Auditor Independence

Assignment 1

GSB604 Issues in Auditing and Professional Practice

Vishal Nadan Naidu

Student Number: 20048146

Words: 2600 approx

Auditor independence is a cornerstone of the auditing profession, a crucial element in the statutory reporting process and a key prerequisite for the adding of value to an audited financial statement (Mautz and Sharaf, 1961). On the other hand, the recent accounting outrage, involving big companies such as Enron in the United States and HIH insurance in Australia , have raised issues over the independence and objectivity of auditors , integrity of financial reports and overall value of audit. Issues such as auditor liability, auditor competence were also brought into light. Furthermore to my research, I will be discussing these audit issues and mandatory reforms initiated by Australia.

The major audit issues arising from the recent collapses in UK and Australia are:

1. Auditor independence

Auditor independence simply means lack of independence between the board members of the organisation being audited and the auditor. Since audit processes constitute the external check of the integrity of financial reports, the auditors carrying out the audit have to have objective, as a result of this auditor independence becomes fundamental to the credibility and reliability of financial reports. The existence of employment and financial ties between an auditors and client can suggest that an auditor is not independent of the client. Where such conditions exist, there may be a number of reasons which would make it difficult for the auditor to adopt an honest approach to the audit engagement and processes.

According to Ramsay report there are three issues when addressing auditor independence which are; employment relationships, financial relationship and the provision of non-audit services. Employment relationship between audit firm and audit client contribute to range of circumstances which, collectively or individually, make it difficult for the auditor to adopt an unbiased approach to the audit engagement. As a result of this the audit client could receive a more favourable audit report than the facts or circumstances portray. Indeed, several studies have found that auditor independence and the quality of auditing decisions deteriorate over time as the auditor-client relationship lengthens (Beck, Frecka, & Solomon, 1988; Dies & Giroux, 1992; Mautz & Sharaf, 1961). This was the case in Andersen's relationship with Enron. Auditor, independence is compromised when an auditor hopes to develop job opportunities with the audited firm. "The specific requirements for individual auditors, audit firms and authorised audit companies are dealt with under separate provisions in the Corporations Act because different liability rules apply to individual auditors, firms and authorised audit companies. Section 324CF of the Corporation act contains three separate but related elements:

* The criminal liability rules which apply to members of an audit firm where there is a contravention of the auditor independence requirements relating to the employment or financial relationship restrictions;

* A notification procedure relating to the termination of the audit firm's appointment as an auditor of an audit client for breach of the auditor independence requirements under section 324CF; and

* The circumstances (the prohibited employment and financial relationships) that must be proved to exist at a particular time, as one of the essential elements of a element of a contravention under subsections 324CF (1) or 324CF (2)". (www.treaury.gov.au/Austrliamn auditor independence requirements .pg. 103).

Non audit services (NAS) have always been in spotlight when a corporation collapses. When a company fail, the quality of an audit is often called in question. Usually the accusations is made that the auditor has allowed inappropriate accounting treatment, hence the auditor independence has been compromised. The reasons could be either the auditor has become too close to the company or because their objectivity is challenged by over-reliance on income from one source. Those who hold these views, think that the only solution to the problem is to prohibit non audit services to their client. To safe guard the investors the Corporation ACT requires directors' of a listed company to disclose the fee paid for NAS provided by auditor and description of each NAS during the financial year. Corporation Act also requires directors to make statement, that they are satisfied that the provision of NAS is compatible with the general standard of independence imposed by the Corporation Act. Corporation Act also requires directors to explain why those NAS did not compromise auditor independence.

"Auditing provides a matchless opportunity to uncover the competitive opportunities and risks of the client, which the management consulting group is then prepared to address. No other profession has the same ability, year in, year out, works with large firms and public clients, on a worldwide basis, division by division. No other profession has the same privileged opportunity to reach regularly into the very sinews of the client, on a basis of complete candour and access. Indeed, for the profession of auditing, the law requires" (www.pobauditpanel.org/downloads/chapter5.pdfSimilar). As a result of this there are legal requirements set to protect share holder interests. Due to the collapse of HIH insurance in Australia, the government has adopted principle -based approach through the Corporate law Economic reform Program (CLERP 9) Act 2004 to address auditor independence issues. The main rulings under CLERP 9 addressing auditor independence are that, there is a new independence rule imposed on auditors which covered sole practitioners, audit firms and audit companies. All audit firms must establish adequate internal control systems to meet the independence requirement and will not contravene the independent requirements. Auditors are responsible to be independent of the audited body. Secondly auditors must give companies a written declaration that the audit team have complied and meet audit requirements of the Act and other professional codes. Thirdly auditors are restricted on specific employment and financial relationship with corporate clients, which will press a treat to auditor independence. All of these requirements are imposed to the auditor as a statutory duty to inform ASIC if the auditor is aware of any circumstances which may lead to influence the integrity and objectivity