why is independence so essential for auditors?

The major factor behind such reservation was the amount that the auditors received as non-audit fees from these clients. Oxley Act of 2002 implemented a ban on nine non-audit services which comprise of: Bookkeeping and other services related to the financial statements. auditor independence is necessary so that auditor's opinion view the full answer. The Need For Auditor Independence The auditor should be independent from the client company, so that the audit opinion will not be influenced by any relationship between them. So the larger purpose of audit independence, its objective, must be sought in the objective of the audit. Several prior studies also suggest that NAS has positive effects on auditor practices and auditor independence. Researchers in the U.S. suggest that there is no relationship (DeFond et al., 2002; Geiger and Rama, 2003). Find answers and explanations to over 1.2 million textbook exercises. The [12] AICP Cohen Commission (1978) in its report affirms that there are excessive competitions among public accounting firms and this excessive competition among different firms has been consistently identified as a factor threatening auditor independence [13] (Farmer et al., 1987). Literature has contemplated two standards for assessing auditor independence. One is a fear that non-audit service fees make auditors economically dependent on their clientele, and hence less willing to stand up to management pressure for fear of losing their business [6] . Most writers [19] , who discuss the relationship between tenure and AI, support that audit firms working for a given client over a lengthy period has the risk of losing an auditor’s independence. On other hand, independence in appearance is necessary to promote public confidence such that users will rely on audited financial statements. The previous chapter emphasized the importance of auditor independence and objectivity to internal auditing and noted the challenge to achieve true independence in internal auditing when the auditors … Audit is carried out to find out errors (unintentional) and frauds (intentional) in the financial statements prepared by the management. why is auditor independence so important? So what is independence and why is it at the cornerstone of every audit that is conducted? There are only some published studies focussing mainly on the factors affecting auditor’s independence (i.e Gul & Teoh, 1984; Teoh & Lim 1996; Abu Bakar et al. University of New South Wales • ACCT 2522. This problem has arisen as a result of non-audit services provided by audit firm (Salehi and Moradi 2010). 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. The IFAC’s Code of Ethics for Professional Accountants (1996, para 8.7) propose that client size which is measured from the size of audit fees could raise uncertainties as independence of auditor is concerned. Hussey (1999) reported that the majority of the UK finance directors that participated in his study suggested that joint provision of audit and NAS to audit clients should continue to be allowed. The key is that the auditor must be unbiased and avoid any engagements that may lead users of the financial statements to question the auditor’s independence. The issue of auditor independence is a crucial element and very important for the audit profession. However, Gul (1989) [17] who finds the contrary, in describing this, he contended that the existence of competition caused auditors to be more independent and thus create a good reputation in order to preserve their clientele. First, large fees paid to auditors may increase the effort exerted by auditors and thereby increase audit quality. What is professional scepticism and why is it important to auditors? Almost all empirical studies that attempted to find relationship between larger audit firm size and AI concluded that there is a positive relation between them [18] (De Angelo 1981). An audit committee consists of a selected number of members of a company’s board of directors whose main duties are to help auditors remain independent of management (Arens at al, 1999), that is, committee should support the auditor instead of management in different audit disputes. First, the more the auditor has at risk in its dealing with the audit client, specifically when the non-audit services correlation has the capability to generate substantial revenues on top of the audit relationship. It has two facets – the fact of independence (also called actual independence) and the appearance of independence (also called perceived independence). In addition, the fees for non-audit services has also increased substantially and are more profitable than fees from audit services, thus strengthening the economic bond and substantially lead to impairment of AI . a. • Failure by auditors to do this undermines the credibility of the accountancy profession and standards it enforces. The other is that the consulting nature of many non-audit services puts auditors in managerial roles, potentially threatening their objectivity about the transactions they audit. Mitchel et al. Gul (1989) who studied the perceptions of bankers in New Zealand found that the effect of provision of NAS was significantly and positively associated with auditor independence. If users believe that auditors are not independent, the value of the audit function is … c. Explain the difference between independence in appearance and of mind. A. auditors are unable to perform any accounting services unless all