A Definition of Audit Independence

A Definition of Audit IndependenceIndependence is fundamentally an attitude of mind for exercise of professional judgment and delineate as an abstr passage concept that is easily issue to misinterpretation. Quality of justness, objectivity, h adeptsty, and impartiality are included in the concept to characterize freedom. Independence is in any case a basic element to the reli world power of canvasors keys. However, it does not mean that an sizing upor must be free of all economic, monetary, and separate relationships to comply with license. Two aspects are c everywhereIndependence of mind.It is essential state of mind to enable an tender to give his effect or conclusion based on professional judgment with surface being affected by compromising enamors.Independence in appearance.It refers to a learning of a third party regarding the visitors freedom. Circumstances and relationships which are incompatible with freedom would organize third party and users of financi al statement to make conclusion that thither is unacceptably spirited riskinesss of scrutiniseors liberty has been impaired.An analyseed accountor should bear ons emancipation of mind except to a fault portrays to others he is independent in an audit engagement. For this to be achieved, he or she should avoid those threats to independence in order to draw in perception as very independent from third party and users of financial statements in order to them confident that the auditors reports are credible.Definition of hearers IndependenceThe concept of auditors independence is an issue that has been debated from many perspectives since the despenny of the profession.Salehi1 stated that the auditors independence has been defined by International Auditing Practices Committee of the International Federation of Accountants as The auditor should be straight forward, honest and sincere in his approach to his professional work. He must be fair and must not allow prejudice or bia s to override his objectivity. He should maintain an impartial attitude and twain be and appear to be free of any interest which might be regarded, whatever its actual effect, as being incompatible with integrity and objectivity.How has the issue of audit independence evolved?During 19th century, the initial concept of audit independence arose fundamentally in British that the unproblematic accountability of professional accountants and auditors was to take charge and safeguard investments in existing and former colonies of the British Empire by those absentee owners and they could tin professional go to different investor groups. Auditors were rigorously forbid from making investment and involving in the business that they audited. The audit independence during this era was at weak level as the background signal of professional operate could be broad and auditors were allowed to perform bookkeeping and financial statements preparation for the entities they audited.There was an economic shift from capital coming in the first place from foreign sources to capital ancestry primarily from domestic sources that led to a change in concept of audit independence during the late 19th and early 20th century. This shift colligate to the emergence of large American corporations and also a change in the understanding of nature and conclude of Business Corporation. During this time, accounting and auditing was essential to valuation of the patented interest of the corporation. There was a need to initiate periodic balance sheets to effectively distri unlesse the retained profit to proprietary interest. By this, auditors primary debt instrument shift from serving absentee ownership interest to collective proprietary interest instead. Normally, large banks or wealthy investors acted as domestic shareholders to compose collective proprietary interest. However, it tends to be more general public involved in stock ownership.The concept of audit independence was f acing another alteration during the New come up to era when Securities Exchange Commissions (SEC) being created. Standards for reporting and auditing grow been established by SEC to place effects on audit independence. As a result, primary duty of accountants and auditor shifted to professional timeworns for preparation and audit of financial statements. During this stage, objectivity and neutrality were essential concept for accountants and auditors in reporting on financial eyeshot and operation performance, rather than loyalty to a particular party.Until 1970s, the concept of audit independence has been eroded. Public accounting impregnables tend to modify objective and neutral steering and advocating clients regarding accounting and auditing matters (non-audit table services) at the time FASB established to be the independent accounting authority. With a rapidly growing business environment, large public accounting whole capable to provide wide range of business service s to their clients and the revenues derived which outpaced the traditional auditing services fees. Increasing hawkish marketplace for auditing services accompanied by complexity of international business practices led most auditors shifted from objective and neutral focus to preferable in becoming trusted advisor of client even though independence issue had been stressed by ASB of AIcertified public accountant during that period.In the mid- 1980s, internal audit activities were regarded as an opportunity area to be expanded by CPA firms for unexampled and existing clients. However, most firms encountered obstacles in rendition outsourcing services to its clients which were resistance from internal audit departments and anxiety over independence of audit committee. External auditor rendering consulting services may enhance audit tonicity because he or she would be provided with realizeable knowledge, operations and application of the audit client. Anandarajan et al.2 stated that The greater the orthogonal auditors insight into the client, the better their ability to understand business transactions and identify key audit risks. External auditor has a chance to