being sued for negligence if the report is found to consist any significant errors).
What is interesting here is that to avoid risk from being sued, the auditor may undertake additional work, hence better quality of the report. Another point worth mentioning is that different audit firms have different quality reputations- some are paid more, some less. To go further the auditing as a made by recognised supervisory bodies (organisations whose members are all uditors or accountants) with little interference from the Government. Therefore all auditors are connected and their decisions affect the whole industry.
An auditor should be independent because not only does he expose himself to risk of being sued and reducing his firm reputation but also bears responsibility to the whole audit profession. Besides auditors, the one who pays the price of fraud are shareholders, employees and sometimes even the society. There are many examples when dependent auditors concealed fraud, and the results are always disastrous, examples such as WorldCom, Enron, Rita Aid and Tyco. But let’s see what happened in the 6th largest cable operator in IJS- Adelphia.
In the beginning of the 2002 Adelphia Communications Corporation was found guilty for fraud, amounting to 2. 3 billion dollars of concealed liabilities. The SEC (The Securities and Exchange Commission) distinguished 3 types of fraud- Hiding debt, misleading information concerning the performance of the corporation and many deceitful omissions. Deloitte was providing Adelphia with external Audit for more than 15 years, but suddenly (in the end of 2001) they stopped working, claiming that the information rovided by Adelphia was unreliable.
After the criminal investigation conducted by the SEC, Deloitte was accused of negligence, deception and failure to reveal fraud. According to the SEC (2005), the results are “Deloitte & Touche LLP has agreed to pay $50 million to settle charges stemming from its audit of Adelphia Communications Corporation’s fiscal year 2000 financial statements. ” Although Deloitte wasn’t pronounced guilty, it is obvious that they could have easily detected and disclosed the omissions and fraud that they could have found.
If that had happened, probably he scale of this catastrophe would have been smaller and Adelphia wouldn’t have gone totally bankrupt. This case inevitably shows us the importance of independent auditing. Another threat to the independence of the auditors is a phenomenon which took place around 3 or 4 decades ago. During that time the number of firms which required audits stopped expanding, the codes that prohibited advertising accounting firms were abolished, which enabled all these firms to steal market from each other.
Furthermore, a lot of audit bodies engaged into consulting, bookkeeping assistance, investigation and tax advices. This trend resulted in accounting firms gaining more revenue from consulting practices than from their main role in the society- monitoring and overseeing financial statements. Thus this led to a great conflict of interests, since consulting firms are supposed to be dependent and in good relationships with their clients but on the other hand audits should be carried in an independent manner.
However, ‘money makes the world go round’ and auditors were reluctant to perform strict audits because they risk losing sufficiently more income than before, so they lost their independence to a great scale. Typically, this loss of ndependence was followed by the Enron and Arthur Andersen great failures. Not surprisingly, the public’s trust and confidence in accounting firms started to vanish in a fast pace. Fortunately, The Sarbanes-Oxley Act of 2002 forbid audit companies to offer both consulting and auditing services to the same firm, which helped improving the independence.
Nowadays, the act is still in power and audit providing firms have the choice whether to provide auditing or consulting to publicly held companies. An Oxley Act of 2002, is the business alliance between PW’C and Thomson Reunters in China. While according to U. K. regulations and U. S. law business coalitions between and auditor receiving company and the auditor itself are forbidden, it has Just been announced that Thomson Reunters (audited by PwC) has already signed a contract with PW’C to provide PW’C with corporate tax technology in China.
Apart from that, Thomson Reunters provides PW’C U. K. with software for dealing with tax clients. According to Francine McKenna (2012), Forbes, “It’s not known if PW’C receives any financial incentives or special considerations for its exclusive use of Thomson Reuters software to provide tax services to its clients in China and the U. K. PW’C did provide a ignificant amount of tax services to Thomson Reuters as part of its audit. ” In this case it is not sure if there are any distinct violations. Maybe there is a slight chance that this will be the next big failure, maybe not.
What is for sure is that close business relationships tend to have negative influence on independence. In summary, the primal role of an external auditor is to provide an independent assessment of a company’s financial statements. His assessment is an assurance to the readers of the financial statements, that these statements are fair and true, free of significant errors and misleading information. It is of utmost importance that the audit performer is truly independent, to have an independent attitude of mind, because, otherwise, under the pressure and influence of his clients, the auditor may act in a dishonest fashion.
Every disclosure of fraudulence has detrimental effect not only on the auditing company or the auditor who produced the report, but on the audit profession, as a whole. The auditor’s economic interest reduces his independence and can cause conflict of interests, which can result in dreadful failures and catastrophes. There are many regulations that try to protect auditor ndependence by limiting and decreasing the auditor’s economic interest.
So it is important for an external auditor to be independent because in the end, the cost of fraudulent report is paid by all people engaged to the examined company, sometimes it is even paid by the society. Bibliography Forbes (2013) ‘Pw’C and Thomson Reuters In China, U. K. Business Alliance Violating Auditor Independence. PW’C and Thomson Reuters In China, U. K. Business Alliance Violating Auditor Independence’ Available at: http://www. forbes. com/sites/ francinemckenna/2012/12/21 /pwc-and-thomson-reuters-in-china-u-k-business- lliance-violating-auditor-independence/ Kim, K. t al (2009) corporate Governance, Third Edition, prentice Hall, USA SEC (2013) ‘SEC Charges Deloitte & Touche for Adelphia Audit. 2013. SEC Charges Deloitte & Touche for Adelphia Audit’ Available at: http://www. sec. gov/news/press/2005-65. htm [Accessed 05 February 2013 Sherer, M. & Turley, S. (2007) Current Issues in Auditing, Third Edition, SAGE Publications, London Van Peursem, K. et al (2007) ‘Three Cases of Corporate Fraud: An Audit Perspective’, Working Paper Series, 94 (1): PI-43