Threats to Auditor Independence
Threats like self-interest, self-review, advocacy, familiarity, and intimidation can compromise auditor objectivity.
What Are Threats to Auditor Independence?
Auditor independence is the choice to do important actions for an organization without any external pressure. They are not connected to the company, so their independent opinion matters to the general public, shareholders, and investors.
An external auditor faces many threats that can affect their independence; therefore, they are unable to issue a fair opinion. If they do not do as the company asks, their career will be affected, decreasing clients' trust in the audited statements.
Threats can arise from multiple scenarios; the AICPA (American Institute of Certified Public Accountants) defines threats as situations that could cause a person or company to be non-compliant with the rules outlined in accordance with independence.
What it means is they are allowed to work in an unbiased environment. It doesn't mean there will be no pressure or restrictions while working; it states there shouldn't be any personal benefits from their actions.
Further independence can be divided into mental and physical. Mental independence includes thinking unidirectionally, maintaining work integrity, and providing constructive criticism.
Physical independence offers the ability to take necessary actions without fear of being judged, the freedom to report problems to third-party auditors, and the ability to publish realistic opinions.
Key Takeaways
- Auditor independence is crucial for issuing fair opinions about a company's financial status. Independence means working in an unbiased environment without personal benefits influencing judgments.
- Threats like self-interest, self-review, advocacy, familiarity, and intimidation can compromise auditor objectivity. These threats stem from personal, emotional, or financial inclinations toward the audited organization.
- Independence can be categorized into two parts: mental and physical.
- To mitigate threats, creating a comfortable audit environment, periodic checks on compliance, and punitive actions for non-cooperation are necessary.
What is Auditor Independence?
Auditor independence is a critical concept in financial assessments. It signifies that an auditor's decisions remain uninfluenced by external parties, ensuring an unbiased and professional approach to the audit process.
It demands loyalty and a professional approach to conducting the audit process. The concept states that an auditor should carry out their work with integrity. It refers to the freedom of internal or external auditors from parties that may have a monetary interest in the organization they are working for.
This helps ensure a reliable audit report, and the auditor should be provided with all the resources required for conducting audits.
For example, if the organization BAC publishes its report stating financial health, but people find out that the auditors have overlooked certain financial errors intentionally.
This not only tarnishes the organization's reputation but also jeopardizes the auditors' future operations, including difficulties in securing loans and potential stock market repercussions.
Therefore, having an independent accounting professional will save the organization's reputation.
Maintaining Auditor Independence
In this profession, the general public must have confidence in the auditors. Public confidence would be reduced if companies lack evidence of their financials. To maintain this integrity, there are some rules which should be followed.
Below is a list of relationships that auditors should avoid and establish in a professional work environment:
- Financial relationships: These are types of relationships where a person is given monetary benefits. They might include salary, stock options, shares in the company, profit, etc. Example: When an individual has personal relations with the director or he/she is a beneficiary to a certain position or amount in the organization.
- Employment relationships: Employment relationships are based on an agreement or contract with a mutual decision to work together. Example: A site contractor hires 150 people to work for 90 days is an example of contract-based employment.
- Business relationships: They are defined by connections between directors, employees, or entities involved in common trade. Example: Two different companies come together to form a partnership.
- Auditor rotation: Auditors are changed every 5 years so that there are unbiased reviews against the company.
- Comply with SEC and PCAOB: Auditors should comply with the Securities Exchange Commission (SEC) and Public Company Accounting Oversight Board (PCAOB). They supervise the audits of public companies to protect investors.
Five Threats to Auditor Independence
Accounts must follow the International Ethics Standards Board for Accountants® (IESBA®) rules. Still, there might be a possibility that they might be pressured not to follow certain standards—accountants who don't comply with the standards of IESBA.
The general public relies on independent judgment coming from auditing procedures. The possibility of complete freedom is not guaranteed, but to keep some regulations and standardization in practice.
There are some clauses, but when such clauses aren't followed due to external pressure, then it is considered a threat to auditing professionals.
Threats are of various types, which are discussed below:
1. Self-Interest Threat
These threats emerge from external auditing professionals who have an emotional or monetary inclination toward a particular organization. Accountants have a direct or indirect self-interest with the company instead of giving unbiased and judicious opinions.
There might be a possibility that he/she might have personal relations with them if they have a certain portion of shareholding in the company, or there might be any outstanding fees.
Example
For example, XYZ company appoints a professional who has been offered monetary benefits apart from his/her service fees; that is when the rule of self-interest is violated.
2. Self-Review Threat
If someone gives you a task to verify your own work, you find it difficult to bring out mistakes from it. You may not be in a position to give a judicious answer due to the fear of being wrong. To solve this, there is a second type of threat.
As the name suggests, when accountants verify and review their own work, they disobey this rule because when an auditor reviews their own work, they cannot provide an unbiased opinion.
Example
For example, in XYZ company, an auditor works in that firm and also permits a final report against the organization, which is not allowed as per the clause.
3. Advocacy Threat
Under this type, if an auditor is promoting their client's financial data or statements to an extent where people feel that the auditor has become biased toward that particular client or firm, that is when there is an advocacy threat.
It becomes obvious that when someone promotes or defends certain information, people feel they are connected or related to that party.
Example
For example, XYZ company appoints a third-party auditor, but that auditor promotes and supports XYZ to such an extent that people doubt the auditor's objectivity.
4. Familiarity Threat
When an auditor shares a close relationship with a client, they become too emotional and sympathetic to the organization or client. When an auditor is not judicious to the party, they are providing service due to the relationship they have in common.
Example
For example, XYZ companies appoint their relatives as their auditors due to the bond which they share becoming overly sympathetic to them.
5. Intimidation Threat
This occurs when an auditor doesn't provide opinions professionally as they fear that there might be a reduction in fees, replacing them. Their clients coerce them to publish opinions that are in their favor despite the mismanagement that is happening in the organization.
Example
For example, XYZ has made certain mismanagement of cash and wants to cover it with a loss in balance. Technically, an auditor should point out that it is unethical to do so, but out of fear, they don’t.
Safeguard to auditors
These are certain actions that are taken to reduce threats to auditors. Supporting auditors will give professionals a sense of security, and they will give honest opinions. A safe environment can be created in two ways, which are mentioned below:
- Creating a comfortable environment where an audit program will happen
- It could be done by providing value to auditing professionals and audit firms.
- Periodic checks if the organization abides by universal standards.
- Taking overview from the committee, independent third-party auditors.
- Taking punitive actions against not being cooperative.
- Developing good standards within the organization
- Development of the top level in an organization that will make policies for the lower level.
- Having a good environment within an organization where auditor independence is the topmost priority.
- Practices or programs that ensure the independence of the auditor.
- Providing training and recognition to employees who abide by standards will promote great spirit among teams.
Conclusion
Threats to auditor independence pose significant risks to the integrity of financial assessments. Threats such as self-interest, self-review, advocacy, familiarity, and intimidation can compromise this objectivity toward the audited organization.
To mitigate these threats, fostering a comfortable audit environment and conducting periodic compliance checks is essential. Independence, categorized into mental and physical aspects, ensures auditors can work without external pressure and deliver realistic opinions, which is crucial for public trust.
To maintain auditor independence, avoiding certain relationships, such as financial, employment, and business ties, and adhering to auditor rotation practices is crucial.
Compliance with regulatory bodies like the Securities Exchange Commission (SEC) and Public Company Accounting Oversight Board (PCAOB) further safeguards the independence of auditors.
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