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Case 1.11 United States Surgical Corporation
What factors in the auditor-client relationship create a power imbalance in favor of the client? Discuss measures that the profession could take to minimize the negative consequences of this power imbalance.
An imbalance of power in favor of the client exists within the auditor-client relationship primarily because the client hires, compensates, and is able to fire the auditor at the client’s discretion.1 Furthermore, the expansion of an auditor’s services from performing regular auditing work into providing services such as management consulting work has also shifted the balance of power in favor of the client.2
These primary factors give the client the upper hand in the auditor-client relationship especially when conflict and disagreement between the auditor and client occur. Furthermore, the main reason why these two factors create a power imbalance in favor of the client is because these two factors minimize the auditor’s independence.3 Independence is a critical component of the auditing profession which requires that the auditor be independent or unbiased in the performance of services set forth by auditing standards.4
Auditors must be independent in both fact and appearance.5 Independence in fact means that the auditor remains impartial throughout the auditing process and that the auditor renders an unbiased opinion. Independence in appearance means that the auditor is perceived by others as independent and also that the auditor actually is independent. Without true or genuine independence on behalf of the auditor, the auditor’s ability to resist certain demands and withstand certain pressures from the client is significantly reduced if not entirely eliminated. With little or no independence and therefore little or no power, the auditor is at a severe disadvantage in terms of the balance of power in the auditor-client relationship. The pendulum of power clearly is on the side of the client.
An auditor is retained and compensated by executives of a given company.6 A company’s executives also set the terms and conditions of employment and they also possess the ability to fire an auditor at their discretion.7 This procedure clearly demonstrates the lopsided advantage of power that the client possesses and the lack of independence and power that the auditor has in the auditor-client relationship. The auditor is more or less put in a position where he or she must comply or conform with the client’s position in areas of disagreement in order to satisfy the client and remain employed by the client.
You can get expert help with your essays right now. Find out more...As a result, how independent can an auditor be under this set of circumstances? The answer is not definitively clear; however what is clear is that what is supposed to be an independent auditor, someone who is impartial and apart or separate from the company being audited, becomes a part of or dependant on the company being audited. If and when disagreement arises in the auditor-client relationship, given these circumstances, the power that the auditor should have at his or her disposal to rectify the problem is relinquished from the auditor and given to the client.
In turn, the auditor is likely to look the other way or change his or her opinion on issues of disagreement that he or she as the auditor would otherwise resolve according to the appropriate auditing standards.8 This factor could have been the reason why the auditors for Ernst & Whinney relied so heavily on what executives from United States Surgical Corporation and Barden Corporation were telling them, and the reason why the auditors for Ernst & Whinney did not look into certain discrepancies much closer. The auditors’ power in this case could have been hindered to an extent that they just simply complied with the client.
Auditors of CPA firms provide more than just regular audit services for clients. Auditors also provide services that include accounting and bookkeeping work, tax work, and management consulting work.9 In many instances, revenue earned by CPA firms that provide management and consulting services for clients is larger than the revenue earned for providing auditing services and the consulting revenue constitutes a significant amount of a firms total revenue.10
The Securities and Exchange Commission (SEC) and others believe that this compromises auditor independence because the CPA firms can become dependant on these clients for the consulting revenue, thus making it more difficult for auditors to remain impartial.11 As stated earlier, when an auditor’s independence is reduced then the auditor’s power is also reduced. The Arthur Andersen-Enron scandal is an example of an auditor-client relationship where the exchange of consulting services and fees impaired auditor independence.12
Some measures that the auditing profession can implement and have already implemented to a certain degree in an attempt to minimize the negative effects of this power imbalance and also to create a more even balance of power between the auditor and client includes measures that strengthen auditor independence. By strengthening auditor independence the auditor is more able to resist pressures from the client, thus increasing the power of the auditor. The SEC has adopted certain rules which enhance auditor independence.
