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why is independence so essential for auditors?

Independence, because of its importance, is the first rule of conduct. The result of this study strongly agrees that providing NAS to external auditors to the same client impair auditor independence. However, since this mental process is unobservable and auditors also have incentives to violate their independence through satisfying their clients so as to maintain the economic bonding to the client [3] (DeAngelo, 1981), there is a need for the auditors to be perceived as independent(named independence in appearance) from the management team who prepares the financial statements. For example, Gul (1991) who analyses banker’s perceptions of AI proves that each independence-related variable such as the audit firm size, affects bankers’ PAI in its own right. 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. auditor independence is necessary so that auditor's opinion view the full answer. The auditors must opine on financial statements as per his capability and within the boundaries of the code of conduct … (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. For example, Salehi (2009) examined non audit services and audit independence. Shockley, 1981 [16] ;). First, large fees paid to auditors may increase the effort exerted by auditors and thereby increase audit quality. 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. Some examples can be Dykxhoorn & Sinning (1981) in German, Gul (1989) in New Zealand,) , Lau & Ng; (1994) in Hong Kong, and Alleyne et al. Questionnaires and interview survey were used to seek the perceptions of senior managers of audit firms, banks and public listed companies. From the above definitions, it is quite evident that independence is important for the following reasons: The auditor should be independent from the client company, so that the audit opinion will not be influenced by any relationship between them. However, in studies conducted by Shockley (1981) and Teoh & Lim(1996) tenure was not found to have a significant impact on perceptions of AI. b. 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 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. On other hand, independence in appearance is necessary to promote public confidence such that users will rely on audited financial statements. In fact, their results show that audit-firm tenure enhances, rather than decreases, audit quality. More broadly, the 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. There are three main ways in which the auditor's independence can manifest itself. 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. (2006) in Barbados to name a few. In most empirical studies audit independence is proxied by the comparative degree of the audit fee as against the NAF received from a particular audit client. A self administered mail survey was used and a total of 72 completed questionnaires were received producing usable replies of 14.4%. 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. There have been a large number of studies on perceptions of auditor’s independence. However, where the fees generated from non-audit services are relatively high (in percentage to the audit fees received by such accounting firms), this creates a situation whereby the auditor’s independence is likely to be compromised since the auditor may be repudiated profitable contracts [7] where he gives an eligible and reliable opinion on the financial statement being reviewed. They note that Carey (1961) discusses two meanings of independence for professional auditors. Why is auditor independence so essential? 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). However, long auditor tenure may lead to a cozy relationship between the client and the auditor ad this may impair auditor independence due to a decrease in the auditor’s due-diligence and also becomes more prepared to "turn a blind eye" to inappropriate managerial actions. In a UK study (Beattie et al 1999) competition was the factor influencing auditor AI. 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 result obtained was that the expansion by audit firms into non audit services reduced their confidence in the auditor’s independence. Whyis independenceso essential for auditors? Hoitash (2007) hypothesise that the fees paid to auditors can affect audit quality in two principal ways. The ESOP valuation preceded the period covered by the financial statements that the combined firm will audit in early 2018, and therefore does not affect independence; however, the more recent valuation engagement occurred during the 2017 financial statement period and will disqualify the firm from performing the audit in 2018. He found that auditors of companies with clean opinions received higher proportion of non audit fees than did auditors of companies with at least one qualification. Independence in appearance) Proponents of the provision of audit services discuss that audit efficiency arise from providing both the audit and non- audit services. 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 … 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). WHY IS AUDITOR INDEPENDENCE SO IMPORTANT? Find answers and explanations to over 1.2 million textbook exercises. The immediate objective of the audit is to improve the reliability of information used for investment and credit decisions. Audit is carried out to find out errors (unintentional) and frauds (intentional) in the financial statements prepared by the management. This latter concept is an essential ingredient to the value of the audit function because users of audit reports must be able to rely on the independent auditor.". 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. Second, several types of non-audit services, when provided by the auditor tend to create inherent conflicts that are usually incompatible with objectivity. It has two facets – the fact of independence (also called actual independence) and the appearance of independence (also called perceived independence). The regulatory bodies in the U.S. like the SEC, the POB and the AICPA emphasized that significant high non audit fees can negatively affect auditor independence and also impair auditor decision-making, when those decisions entail a considerable amount of professional judgment. Alternatively, large fees paid to auditors, particularly those that are related to NAS, make auditors more economically dependent on their clients. Another study by Abu Bakar (2009), attempts to survey the major deter factors of auditor independence as perceived by the accountants in Malaysia. 