Assignment Requirements : Audit Independence
FINAL YEAR OPTION :AUDIT AND ASSURANCE
ASSESSED WORK ASSIGNMENT 2006/7
TOPIC : Auditor Independence
The growing number of audit failures leads the authors to question the current
auditing relationship. In no profession is impartiality more important than in
auditing. Yet psychological research indicates that such impartiality is
impossible under current institutional arrangements.
An audit is meant to ensure that a company's financial statement is valid,
reliable, and complete. The auditor gives an unqualified opinion that the
statement "fairly presents" the company's financial position. But the
management of the company hires and pays the outside auditor; the
company and its managers become the auditor's "client," thus making
psychological independence impossible.
Bazerman et al. examine a series of experiments on self-serving bias, in which
bias entered unconsciously and unintentionally while subjects made
supposedly impartial judgments. In the auditing relationship, certain
characteristics exacerbate self-serving bias, causing auditors' judgments to
favor their clients:
1. People tend to be less concerned about harming a statistical victim than a
known victim. An auditor doesn't really know who will be harmed by
misinformation, but he or she does know the people in the firm who would be
harmed by a negative audit.
2. The negative consequences of a negative opinion on an audit are
immediate, i.e., loss of contract or employment.
3. Auditors have long-standing relationships with the companies they audit.
4. Reporting standards are flexible or ambiguous.
5. People can mislead themselves about the nature of trade-offs and
rationalize their behavior.
Other factors add to the pressure on auditors such as the increased
competition among accounting firms and consulting firms that also provide
Lecture Session 11 – Assessed Work Guidance 2006/7
auditing services. An unfavorable audit, risks not only the auditing relationship
but the consulting one as well.
you are required to
identify and research the issues of concern referred to in the attached article
which impact upon the auditing profession.
address specific matters in respect of this topic.
Marks will be awarded for presentation and layout, the level and
validity of technical content, the relevance and quality of references
and, also for the depth of understanding demonstrated by the writer in
his/her discussion of the issues.
comment on certain matters referred to in the article
For this purpose you will need to have developed an understanding of the
nature of professional independence and current developments in this area.
You will be required to answer in essay form. Whilst no particular referencing
system is required, you should make all references clearly identifiable and
traceable (Eg. Author, publication, date, publisher).
Harmonization of Independence Standards for Accountants Around
Partner, Urbach, Kahn & Werlin, LLP
Chair, IFAC Ethics Committee
“Ethical standards are evolutionary and must change over time. A profession’s
ethical standards reflect the social, legal, economic, political and cultural norms of a
society at a given time. As norms and values and circumstances change, ethics rules
must change as well.” This comment was made in 1907, but is still relevant nearly
100 years later.
Each of the member bodies in the International Federation of Accountants (IFAC) has
its standards, which are based on the circumstances and the social and political
environment and shared values of its members. Accountants around the world,
however, also share the most basic values of our profession, commitment to the
integrity and objectivity which, in the perception of the public, is the cornerstone of
our profession. Harmonization of standards would be a major step forward to
strengthen the accounting profession and protect the public interest in all countries
around the world.
The global business community has changed rapidly over time, and particularly in the
last decade. Technology and the growing potential of E-commerce put international
business within the reach of small locally based companies as well as larger
transnational corporations. Cross-border investments and stock ownership, whether
through employee benefit programs or individual investment, are growing at a rapid
pace and will likely increase ten-fold within a short period of time. While in the past
it was considered unusual for a spouse to be employed in a high-level management
role with a client, this is no longer the case. The advent of E-business opportunities,
coupled with improvements in telecommunications and increasingly flexible work
arrangements, have made the accountant increasingly mobile and able to perform
services from a wide variety of places.
The public reliance on the reports of accountants in public practice is a keystone for
financial markets. This holds true for publicly traded companies as well as millions of
others that are privately held. Government, regulatory and nonprofit organizations
also rely on the independence of the auditor as the demonstration of our objectivity
The Standard which the IFAC Ethics Committee has recently issued for Exposure
defines independence as “(a) Independence of mind--the state of mind that permits
the provision of an opinion without being affected by influences that impair
professional judgment, allowing an individual to act with integrity, and exercise
objectivity and professional skepticism, and
(b) Independence in appearance--the avoidance of facts and circumstances that are
so significant that a reasonable and informed third party, having knowledge of all
relevant information, would reasonably conclude a firm’s, or a member of the
assurance team’s, integrity, objectivity or professional skepticism had been
Both are equally important, but those whose interest lies in protecting the public can
measure only independence in appearance. Accordingly, the IFAC Standard proposes
to address independence matters with a conceptual approach, which provides broad
principles to govern independence. It also provides specific guidance on considering
potential threats to independence in particular situations, along with safeguards, which
should be considered to minimize the risk that objectivity may be impaired.
The IFAC proposal is compatible with the Common Core of Principles for the
Guidance of the European Profession, recommended by the Federation des Experts
Compatables Europeans (FEE), in 1998 and Statement of Concepts—A Conceptual
Framework for Auditor Independence exposure draft issued by the Independence
Standards Board (ISB) in the U.S. during 2000. This proposal provides a framework,
built on strong principles, to identify, evaluate and respond to potential threats to
Five threats are identified:
1. A Self-Interest Threat, which occurs when a firm or a member of an assurance
team could benefit from a financial interest in or other self-interest conflict with
an assurance client.