identify and esteem the clients business issues since they involved in the day-to-day basis operations of client while they were performing consulting services. This would take advantage for subsequent quality of the audit.C. Richard3 mentioned several shipway to enhance auditor independence prior to Sarbanes- Oxley ProposalsLegal prohibition of financial interests in client companies.It has been the essential universal auditor independence principle that followed by both the SEC and public accounting profession. Elaboration of the rules and reporting structures form been formulated for professional employees of accounting firms including their direct family members to disclose any type of financial interests.Rotation of audit appointmentsSarbanes-Oxley required that individual auditors rotat e off a client on periodic basis to depress the threats to independence to happen. However, it has been objected by auditors by claiming on loss of high start-up cost associated with the initial years of audit if rotation of auditors was being enforced.Peer ReviewThis means reviewing the work of an audit firm by another auditor. It was gradually depart common in many countries.An independent auditor-appointing and fee-setting body.This would help to enhance auditors independence judgment and action by reduce the ability of client management in de callining the scope of audit and remuneration of auditors.In year 2002, the business failures of several large firms in united States such as Enron, WorldCom and the care led to authoritative accounting scandals that shock the market. Subsequently, several officials disclosed to the public that they had intentionally misled investors and this had trigger to question the role and integrity and doubt on independence of these companies au ditors. The far-reaching legislation resulted from these accounting scandals was the Sarbanes-Oxley Act (SOX) and this SOX also created Public Accounting backsliding Board (PCAOB), a professional body for the purpose of establish standards (auditing, ethical and independence standards) to police the auditors behavior. Strengthened independence rules and placing audit committee to oversee the auditors engagement are covered in the further consequences. The enforcement of SOX had alter corporate governance in United States and had a profound mildew abroad.Auditors independence was also an important concern in SOX. Section 201 list out those prohibit services to be provided by registered auditor to its clients. The list comprised of non-audit services including bookkeeping, financial information systems design and implementation, and valuation services. It is argued that auditor independence was being negatively affected by non-audit fees, supported by Enron and other scandal-ridden companies case. However, it is not guaranteed that prohibition of certain non-audit services will effectively increase auditors independence. Another important pillow slip was the independence standards previously establish by the AICPA and SEC through the Independence Standards Board has been recognized by PCAOB. It is under suspicious that whether these rules under SOX enforced were qualified to meet publics perception on auditors independence.After the enforcement of SOX rules, it is necessary to have a proper reconsideration of the concept of auditor independence. A new concept of auditors independence might arose which in favor of reasserting former objective and neutral concept to accounting profession rather than provide non-audit services to clients. Emergence of ongoing accounting and auditing scandals could be viewed as a strong evidence to instal that independent auditors are not appropriate in providing non-audit services to its clients. barely, this issue was not turn to in SOX or PCAOB independent standards.Another issue regarding audit independence was that client management may still hold the ability to influence scope of audit engagement and audit fees. Even though Section 301 of SOX has clearly specified that audit committee directly responsible for the appointment, compensation, and oversight of independent auditors, but there was no specific enforcement mechanism guaranteed that client management will not involved whether directly or indirectly in selection of auditors, ending of scope of audit and audit fees.In order for this new concept of auditors independence to be effective, two propositions are needed to be incorporated independent auditors should not subject to provide non-audit services to client.Management should be strongly forbidden by legislation in determining the scope of audit and audit fees to avoid unclear influences that management might exert to auditors.C. Richard3 stated without a transition to this concept, audi tor independence standards will most likely be primarily cosmetic and will not provide sufficient say-so that auditors are in fact independent from client management. If this happened, may lead auditors independence appears to be unnecessary and auditing will no foresighteder be trusted by third party and other users of financial statements since it unable to meet public perception on assurance.To create a entreat for audit services, auditors must convince the market of their independence and also their competence. It has long been recognized that a reputation for independence is an auditors greatest professional asset and that any negligence on an auditors part will leave them open to severe penalties in the form of, inter alia, a loss of reputation (Owens 1941, Ashley 1942, Johnstone et al. 2001).Reputation serves as a collateral bond for independence, in that the reputation of an auditor found to be less independent than evaluate will be damaged and the present value of his o r her audit services will be reduced (Watts and Zimmerman 1986).Reputation and independence of auditor is overmuch important nowadays if compared to previous year collect to many corporation scandals that happens before. There is hard to clarify and determine the auditor independence. There are 2 types of auditor independence which is independence in fact and independence in