These rules require the rotation of auditors from an audit engagement team every five years.13 Also, audit committees have been introduced as a way to strip the responsibility of hiring and firing auditors from company executives and placing this responsibility with members of a company’s Board of Directors.14 An audit committee is composed of members from a company’s Board of Directors who are independent and separate from management.15 The audit committee oversees the retention, compensation, and work performed by the auditor.16 Peer reviews have also been implemented as a way to try and ensure that auditor independence is maintained.
Find out how our expert essay writers can help you with your work...Peer reviews are conducted by certified public accountants (CPA’S) with no direct interest in the CPA firm that he or she is reviewing. The CPA doing the review checks and makes sure that the CPA firm in question has established proper quality control elements including the independence element, and also makes sure that procedures are in place in order to ensure that the independence requirements are being achieved.17 Furthermore, the Sarbanes-Oxley Act and the SEC have restricted the types of non-audit services that CPA firms are allowed to perform for clients. Whenever non-auditing services are performed for a client the client must report to the SEC the amount of fees they paid the CPA firm for both the audit work and non-audit work.18 Also, the client must provide the SEC with particular information and details in regards to what type of non-auditing services the CPA firm provided.19
According to some individuals with knowledge and expertise in the accounting and auditing field the above requirements and provisions only go so far to ensure increased auditor independence and power for the auditor and they maintain that more effective measures need to be established.20 In particular, these individuals propose that public companies should be required to purchase audit insurance from various insurance providers that would offer it.21 This would then make the insurance companies financially responsible for auditing work.22
Also, it would be the insurance companies, not the company being audited, responsible for the retention and compensation of auditors.23 This would increase independence and the power of the auditor because the auditor would no longer be dependant on the client for employment and compensation. The auditor would be independent from the company he or she is auditing and therefore he or she will better able to perform the auditing services according to the appropriate auditing standards.
1Stephen P. Pizzo, “Making Accounting Add Up,” Forbes.com (2002).
2Pizzo.
3Pizzo.
4Alvin A. Arens, Randal J. Elder, and Mark S. Beasley, Auditing and Assurance Services 12th ed. 85.
5Arens, Elder, and Beasley 85.
6Michael C. Knapp, Contemporary Auditing 6th ed. 142.
7Arieh Goldman and Benzion Barlev, “The Auditor-Firm Conflict of Interests: Its Implications for Independence,” Accounting Review (1974): 710.
8Goldman and Barlev 707.
9Arens, Elder, and Beasley 12.
10Arens, Elder, and Beasley 88.
11Arens, Elder, and Beasley 88.
12Deborah L. Lindberg and Frank D. Beck, “Before and After Enron: CPAs’ View on Auditor Independence,” The CPA Online Journal (2008).
13Arens, Elder, and Beasley 86.
14Arens, Elder, and Beasley 86.
15Arens, Elder, and Beasley 86.
16Arens, Elder, and Beasley 86.
17Arens, Elder, and Beasley 38.
18Arens, Elder, and Beasley 85-86.
19Arens, Elder, and Beasley 86.
20Pizzo.
21Pizzo.
22Pizzo.
23Pizzo.
Works Cited
Arens, Alvin A., Elder, Randal J., and Mark S. Beasley. Auditing and Assurance Services
12th ed. (2008): 38-86.
Goldman, Arieh, and Benzion Barlev. “The Auditor-Firm Conflict of Interests: Its Implications for Independence.” Accounting Review (1974): 707-710.
Knapp, Michael C., Contemporary Auditing 6th ed. (2006): 142.
Lindberg, Deborah L., and Frank D. Beck. “Before and After Enron: CPAs’ View on Auditor Independence.” The CPA Online Journal. (2008). <www.nysscpa.org/cpajournal/2004/1104/essentials/p36.htm>
Pizzo, Stephen P. “Making Accounting Add Up.” Forbes.com. (2002).
<http://www.forbes.com/2002/02/26/0226pizzo.html>
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