IMPORTANCE OF AUDITOR INDEPENDENCE (Essay Sample)

The Importance of Auditor Independence Name: Institution: Date: Word Count- Introduction Auditing is a process of investigating for the assurance of the viability of financial information. This process is undertaken by individuals who are independent of the preparer of the financial information i.e. the organization in question, and the party that gains from the information i.e. stakeholders (Petrascu, 2014). Auditors follow an applicable reporting framework that provides a set of guidelines and regulations by regulatory bodies, to compare the financial information provided and conclude on whether the information is credible or not. The International Financial Standards that are used in 109 different nations and the Generally Accepted Accounting Principles that are tailor made for individual countries. Auditor independence refers to auditors who investigate a firm's finance and make conclusions based on the stated regulations without any bias or prejudice. The primary objective of an auditor is to enhance the credibility of financial statements in accordance with the regulations provided by the regulatory body and reduce the risk of engagement by the investors and stakeholders. There are various types of auditors, government auditors review financial information of federal agencies, internal auditors examine the finances and operations of a firm and are employed by the firm in question while external or independent auditors are not employed by the organization in question (Megh, 2013). Audits are performed based on three justifications, namely; the insurance hypothesis, which states that audits provide insurance to stakeholders because they can recover their investments from inefficient and negligent auditors, the information hypothesis that argues that decision makers rely on the information provided by audits. Finally, there is the agency theory that states that managers cannot be trusted to use efficiently company resources (Brewster, 2013). This study will examine the importance of auditors, specifically independent auditors, their roles, why they are more preferred by stakeholders in comparison to internal auditors, and how various kinds of conflict and risks can affect the independence of the auditor. This study will also evaluate the requirements of the International Standard of Auditing (ISA), and the International Federation of Accountants (IFAC) code of ethics. Importance of auditor independence As discussed above there are three types of auditors, they are internal auditors, external auditors, and government auditors. External auditors are hired by parties who are likely to benefit from the information provided in the audit like stakeholders and investors. Therefore, independent auditors examine the financial records of a company that he/she is not affiliated with. The primary objective of independent auditors is to provide valid information to the stakeholders and reduce their engagement risk by limiting fraudulent behavior that could lead to loss of investments (Muller, 1998). External auditors are preferred to internal auditors because they have no affiliation with the company in question and the information provided will be unbiased. Internal auditors are likely to be biased because they are hired by the business and, therefore, are affiliated. Another advantage of external auditors is that they identify the internal weaknesses of the business that may lead to the failure of the business and negatively affect the stakeholder's interests. Stakeholders also view external audits as more reliable than internal audits (Stirbu, et al., 2009). External auditors give credibility to financial reports provided by the company and reduce the risk of engagement. Lenders such as banks and other financial institutions also prefer to have external auditors examine the financial reports of the enterprise. This allows the lenders to identify the company's cash flows and expenses and estimate whether the firm, about its financial report, can pay back the loans in the given period. External auditors also reduce legal and tax implications caused by fraudulent behavior by the management of the organization. In a bid to sway more investors their way and appease existing investors, then the management may manipulate profits and reduce losses. This is against the law and sometimes the company may face high tax fines from the relevant bodies. However, the existence of regular external audits makes sure that the managers do not ‘cook' the books. Business owners also benefit from the services offered by external auditors in decision making. The information provided by external auditors helps business owners identify accounting errors and, therefore, make more efficient decisions (Verschoor, 2010). External auditors can also examine and discover sales trends; this helps the business owner to plan and forecast future sales trends. The firm's financial reports are declared valid in agreement with the set guidelines of the relevant regulatory bodies i.e. IFRS and GAAP U.K. Requirements of ISA International Standards In Auditing, (ISA), are a set of guidelines and regulations for the effective auditing of financial information provided by the International Auditing and Assurance Standards Board (IAASB). According to the ISA, the auditor (both internal and external) is subjected to various requirements namely; ethical requirements, professional skepticism, and professional judgment (IFAC, 2007). These ethical requirements consist of integrity, objectivity, professional competence, confidentiality and professional behavior. An auditor is required to have integrity in that he. She should be honest and maintain a professional relationship with the organization. Auditors are also expected to be unbiased and objective. This means that the auditor should not show favoritism to a particular firm of a department. The third ethical requirement is professional competence, referring to the knowledge, skills and techniques that the auditor must possess so as to do the job effectively. The confidentiality clause requires the auditor use the information obtained from the parties involved and not third parties or for individual gains. The last ethical requirement is professional behavior, states that the auditor should maintain professionalism throughout and make sound conclusions only based on facts and not assumptions. Under Professional Skepticism, the auditor is required to be alert to important factors involved in auditings like evidence and processes, indicators of fraudulent behavior, additional information and financial reports (Schilder, 2011). This makes sure that the auditor is keen and does not overlook any unusual circumstances and information, past and current. Professional judgment requires the auditor to obtain relevant and efficient to reach a conclusion. The auditor is also expected to show proof of the information acquired and the final report. This helps the parties involved identify problem areas with the information obtained and the final report made based on this information. Threats to Auditor Independence According to Parker (2015), most independence breaches are caused by self-review threat in cases where the auditor is working closely with the accounting department. This hinders the auditor from making independent evaluations and conclusions. Another threat to auditor independence is self-interest. This refers to the auditor's decision to use the information to benefit him. For example, an auditor with only one client may choose not to share information that may cause the customer grief so as not to lose the client. Familiarity is also a threat to auditor independence; an auditor is likely to be biased if he/she has worked for the company before or has had a relationship with the firm. Depending on the relationship, the auditor may manipulate information to reflect the company's finances in a positive or negative light (Livne, 2012). The auditor may choose to overlook vital information because of familiarity. An auditor, who also gives financial advice to the firm, gives rise to a conflict of interest that would be cause for auditor dependence. The final threat to auditor independence is relations threat. This occurs when the auditor has a professional or personal relationship with the company and its employees. A business relationship would fall under economic bonds while friendships with the enterprise employees refer to social bonds. Codes of Ethics by IFAC regarding auditor's independence According to IFAC, a code of ethics has been established so as to enhance auditor independence and promote ethical behavior. These codes are based on several principles such as Integrity, objectivity, professionalism, confidentiality, and professional behavior. An auditor is obligated to be straightforward in all professional transactions and business relationships. Objectivity, in this case, refers to the auditor's ability to make fair judgments without conflict of interest and undue influence (EC Staff, 2011). Due care and professional competence obligate the auditor to have sufficient knowledge, and experience in the field, this can be done by passing ACCA examinations. The auditor is also obligated to perform the auditing by regulations provided by the significant regulatory body. Confidentiality refers to the auditor's ability to give the in...