appearance. Independence in fact exists when the auditor is actually able to maintain an unreserved attitude throughout the audit, whereas independence in appearance is the result of others interpretations of this independence.The issues that happens currently in Asia ground about audit independence issues are public feels that the rendering of independence is unclear, expectation gap leads to problem of audit independence, offering non audit service will reduce audit independent, the more longer audit tenure, the more audit can resist management pressure,Definition independence is unclearThe current issue happen in Asia country about auditor independence is public feel that the meaning, the definition of independence is ambiguity. Public do not know how to identify the independence of peculiarly the new client. This auditor independence has been subject to vigorous debate in recent years due to major corporate collapses and perceived audit failures, such as Cendant, Enron, Global Crossing, WorldCom and Xerox in the United States. Which audit firm should public trusted since Big Five previously Arthur Anderson also having the problem of audit independence?Expectations GapOther than that, there is a research the auditor independence concept in Taiwan be influence by audit expectations gap literature. The expectations gap indicates differences in views on the nature and role of auditing amidst client and auditors. There is a different interpretation makes independence concept issues has arise. Financial users expect too much for auditors work, pubic will think that auditors independen ce has impair due to expectation gap. To solve this problem, to rebuild the trust of public on the issues of audit independence, a number of local and international independence pronouncements and regulations have been revised and reissued.Non Audit Services (NAS)There is a research shows that there is a significant negative relation between non audit services and the extent of client agreement with the auditor over financial reporting issues. Produce non-audit services to client will reduce audit independence.The ability of the auditors to resist client management pressure in auditor-client negotiation over financial reporting issues is important to investigate because it concerns over the issues audit quality and the effectiveness of auditors and will reduce management discretion if auditor do not have ability to resist client management pressure.The ability of the auditor to resist client management pressure in negotiations over financial reporting issues is likely to be weaker when the extent of NAS provided to a client increases. But the ability of the auditor to resist client management pressures in negotiations over financial reporting issues is likely to be increasing as auditor tenure increases.When requiring auditing in NAS, clients are less likely to agree with a Big 5 auditor, but are more likely to agree with auditors perceived by industry specialists. Because of specialist has more greater knowledge of the clients industry, specialists should have greater ability to resist client management pressure about financial reporting issues Auditor independence may be impaired when auditors pursue economic self-gain, instead of serving the public interest during auditor-client negotiation.Audit feesThe current study uses the extent of non-audit services (NAS) measured as a percentage of non-audit fees over total fees stock from the client, because non-audit fees are increasing and are often significantly high than audit fees and this has become the majo r source of revenue for most large audit firms. This argument implies that the auditors independence may be impaired when the auditor and client negotiate issues over financial statement reporting, and thus reduce the relative power of the auditor to resist client management pressure because of the auditors dependence on NAS services fees received from the client.The business community countered that annual audit fees would be increased substantially as a result of the minimum audit fee schedule especially for the small companies. They also charged that a minimum fee structure to the client which it would disagree with the principle of pricing based on free competition. Therefore, some large or more efficient firms which would not allowed charging less compared with other small audit firm.Code of Ethics for Professional Accountants and the EFAA (1998) suggest that client size of it which is measured from size of fees could raise doubts as to independence, but do not state what cons titutes an unacceptable proportion of total fees. However, the EFAA clearly states that, the total fee from one client should not exceed a certain percentage of the total turnover of the audit firm. In Malaysia, Noordin (1990) expresses his concern that a code of ethics should provide guidance to limit over-dependence on one client for revenue. The ICAEW has ruled that the size of audit fees of a major client should not exceed 15 per cent of total fees to avoid impairment of auditor independence. This 15 per cent criterion has also been the level generally used in Australia at which auditors have to consider their independent position and there is even a suggestion that the 15 per cent is too low. The Cohen Commission (AICPA, 1978) directed attention to the importance of size of audit fees as one of the crucial independence-related issues.Burton and Fairfield (1982) point out that there may be a close linkage between management assurance service and size of audit fees. As the provis ion of management assurance service increases, the auditor is likely to be more dependent on the client due to the size of the fees generated. It also seems plausible that smaller audit firms will be more dependent on the client if the size of audit fees generated is a significant proportion of its overall revenue.Size of audit firm and the level of competition in the audit services marketFurther, in a highly emulous environment, the auditor is also perceived to be less independent due to the increased likelihood of losing a client and the revenue the