rules of conduct in the AICPA Code of Professional Conduct are​ followed, including independence. Several prior studies concluded that NAS has negative effects on auditor practices and auditor independence. The auditor should be independent from the client company, so that the audit opinion will not be influenced by any relationship between them. For example, Salehi (2009) examined non audit services and audit independence. On the other hand, long auditor tenure is beneficial as auditors gain expertise in the field they audit and may reduce the auditor’s ability to detect irregularities or material misstatements (Gul et al., 2009). Independence refers to the auditor’s ability to present his opinion about the reliability of financial statements honestly and impartially away from his interest or the pressure of clients [1] (Ahmad, 1985). Expert Answer . A Survey carried out by Wines (1994) suggests that auditors receiving NAS fees are less likely to qualify their opinion than auditors that don’t receive such fees, based on his empirical analysis of audit report issued between 1980 and 1989 by 76 companies publicity listed on Australian stock exchange. There are three main ways in which the auditor's independence can manifest itself. Reporting Independence: The auditor should never let any feelings of loyalty towards the client to affect his work. Thus auditors should always remain free from interference of client managers. Independence, because of its importance, is the first rule of conduct. And although you must be independent, gauging firm independence isn’t a decision you have to make until you reach the level of senior manager or partner at an auditing firm. Together, these results suggest that audit opinions may be influenced by the magnitude of non-audit (and non -audit) fees received from clients. Large audit firms will make sure to provide an independent quality audit service as the larger audit firms tend to have better research facilities and efficient financial resources, more advanced technology and more skilled employees who will be able to undertake large company audits compare to smaller audit firms. The sample comprised of audit partners and the author argued that the factors affecting the perceptions of AI are likely to change over time owing to changes in the local economic, political, cultural and regulatory environment. (1993) believed that the joint provision of audit and NAS to audit clients would cause unfair competition due to the use of audit services to the same client and thus would impair AI. Independence in appearance) Course Hero is not sponsored or endorsed by any college or university. This concept has been discussed widely and many definitions have been presented in literature. The questionnaire and the interview survey reveal that most of the respondents are in the opinion that auditor independence would be secured by the presence of an independent and active audit committee. In Malaysia Gul and Yap (1984) reported that NAS provision increased their confidence in auditor independence. The non-rotation of audit firms is not considered to be a dominant factor but the formation of audit committees is found to have a strong positive impact on improving auditor independence, while the positive impact of disclosure of non-audit fees is considerably less. In Malaysia the MIA By-Law (Section B-1.98 on Professional Independence) has emphasized that "if the total fees (arising from both assurance and other non-assurance services) yielded by one assurance client or its related entities surpass 15% of the firm’s entire fees in each year over two successive economic periods, financial dependency shall be considered to exist, in which case, a self-interest threat to independence is created. Users of financial statements would be unlikely to rely on the statements if they believed auditors were biased in issuing audit opinions. Mautz & sharaf(1961), who are among the pioneers in the study on auditors independence have developed a perception of independence with two mechanisms: practitioner-independence (independence in fact) and profession-independence (independence in appearance). 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). Thus, the audit committee is anticipated to ensure that the firm has sufficient internal controls, proper accounting policies, and independent external auditors that will prevent the incidence of fraud and promote high quality and timely financial statements. Auditor reputation is directly associated with audit quality. Independence is essential to that contribution. Church and Zhang, (2002) argue that independence in fact is necessary to enhance the reliability of financial statements. Most empirical studies conducted on size of audit fees do not take into consideration the factor itself; instead the studies are inter-related with other factors. Arruanda (1999, p. 165) pointed out that joint provision of audit and NAS would reduce overall cost, raises the technical quality of auditing, enhance competition. In a UK study (Beattie et al 1999) competition was the factor influencing auditor AI. There have been a large number of studies on perceptions of auditor’s independence. The issue of maintaining auditor independence is more crucial for smaller firms than larger firms. 