Auditing is the independent examination of books of account and the source documents used in their preparations to ascertain the truth and fair view representation of the concern under review. The auditor recognizes the propositions that are put forward by the organization, collects evidence and examines them to help create an objective opinion that is delivered to the organization through the audit report. Audits are carried out to ascertain the level of an organization’s internal control and establish the credibility of the financial records of the organization.
For the auditors to do their jobs objectively, their independence should not be compromised. Independence of an auditor refers to the independence from parties whose financial interests may be harmed due to the audit results to be produced by the audit (Davies, 2010). The auditor should have independence in his mind and in his appearance to the public for the public to have trust in their reports. For the auditor to produce results that are objective and represent the true picture of the organization he should be free from the influence of these interested parties who may want the results to portray their interests instead of the truth. The internal auditor should be free from the influence of the management, debtors, creditors and other parties that are interested in the final financial statements of the firm. This will ensure that all the financial reports generated by the firm represent the fair value of the transactions carried out and the true financial position of the firm (Scherf, 2014).
The external auditors too should be independent in their duties from all the interested parties in the firm’s published financial statements. These will be necessary for the stakeholders to receive accurate data that is representing the financial reality of the firm (Oringel, 2012).
The independence of audits is the cornerstone of this process because the end users of financial data need assurance that the information provided is credible and represents the actual information of the firm under review. The independence of auditors comes in three forms as discussed below; First independence is the programming independence. In this case, the auditor should be free to decide the best method to use in conducting his audit. The firm being audited or the interested parties should not influence whatsoever the choices of methods to be applied to the audit by the auditor (Gleason and Mill, nd ). With the dynamic changes in the auditing techniques the auditor should be free to apply whichever method he thinks best but it should be in line with the professional ethics and take into account the changing activities that the firm may be engaged in due to growth (Clout et al,. 2013).
The auditor should also have investigative independence. The audit report to be produced by the auditor is dependent on the evidence collected by the auditor, therefore, for the report to be relevant the auditor should have access to all the necessary financial information required to prepare the report. For this reason, the company should answer all the questions but forward by the auditor and provide unlimited access to information for the auditor (Nasution and Ostermark, 2013).
Reporting independence provides the auditor with the ability to disclose the information they feel to the public without limitation as long as it is within their professional ethics to do so. This is the most fundamental freedom to the auditors because of the agency conflict between managers and shareholders the managers may decide to falsify or withhold some information from the shareholders (Gaganis et al, 2011). In such a case, the independence of the auditor plays a key role in reducing the agency conflict and protecting the interest of the shareholders.
Threats auditor’s independence
The independence of the auditor in the firm faces a number of threats from which the auditor needs to be protected to maintain the objectivity and independence of the audit reports. In this case, the auditor faces the following threats;
This is the threat that arises when the auditor has some business, personal or other interests in the firm he is supposed to review. For example when, the auditor offers other non-auditing services to the firm. This, interest may prevent the auditor from objectively carrying out his duties in the firm and producing a credible review of the firm’s financial records (Konzelmann and Fovargue-Davies, 2013).
These threats arise when the auditor has taken a stand on any issues affecting the organization that may corrupt his ability to investigate fairly and report on the financial credibility of the organizations reports (Nasution and Ostermark, 2013). For example, if the auditor takes a stand for the firm’s financial reporting method before carrying out the audit his independence will already be questioned because of lack of independence of mind.
This is a threat that arises out of too much familiarity with the client. The familiarity may create a level of trust in the client which may erode the level of skepticism in the auditor for the auditor to carry out an objective and independent audit (LaBrosse et al,. 2011).
This is the threat to auditors who uncover unscrupulous reporting by some managers. In this case, some managers may threaten to cancel the contracts of the auditors that fail to provide clean audit reports on their firms. This case of intimidation may compromise the independence of the auditors (Gaganis et al,. 2010).
Self –review threat.
This is a threat that arises when the auditor needs to challenge an initial opinion formed by him or the firm in the process of his auditing. The auditor may want to prove his initial opinion which may, therefore, reduce his objectivity and therefore reducing the credibility of his audit report (Bochner and Mahoney, 2011).
