An independent auditor is a certified public accountant (CPA) or chartered accountant (CA) who examines the financial records and business transactions of a company with which they are not affiliated. An independent auditor is typically used to avoid conflicts of interest and to ensure the integrity of performing an audit. Independent auditors are often used—or even mandated—to protect shareholders and potential investors from the occasional fraudulent or unrepresentative financial claims made by public companies. The use of independent auditors became more critical after the implosion of the dotcom bubble and the passage of the Sarbanes-Oxley Act (SOX) in 2002.
An auditor may perform various auditing, tax, and consulting services for individuals, corporations, nonprofit organizations, or government entities. An independent auditor either works for a public accounting firm or is self-employed. An auditor examines financial statements and related data, analyzes business operations and processes, and provides recommendations on achieving greater efficiency. They evaluate company assets for impairment and proper valuation and determine tax liability, ensuring compliance with tax code and laws. The auditor develops an opinion asserting the reliability and fairness of clients' financial statements, then communicates the information to investors, creditors, and government organizations. Also, an auditor may perform other auditing, tax, and consulting services for individuals, corporations, nonprofit organizations, or government entities. An independent auditor asks questions of management and staff for a better understanding of the business, its operations, financial reporting, internal control system, and known fraud or error. They may perform analytical procedures on expected and unexpected variances in account balances or transaction classes, then test documentation supporting those variances. The auditor also observes the company’s physical inventory count and confirms accounts receivable (AR) and other third-party accounts. The Sarbanes-Oxley Act of 2002 was passed after Enron, WorldCom, and several other technology companies collapsed due to accounting improprieties. The goal of SOX was to improve corporate governance and restore the faith of companies' investors. However, many in the business world are against SOX, seeing it as a politically motivated move leading to a loss of risk-taking and competitiveness. Of concern to many is the mandate requiring that public companies obtain an independent audit of their internal control practices. The cost of the requirement is felt most acutely by companies with a market capitalization of $75 million or greater. The audit standards were modified in 2007, reducing costs for many firms by 25% or more annually.
Despite the high initial costs of the internal control mandate, companies can experience many benefits from the independent audit process. Managers can use the information to continually improve internal processes. Companies frequently find that over time the internal control testing becomes more cost-effective. Additionally, markets use the information from the audit to assess businesses more effectively. Audits provide a clear picture of a company's worth, which helps investors make an informed decision when considering whether to purchase shares in a company. Financial analysts and brokerage companies also rely on an audit's results when making investment recommendations to their clients.
Accountants in public practice should be independent in fact and appearance when providing auditing and other attestation services. If you provide attestation or assurance services to clients, a conflict of interest may prevent you from also providing investment advisory services. AICPA rules state that an accountant’s independence will be impaired if the accountant:
Accountants may provide certain advisory services to audit clients without impairing independence. Accountants can:
By Josephine Haste Let me take you back to your time at university. Do you remember when you would diligently attend your audit lectures and madly scribble notes on every word the lecturer said? No? Recent observations from CPA Australia’s quality review program suggest that many of us skipped the lecture (and forgot to collect the notes!) on the fundamental importance of actual and perceived independence. The quality review program continues to find members who have failed to comply with this most critical accounting principle. Perhaps even more concerning is that when a breach of independence is reported, many members don’t fully understand that it may be illegal not to satisfy the requirements of actual and perceived independence. So what is independence and why is it at the cornerstone of every audit that is conducted? The purpose of an audit is to express an opinion that is objective, impartial in judgement and reliable for those who are using an audit opinion to make decisions about investment or for regulatory purposes. For an audit report to be worth its salt, the auditor who prepared it must be seen to be free of any undue influence. In financial terms, this means that the auditor should not have any dependency on the client by either personal affiliation or financial reliance. An auditor who fulfills these criteria is regarded as independent. Actual independence is quite straightforward for an accountant who is across the requirements. If, however, there is a significant financial connection, other than through the reasonable fees paid for the auditing services, or a connection via a personal relationship, actual independence may be impeded. This could be a problem to the point where it is unlikely that any safeguards would ensure that the audit opinion is seen as objective, even if an independent auditor would have drawn the same conclusions from an examination of the entity. "Perhaps it is the time for your practice to take an independence health check."— Josephine Haste Perceived independence is where shades of grey creep in to the normally black-and-white world of audit. Looking at the relationship between the auditor and the client, every individual may perceive an arrangement differently, and this is where professional judgement comes to the fore. As a guiding principle, perceived independence is when a third party looking into the arrangement would consider the auditor independent from the client. When faced with a perceived independence issue, an appropriate consideration is materiality. APES 110 Code of Ethics for Professional Accountants suggests that “When assessing materiality, a member in public practice or a firm shall consider both the qualitative and quantitative aspects of the matter which might have, or be seen to have, an adverse effect on the objectivity of the member or the firm.” What is key in this quote are the words “or be seen to have”, which suggest that the accountant should adopt a wider viewpoint when assessing perceived independence.
To help members better understand the independence requirements and fully digest this information, the Joint Accounting Bodies issued the fourth edition of the Independence Guide in February 2013. This provides practical, case-based scenarios to help practitioners assess issues of independence that they may encounter. So let’s now take the mid-semester test on independence. For each example given below, state whether you think the accountant is independent or non-independent and, if the accountant is non-independent, whether that non-independence is actual or perceived.
You may consider these examples to be great works of fiction, but in fact they are taken from case findings from the quality review program. All of these examples are real concerns for auditors. How did you score on the test? Perhaps it is time for your practice to take an independence health check. Here’s a prescription for some resources which may help you assess your own independence, both actual and perceived: Josephine Haste is CPA Australia’s manager for quality review education. |