3.23 The following relate to auditors' independence. Before we discuss the specific independence requirements, we first discuss external factors that may influence auditor independence. The study examines the opinions of commercial loan officers who were the users of financial statement and who would know the significance of audit report and the issues related to auditor independence. In this study, only factors such as the provision of non audit services, the audit firm size, the audit firm’s tenure, the degree of competition in the audit services market, the size of audit fees and non audit fees and the audit committee will be analysed and whether these factors will impair or enhance auditor’s independence. For example, the auditor must have access to books and records and also effective assistance from management personnel during audit examination is required (salehi 2009). This 15% criterion has also been the level generally used by the ICAEW and Australia at which auditors have to consider their independent position. The Financial services code, updated and published in September 2017, by a committee of representatives from the banking and insurance industry, the Financial Reporting Council, the Prudential Regulation Authority and the Bank of England established by the Chartered IIA further promoted the independence and authority of internal audit; stating that … 2005, 2009).The study Gul and Teoh(1984) analyses the main effects of combined audit and management consulting services provided by public accounting firms and the population sample taken comprised of bankers, public accountants, managers and shareholders. Although there are market-based incentives for auditors to remain independent, there are also forces that potentially threaten auditor independence. A total of 86 officers responded to the self administered questionnaire. The result obtained was that the expansion by audit firms into non audit services reduced their confidence in the auditor’s independence. Nevertheless, following the collapses, auditing profession as a whole has been affected and changes were proposed to ensure that audit firms reduce their over-reliance on NAS (The Star, 2002). Try our expert-verified textbook solutions with step-by-step explanations. The most important factor affecting AI is given by Audit firm size, followed by audit firm tenure, high competition, audit committee, MAS and size of audit fee. The result concluded that the Big Four firms were identified to be better and more efficient compared to the other firms in all characteristics connected to independence from their business clients. Many firms which operate in an intensely competitive environment may have difficulty remaining independent as the client can easily acquire services of another auditor. However, in studies conducted by Shockley (1981) and Teoh & Lim(1996) tenure was not found to have a significant impact on perceptions of AI. Independence for an auditor is essential for all services an auditor performs to prove to end users that ownership interests are not being influenced in any way. 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). However as suggested by Linberg and Beck (2004), Competition in the audit market makes the auditor more careful and concerned with the audit assurance level in their services. Orren (1997) states that independence in fact refers to the actual, objective relationship between auditing firms and their clients whereas independence in appearance is the subjective stated of that relationship as perceived by the clients and the third parties. 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). According to Beeler and Hunton (2002) contingent economic rents such as potential non-audit revenue, increase unintentional bias in the judgments of auditors. Questionnaires and interview survey were used to seek the perceptions of senior managers of audit firms, banks and public listed companies. In reality there are many factors which impair auditor independence and some studies concentrated on only one factor. Many empirical studies have proven that the excessive level of competition in the audit firm has weaken auditor independence (e.g. In order to ensure the independence of auditors and to protect the interest of investors, the accounting profession in most countries has come up with a code of ethics that spells out guidelines for auditors’ competency and independence. 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. • A lack of independence may lead to a failure to fulfill professional requirements to obtain enough evidence to form the basis of an audit opinion, in this case, to obtain details of a questionable material item. The EFAA (October, 1998, p.4) clearly states that," the (total) fee from one client should not exceed a certain percentage of the total turnover of the audit firm". Furthermore, the research discusses also the different policies related to auditor independence. Pearson (1980) found the larger size of audit firms will enhance auditor’s independence, because, smaller firms would experience more difficulty in resisting client pressures in situations of conflict. Research on audit fees has also documented that client size is an important determinant of audit fees (Simunic, 1980; Francis, 1984), while other research indicates that the relative magnitude of non-audit fees is also higher for larger clients (Abbott et al., 2002). However, as pointed out by Goldman & Barlev (1974), it cannot be concluded that large CPA firms are more resistant to pressures from their clients. 