Motivations for the changes in auditor independence
Auditor’s independence came under very intense scrutiny during the banking and global financial crisis that started during 2008 to 2011. In this period, auditing was blamed for being part of the problems that caused the crisis because the audit reports failed to report the risky ventures into which managers were engaging that led to the crisis (Muhamad Sori and Karbhari, n.d.).
The losses suffered by banks starting from the year 2007 to the year 2010 on portfolios and investments that auditors had given clean report motivated the need to recheck the auditing regulations. The governments sought to bring about changes that will prevent future financial crises due to failures of auditors to recognize the risks associated with some investments that companies take. Backed by these objectives most countries sought to bring about legislations that will provide the auditors with more freedom to enable them provide better financial reports than before. Because of these shortcomings the regulations on the auditor’s independence were altered to improve it (Bochner and Mahoney, 2011). The following changes were adopted;
Prohibiting provision of most non-auditing services to clients by auditors
Provision of non-auditing services to the clients by auditors increased the familiarity between the auditors and their clients and ion the other hand created self-interests of the auditor in the firm. These interests and the increased familiarity, therefore, compromise the independence of the auditors (Scherfer, 2014). Ones the independence of the auditors is compromised the objectivity of the auditing reports is eroded. For this reason European authorities that regulate the auditing standards chose to prohibit the auditors from providing tax services and services that involve playing a part in the decision-making and management of the firm and other non-audit related services to the clients (Oringel, 2012).
The effectiveness of this method
This method eliminates the self-interest that is created by the fee that is received for offering the services. These monetary rewards may compromise the auditors to giving in to clients wishes so as to maintain the contract and, therefore, may lead to erroneous audit reports. The prohibition of the non-audit services also limits the threat of self-review whereby the auditor may review the decisions he made, or he advised the management to take (Rittenberg, et al,. 2012). This may influence the auditor to provide an audit report that positively reviews the work done contrary to the reality of the financial position of the firm (Krishnamurthy et al,. n.d.).
The intimidation threat is neutralized by this method; the management of the firm may blackmail an auditor against giving a negative report on the firm by threatening to discontinue his other services provided to the company. This may make an auditor that is financially dependent on the contract to give a biased report. By barring non-auditing services the regulators achieve independence to auditors. Finally, the prohibiting the auditors from offering non-auditing services eliminates their dependence on the managers. This makes them able to provide actual audit reports that are less biased and that reflect the true financial position of the firm (Gramling et al,. 2012).
Mandatory rotation of audit firm
Long interaction of the auditor with his client may create a familiarity threat to the auditor’s independence. Therefore for the independence of the auditors to be maintained the firms are required to change audit firms regularly (LaBrosse et al,. 2011).
The effectiveness of the method
It improves the quality of the auditors work. The quality of the auditors work declines with time due to familiarity with the clients therefore rotating the auditors regularly reduces the familiarity therefore improving their output. With long engagements auditors tend to form close personal relationships with the employees of the client which may compromise the quality of reports of the auditor (Davies, 2010).
The rotation of audit firms and the auditors promotes competition among them which leads to improved quality of services offered and the provision of the services at a competitive price. The cost of auditing in a firm adds to the firm’s overall costs therefore reducing its profits. For this reason firms would prefer quality services at the cheapest prices possible this can only be achieved by competitive pricing of auditing services. This reduces the cost to a firm than when contracting audit firms unlike when the job is done by a single firm where it will charge monopoly prices (Nasution and Östermark, 2013).
Rotation of firms improves the perception of the public on the independence of the auditors. The notion of the public on freedom of auditors is very vital, in this case, when the auditors are rotated on a regular basis the public confidence is improved. The public confidence in the reports is very crucial since the public is the consumer of the financial information that is provided (Gaganis et al,. 2010).
The financial crises in the banks in United States and the UK led to the world financial crisis from 2007 to 2009. This necessitated the changes in the regulations in the way auditors report their findings and their general independence. If the independence of the auditors was better before the crisis, much of the banking crisis could have been avoided. The regulations that are put in place though increase the cost of conducting auditing for firms are the cheaper options considering the cost of an auditing failure which is collapsing of the firm.
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