client generates. Thus, the adverse effects of MAS, the size of the audit firm and competition on a third partys problem of auditor independence actually arise because of the linkage of these variables to audit fees.Basically, a positive relationship means that the larger the audit firm size, the greater the auditors independence. They prove that large firms are more resistant to client pressures, thus maintaining higher audit indepen dence. In fact, it has been argued that large firms, due to their very size, may be more able and motivated to provide better audits. However, as pointed out by Goldman and Barlev (1974), one should not conclude that large CPA firms are immune to pressures from their clients. Competition among the offices of some large firms for clients may be as great as the competition among small, independent CPA firms. More to the point, the few court cases which challenge the assumption that CPA firms acted independently indicate that the use of a large CPA firm is no guarantee of its ability to resist pressures from clients, as happened with Arthur Andersen and Enron.Tenure of an audit firmAn audit firms tenure, which is the length of time it has been filling the audit inescapably of a given client, has been mentioned as having an influence on the risk of losing an auditors independence. Most writers, who discuss the relationship between tenure and audit independence, support this view. A lon g association between a corporation and an accounting firm may lead to such close identification of the accounting firm with the interests of its clients management that real independent action by the accounting firm becomes rough. Some critics invoke the vested interest argument to support the assertion that auditors might compromise their independence to gain continuing audit engagements, the prospect of raising audit fees if the client firm expands, and opportunities of providing non-audit services later. Example, Enron and Arthur Anderson has associate for 15 years and does not change any other audit firm.In my opinion, the definition of auditors independence is very subjective until today. This is no absolute answer to justify the issue. However, we, as a forgiving able to do are to rectify and amend the standard and regulation to solve the current issue. The standard and regulation are created by us and as a human is imperfect at everything. Sometimes we created the thing and did not consider the further weaknesses. We need to keep improve and rectify it while we face the cases and issues. A country used few hundred years to create and revise a better constitution. In addition, the auditing standard only used few decades to create the act and policy. We need more time to revise it to be a better regulation. Besides, the scandal or cases happened like Enron would scandalize the accounting and corporate level, but it also leave an opportunity to the standard board to revise and restrict the standard. Like the common law of the U.K., that is a lot of cases behind the law could guide the soulfulness to make a justice or correct judgment. The cases like Enron could be guidance for accounting and auditing standard board like Sarbanes-Oxley Act and Audit Oversight Board. Sarbanes Oxley Act was started to more emphasize the auditors independence and the occurrence of Audit Oversight Board was established to oversee the performance of audit team and audit co mmittee. However, sometimes the constitution and standard board are intentionally to show themselves have perform their responsibility and task instead of truly rectify the problem. The standard is like a pendulum. The best of the standard is the middle of pendulum. Sometimes a case happened and the pendulum is out of the middle, may be moved a bit to the left side. But the pendulum was shaken by the constitution and standard board compel to push it to the right side instead of push it back to the middle. Their action was more to prove themselves have performed their responsibility to bring forth the confident from the audience. If a case happened again, they would push it to the left side. Besides, the person of the constitution and standard board is being paid the high salary by government or sponsor. They need to perform something to prove their responsibility to continue to hold his or her position inside the organization and get the pay rather than rectifies the issue. As an e xample, the Sarbanes-Oxley Act had restricted the audit firms need to rotate the clients every certain period. It could increase the cost for auditors to start-up the new clients (Baker, 2005). Furthermore, the ICAEW has ruled that the size of audit fees of a major client should not exceed 15 per cent of total fees to avoid impairment of auditor independence (Noordin, 1990). This enforcement is to reduce the risk of auditors independence issue but it would restrict the revenue of the audit firms. Although audit firms are providing the professional services, it is still a profit-oriented firm. The middle of pendulum is the standard could maintain auditors independence and audit firms profit, but the revision of standard is already pushed the pendulum from left side to the right side or vice versa.Besides, the expectation gap between independence of auditors with financial report users is still occurring until today. This issue is unavoidable because the perception of audit incentive between auditors with financial report users is different. The perception from shareholders is they expect the auditors could give an assurance to the financial statements which is issued by the management. The perception from auditors is they provide the audit service to the client and the management would pay the audit fees. The audit fees are one of the issue could influence the auditors independence. This occur the contravention of interest between the auditors, shareholders and management. Although the auditor is independent, the financial reports users are eer commit the unqualified audit report and invest to the company. However, the unqualified audit report is not absolutely eliminated the risk and fraud of the