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 concern… Some studies can be those of Abu Bakar (2005) who analyses the factors influencing auditor’s independence from the perceptions of Malaysian loan officers. Why is independence so essential for external auditors? However, there is a study that proves otherwise. This preview shows page 3 - 7 out of 10 pages. For example, Shockley (1982) in his study suggests that the negative effects of MAS, the size of the audit firm and competition on a third party’s PAI actually arise because of the linkage of these variables to audit fees. 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. Auditor’s services relationship brings up two categories of independence concerns. One could argue that for internal auditors to do their jobs successfully, this requires full independence from senior management in order that the board is able to rely on their internal audit department for the necessary assurance in relation to internal controls, risk prevention and so on. In cases of accounting scandals (for example Enron and WorldCom), the audit firm appeared to be in collusion with the management in hiding fraudulent activities. A. auditors are unable to perform any accounting services unless all rules of conduct in the AICPA Code of Professional Conduct arefollowed, including independence. The auditors are expected to give an unbiased and honest professional opinion on the financial statements to the shareholders. They found no evidence that lengthy audit-firm tenure has a negative effect on audit quality, thus impairing auditor independence. Management are never allowed to pressurize the auditor. Some prior research base on the effect of non-audit fees on auditor independence is also inconclusive [21] (for example, Wines 1994). I run into more than a few internal auditors who struggle with independence. Further, the provision of non-audit services help the incumbent auditor to have a better understanding of the client and knowledge spillovers ( Francis, 1984), and thus to a better informed audit reporting decisions. The purpose of audit is to express an opinion on the truth & Fairness of Financial statements.for this auditor independence is necessary. The results indicate that audit firms operating in a relatively high level of competitive environment, larger size of audit fees, audit firm serving a client over longer duration, audit firm providing managerial advisory services and the absence of an audit committee are perceived as having the risk of losing auditor’s independence. A self administered mail survey was used and a total of 72 completed questionnaires were received producing usable replies of 14.4%. Why is independence so essential for auditors? auditor is the watch dog for the company and his independence gurantees true and fair accounting of transaction which are reflected in the financial statement. 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.” and do not necessarily reflect the views of UK Essays. Whyis independenceso essential for auditors? Large audit firms have larger client portfolios which enable them to resist management pressures whereas small firms provide personalised services as their client portfolios are limited and they have to succumb to management requirements (Lys and Watts, 1994). It is critical for an auditor to be independent of the firms they audit due to many reasons. 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 … Kinney et al (2004) denoted knowledge of a client’s information system and tax accounting could spill over to the audit, improve the information available to the auditor and thus improve audit quality which in turn would increase the probability that problems are discovered. To assess how audit-firm tenure affects audit quality, Myers et al. The results conclude that a large audit fee received from a single client is the most essential factor leading to the risk of losing AI, followed by the provision of management consultancy services. Unfortunately, the research stream which evaluates the association between non-audit services and auditor independence, by examining the effect of non-audit fees on the auditor’s propensity to issue a going concern modified opinion (hereafter GC), has produced rather mixed results [20] . The non-big four firms are more risk averse with regard to litigation arising from fraud and irregularities compare to non-big four firms. SEC requires Audit Committees to evaluate the independence of the company’s external auditor when deciding whether or not to hire the auditor for providing non-audit services. Independence is the main means by which an auditor demonstrates that he can perform his task in an objective manner. American Institute of Certified Public Accountants (Public Oversight Board, 1979): "While it is, of course, essential that an auditor preserve his objectivity and integrity from his own viewpoint, commonly called "independence in fact," it is also important that the auditor appear independent to all users of the financial information he provides. Braiotta (1999) and Goldman (1974) maintained that audit committees could monitor the financial reporting process and provide recommendations in the selection of auditors, negotiation of fees and termination of external auditors, which would ultimately diminish management’s power over the auditor. An auditor needs to pay much attention when audit and non-audit services together are offered to the same client, because these non-audit services may threaten the independence of auditor. If, it is a reporting entity, the value of the concept credibility! Been a large number of studies on perceptions of auditor independence ( e.g be! 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