2. A Self-Review Threat, which occurs when (1) any product or judgement of a
previous engagement needs to be re-evaluated in reaching conclusions on an
assurance engagement or (2) when a member of the assurance team was
previously a director or officer of the assurance client or was an employee in a
position to affect the subject matter of the assurance engagement.
3. An Advocacy Threat, which occurs when a firm, or a member of the assurance
team, becomes an advocate for or against an assurance client’s position or opinion
to the point that objectivity is, or is perceived to be, impaired.
4. A Familiarity Threat, which occurs when, by virtue of a close relationship with
an assurance client, its directors, officers or employees, a firm or member of the
assurance team becomes too sympathetic to the client’s interests.
5. An Intimidation Threat, which occurs when a member of the assurance team
may be deterred from acting objectively and exercising professional skepticism by
threats, actual or perceived, from the directors, officers or employees of an
The assurance team approach that the Committee has chosen recognizes that the
greatest risk to independence comes from the actions and judgement of those who
have the most opportunity to influence the engagement. The assurance team includes
not only those professionals who directly participate in the engagement, but also all
others within a firm who can directly influence the outcome of the assurance
engagement. This would include those who have direct management, supervisory or
other oversight responsibility for the assurance engagement partner.
The firm must clearly identify and assess the level of risk and put the most stringent
safeguards in effect to protect the public interest at the level where it is most likely to
cause harm. This approach recognizes the changes in the business and professional
environment and structures, which have made arbitrary “across the board”
prohibitions throughout a firm and its related entities unworkable and sometimes
Over the last several years, the accounting profession as well as the business
community and regulators have developed additional and stronger safeguards to
protect and maintain the independence of the firm. These can be broadly grouped into
(1) Safeguards created by the profession, legislation or regulation.
(2) Safeguards created and maintained within the assurance client.
(3) Safeguards within the assurance practitioner’s own systems and procedures.
Safeguards include education and training requirements for entry into the profession,
professional standards and disciplinary processes, external reviews of quality control
systems, corporate governance structures which include communications with strong
independent audit committees, “tone at the top” where firm leadership stresses the
importance of independence and the expectation that members of the assurance team
recognize public reliance on their work, policies and procedures which prevent
individuals who are not part of the assurance team from influencing the engagement
as well as many others.
Firms and assurance team members have an obligation, under the principles-based
approach, to identify and evaluate circumstances and relationships that may create
threats to independence, and to take appropriate action to eliminate these threats or to
reduce them to an acceptable level by the application of safeguards. The nature of
assurance engagements may differ and consequently different threats may exist,
requiring the application of different safeguards. This focus on a thoughtful
identification of threats relevant in a particular situation and the development of a
tailored plan to safeguard independence for each individual circumstance is likely to
provide better protection of the public interest than merely complying with a set of
detailed rules. Rules are often arbitrary, may be interpreted differently by various
users, and can never address all of the different combinations of circumstances which
can occur as the profession continues to evolve rapidly in the years to come.
It is important to recognize that in some situations there will be no safeguard that is
adequate to mitigate the risk. For example, it would never be acceptable for an
individual on the assurance team to have a direct financial interest in the client or to
serve as a director, officer or employee of the client. Likewise, if the firm or a
member of the assurance team makes management decisions on behalf of the client,
they would not be independent and thus could not perform the assurance service.
In addition to the broad principles, the Code would include guidance on the
application of the available safeguards to certain specific situations that commonly
occur in practice. These include various types of financial interests, close business
relationships with an assurance client, family and personal relationships, long
association of senior personnel with clients, issues related to fees and pricing, gifts
and hospitality and litigation.
Firms have traditionally provided a range of non-assurance services for which they
are well qualified with strong skills and experience to assurance clients as well as
others. As the nature of accounting practices and the services we provide have
expanded, some have raised concerns regarding whether the provision of nonassurance
services to assurance clients could impair independence. The conceptual
approach provides guidance for assurance providers to evaluate the circumstances
when such services are provided and be sure that appropriate safeguards are applied in
order to be sure independence is maintained. The level of threat may differ depending
upon the nature of the engagement, whether it is a publicly traded or privately owned
company and the extent and nature of the other services performed.
Applications of the principles to specific situations are discussed in relation to specific
services including preparing accounting records and financial statements, providing
valuation services, internal audit services, IT systems services, temporary staff
assignments, acting for or assisting a client in the resolution of disputes or litigation,
legal services, recruiting senior management, and corporate finance activities. It is
anticipated that as new services develop or as questions arise relating to the
application of principles to other specific situations are raised that additional
information about specific situations would be considered by the Ethics Committee.
The conceptual or principles approach to independence offers significant advantages
to the public, to clients and to assurance providers. The users of assurance reports,
and audits of financial statements, including investors, regulators, and creditors, will
benefit because principles are straight-forward and more understandable to the public
than a maze of different, complex and sometimes unenforceable rules. Audit
committees and Boards of Directors will have a logical baseline to frankly discuss
independence concerns with their companies’ auditors.
Clients will also benefit from a better understanding of how their auditors apply
safeguards to mitigate risks. Simplification of the rules will also reduce the costs of
identifying potential independence risks and provide for appropriate safeguards
specifically designed for the client and the services, which are being performed by the
firm, rather than by interpretation of rules, which may not directly apply.
When the public interest and the client interest are benefited, assurance providers
benefit also, with less confusion about what independence means and increased public
confidence in our objectivity.
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