company, especially the inherent risk likes going concern issue. The auditors are difficult to justify the going concern issue in the audit report because the auditors are difficult to know the internal information from management. The auditors only can provide the reasonable assurance to the clients financial statements. This is mean the auditors does not guarantee or confirm the financial statements are true and fair view and they only can provide the audit opinion based on the information from management assertion. Although this kind of clarification is stated in audit report, it is still a lot of financial report users believe the auditors could eliminate the fraud. If the company is collapsed, the shareholders would directly think that is the auditors fault and they are not independent. Furthermore, the accounting scandal like Enron already worsened the confidence of financial report users toward the auditor independence and audit report. The expectation gap to auditor independence become larger because the failure of Arthur Anderson.The audit fees are the biggest challenge to the auditors independence. In the item of professional ethic, the auditors should provide the professional audit service as primarily objective of the firms rathe r than profit orientation. The professional behaviour included independence, honest, competent and others. However, it is difficult for auditors to follow this behaviour because the nature of business. The audit firms could not survive without the profit. With the fierce competition in auditing, the auditors would intend to fulfil the client request to avoid losing a client and getting a better audit fees. The non-audit service and management audit service are one of the solutions to get a higher audit fees. These kinds of extra services could maintain the client relationship with the audit firms. Unfortunately, the accounting scandals and the labor for audit independence decrease the profitability of audit firms. The competition becomes fiercer and the independence of auditors is weakened. Besides, the size and tenure of the audit firms could affect the auditors independence. The larger firms could have the larger tenure and resistance to the management influence to the auditors i ndependence (Goldman and Barlev, 1974). Like Big 4, they always serve the bigger clients than the smaller audit firms, they seem like have more authority to negotiate the audit engagement with the clients. The losses of some clients would not strongly affect the total revenue of the audit firms, but for the smaller audit firms are vice versa. The proportion of total fees to the revenue would strongly influence the audit independence (EFAA, 1998). The smaller audit firms have the greater proportion of total fees to the revenue, but it is still have some exemption cases like Enron and WorldCom. Therefore, harmonise to the restriction for auditors independence from Sarbanes-Oxley Act, PCAOB and ICAEW, the smaller audit firms have the greater possibility to influence by the client in term of audit independence.According to the statements above, it have many issues could affect and weaken the audit independence. However, the audit independence would not influence the demand of the audit ing. The auditors independence only strengthens the reputation of the audit firms and has a competitive advantage in the audit market. The financial report users would not invest to a company that is not audited by the auditors. The agency theory could prove that the demand of audit is still necessary to the shareholders. The shareholders invest to a company and hire the employees to manage the operation and prepare the financial statements. The management would hire the auditors to issue an audit report to verify the financial statements. The information asymmetry and conflict of interest could happen between the shareholders and management. The shareholders invest a company is to get the return of their investment, but for the management is to get the higher salary. These kinds of incentives are the main issue to the conflict of interest and information asymmetry. Therefore, the audit is necessary to reduce the information asymmetry and conflict of interest between them. Furthermo re, some of the countries do not state the mandatory regulation that the companies financial statements must be audited and issued an audit report by the auditors. The shareholders mostly would request the management to hire the auditors to audit the financial statement and issue an audit report because they know the importance of auditing for their company.Moreover, the audit independence is strongly depending to the both auditors personality and management behaviour. The professional ethic and monetary incentive are the intersection between auditors and management. One of the weaknesses is the standards like Sarbanes-Oxley Act only emphasize the restriction of auditors independence and it does not emphasize the management interruption and influence to the auditors. Although an auditor has a strong independence but it could influenced by the management in term of monetary benefit to the auditor and his firm. Therefore, the current auditing standards should revise and more specify the both regulation of auditors and management to restrict the audit engagement.It seem like the auditing standards have a lot of the flaw in the current regulation, but it is the normal phenomena because the standard is imperfect same like the human. This is the reason for us to keep improve and revise the standard to become better and better. Besides, the standard is necessary in auditing because it is the guidance to the auditors to perform their competent task and provide the independent audit opinion. Although the standard is impossible to absolutely eliminate the fraud and the failure of audit independence, it could minimize the possibility and the frequency to happen the issues or cases like Enron and WorldCom. Hopefully the further exploration and rectification by standard board could improve the auditing standard and recover the confidence to the audit independence from the public.