Auditor independence
Auditor independence is an important factor in establishing the
credibility of the audit
opinion.
Auditor independence refers to the independence of the auditor from parties, other than shareholders, that have an interest in the financial statements of an entity and in particular independence of the auditor from the management of the entity. See The CPA Journal article entitled The Varying Concept of Auditor Independence: Shifting with the Prevailing Environment.
There are two aspects to independence: independence in fact and independence in appearance. Independence in fact refers to the 'actual' independence of the auditor. This is also referred to as "independence of miind". It is concerned with the state of mind of the auditor and how the auditor acts in a specific
situation. It is extremely difficult, and in many cases not possible, to determine whether an auditor is, in fact, independent, because it involves knowing what has gone on in the mind of the auditor.
The other aspect of independence is independence in appearance. This is how another reasonable and informed person, who has knowledge of all the relevant information, might view the independence of the auditor. It is necessary for auditors to not only act independently, but be seen to be independent because independence in appearance reduces the opportunity for an auditor to act otherwise than independently. See ICAEW's Auditor Independence: Guidance on Best Practice from 1 November 2002.
Auditor independence as it relates to independence in appearance may be addressed in statutory law, professional standards and audit firm policy. For example,
statutes, standards and/or individual audit firm policy may address
independence by:
- prohibiting owners of accounting firms (e.g. proprietors and
partners) and their staff from holding shares in, lending to, or
otherwise having a beneficial interest, either directly or
indirectly, in audit clients.
- prohibiting owners and their staff from receiving any benefits
from client organizations, other than through the receiving of
audit fees. This includes a prohibition of owners and their staff
from:
- borrowing money from the audit client,
- accepting commissions for new business referred by the audit firm to the
audit client, and
- accepting discounts given to audit staff members normally only available
to the client's staff.
- prohibiting owners and their staff from holding any office,
including the office of director, in client organizations.
- the preparation and maintenance of a list of clients and
associated companies that is made available to all owners and staff
of the audit firm, and
- the annual signing by all owners and staff of an independence
statement, stating that they are familiar with the firm's
independence policy, they hold no prohibited investments and they
hold no prohibited relationships.
- prohibiting the undertaking of non-audit services (such as
taxation and corporate advising work) for existing audit
clients [fn].
Some accounting firms establish so-called "Chinese
walls" [fn] with
respect to audit and management consulting services provided to the
one client. Other firms may limit the value of consulting work for
an audit client to an amount not exceeding the audit fee. However,
there is increasing concern that these strategies do not fully
address the problem of independence. The argument by some members
of the auditing profession that the knowledge gained through the
undertaking of such consulting work by audit firms enables the
auditor to perform a more effective audit is somewhat specious, as
the consulting work performed for an audit client is (or should be)
performed by employees within the audit firm who have no auditing
responsibilities for the client.
- rotating audit staff, including the auditor (commonly referred
to, in a partnership of auditors, as the engagement partner) and any senior person(s) responsible for the review of the work of the auditor, say
every five years [fn]. A primary objective of the rotation would be to
guard against the possibility of the auditor and his/her staff
becoming too close or familiar with senior management, with a consequent
impairment of the auditor's independence [fn]. Along similar lines is
the idea of fixed term audit engagements, in which one audit firm
retains the audit engagement for a fixed period, say five
years. Undoubtedly, such policies would increase the cost of an
audit engagement. However, the decision as to whether or not this
increased cost is justifiable is not one for the auditing
profession alone [fn].
- not accepting entities as a client in which partners (or former
partners) of the auditor are members of the governing body of the
client. This would, for example, require an auditor to relinquish
the audit of a company which engaged a former partner as a
director. In practice, such a policy may result in audit clients
not offering, or former audit partners not accepting, such
positions. See The CPA Journal article entitled Auditors’ Need for a Cooling-off Period.
- not accepting audit engagements which would result in the fees
earned from that audit engagement being greater than, say, 5% of
the total income of the audit firm. Such a law, standard or policy
requires a degree of flexibility in relation to the establishment
of a new auditing firm which may only have three or four audit
clients.
- having another appropriately qualified and experienced person
within the firm (commonly referred to as a review partner) review
the work performed by the engagement partner.
Some of the above polices, and others, are referred to in ISA220
Appendix A.
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