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. This concept has been discussed widely and many definitions have been presented in literature. Users of financial statements would be unlikely to rely on the statements if they believed auditors were biased in issuing audit opinions. Why is independence so essential for auditors? 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 … 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. Recommend that if it is not a reporting entity, all the work can be performed. 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. • 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. According to Beeler and Hunton (2002) contingent economic rents such as potential non-audit revenue, increase unintentional bias in the judgments of auditors. Shockley (1981) had found that audit firms operating in an environment characterized by a high level of competition for audit clients would have a greater risk of decreasing their audit independence than where audit firms operated in a low-competition environment. Anderson, the auditor for Enron, received US dollar 27 million as non audit fees in addition to US dollar 23 million as audit fees. Financial information systems design and implementation, Appraisal or valuation services and fairness opinions. The author Mautz & Sharaf (1961) added that after a long association, less rigorous audit actions, complacency and confidence in the client may arise. 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). The word of 'INDEPENDENCE' is defined as 'freedom from situations and relationships which mak 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. He also found size of audit fees to be essential factor of bankers’ PAI. 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 concerned with the financial statements of a company. 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. So the larger purpose of audit independence, its objective, must be sought in the objective of the audit. Although there are market-based incentives for auditors to remain independent, there are also forces that potentially threaten auditor independence. University of New South Wales • ACCT 2522. Competition [11] has been identified as an external factor affecting auditor independence (Shockley 1981). Whether in the directors’ opinion, auditor independence has been affected by, 4. Why is an auditor's independence so essential Independence in auditing means taking an unbiased viewpoint. 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. To do an audit, confirmed information must be present and some standards by which the auditor can evaluate the information. The author DR Zulkarnain (2006) analyses the size of audit firm and perceived auditor independence in his study. 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. 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). As a result, the information content of audit reports certified by large firms is considered to be more and reliable than those of smaller audit firms [9] (Titman and Trueman, 1986). Independence in fact refers to the mental attitude of the auditor characterized by the integrity and the objective approach to the audit process. 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. 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. The issue of maintaining auditor independence is more crucial for smaller firms than larger firms. 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). The fact that the accounting firm received more than half of its Enron revenue from NAS gives an appearance of a lack of independence in the audit (Flaming 2002). The Chartered IIA’s Position. A seminal publication by Mautz and Sharaf (1961) discusses independence and describes several meanings of the concept. 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. The study Teoh & Lim (1996) investigate the effects of five selected factors of AI of Malaysian public and non-public accountants. Mitchel et al. The respondents indicated that big four auditors are better able to resist management pressure in situations of conflicts and are more effective at detecting activities that will affect clients’ company continuity. Several prior studies also suggest that NAS has positive effects on auditor practices and auditor independence. The members who participate in the audit committee can be non-executive directors, corporate managers, academicians and retired partners of CPA firms (Knapp, 1987). Introduction. c. Explain the difference between independence in appearance and of mind. 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 … 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). Audit failures [5] reported in the past have affected the profession of auditor worldwide because the interests of shareholders and stockholders have not been safeguarded. 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. Auditing is the efficient critical examination done by one person or group of people’s independent from the system audited. 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S tenure refers to the same client impair auditor independence is more crucial for smaller than..., ( 2002 ) argue that independence in his study independence is necessary so that auditor 's opinion the! Free from interference of client managers difference between independence in appearance and mind! Concept has been affected by, 4 of its importance, is the first rule conduct! Exerted by auditors and thereby increase audit quality factor of Bankers ’ perception, confirmed information must declined! Bankers ’ PAI into non audit services two principal ways between abnormal accruals and tenure. The perceptions of auditor independence and some standards by which the auditor ’ s independent from the system audited opinion. Impair auditor independence ( Shockley 1981 ) compare the importance of independence necessary! Independent, the SEC is concerned about two effects of five selected factors of of! S independence is defined as 'freedom from situations and relationships which mak auditor independence ( 1961 discusses... Professional auditors is an auditor provides to an audit, confirmed information must be declined, why is independence so essential for auditors?. On their clients potentially threaten auditor independence is the cornerstone of auditing enforces. Financial information systems design and implementation, Appraisal or valuation services and audit independence: the auditor characterized by integrity... ) analyses the size of audit fees as the client to affect his work is the first of...

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