Literature Review External Auditor Accounting Essay

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An organisation is required, by statue or specific laws, to have its financial statements audited by either an internal or external auditor. An internal auditor is responsible for providing independent and objective assessments of the organisation's financial and operational business activities, including its corporate governance. On the other hand, the external auditor's duty is to express an opinion on whether the financial statements show a true and fair view, which is the main purpose for their appointment by the shareholders. The concept of true and fair view, according to Kershaw (2006) means compliance with applicable and relevant accounting standards. The duty of the external auditor is to increase the confidence of the stakeholders in the financial information included in the financial statements, to give a reasonable assertion that the financial information is free from errors and presented in accordance with the accounting standards and with the general accepted accounting principles (GAAP). Also according to Deegan et al. (2011) the external auditor is responsible for the verification of the financial statements and report that they are reliable and correct for the purposes of decision making. In an audit, the financial statements are evaluated by the external auditor, who is objective and knowledgeable about auditing, accounting, and financial reporting matters. In order to perform an audit of an entity in the best possible manner, the external auditor needs to possess the characteristic of independence which is fundamental for the expression of an unbiased and independent audit report. As stated by Wines (2011), the external auditor need to be independent since the latter reviews the financial statements on behalf of the shareholders which should be done without impartially and without bias.

Meaning of independence

Independence helps to instill confidence in the minds of stakeholders, most particularly the shareholders, that the audit was performed in the most effective manner and that the financial statements are free from material misstatements and that they show a true and fair view. According to Knapp (1985), auditor independence refers to the ability and willingness to resist client pressure. Likewise the Independence Standards Board (ISB) (2000) defined auditor independence as the:

…"freedom from those pressures and other factors that compromise, or can reasonably be expected to compromise an auditors' ability to realize unbiased audit decisions".

Moreover auditor independence has been evaluated based on two standards, which are, fact and appearance. Independence in fact refers to the actual objective state of the association between auditing firms and their clients. Church and Zhang, (2002) stated that independence in fact, is essential to enhance the reliability of financial statements. Also independence in fact elaborates that the external auditors are required to express an opinion on the reliability and trust worthiness of the financial statements as a neutral and professional observer, unaffected by personal bias during the audit engagement. Independence in appearance on the other hand, refers to the subjective state of that association as seen by clients and third parties (Arens et al. (2006) and Whittington and Pany 2004). Moreover, the South African Institute of Chartered Accountants (SAICA 2010) evaluated the independence in appearance as the avoidance of facts and situations that are so important that a reasonable third party would be likely to conclude, considering all explicit facts and situations, that an organisation, or member of the audit team's, objectivity or professional skepticism has been compromised. Moreover, independence in appearance expects auditors to avoid circumstances that might lead others to determine that they are not preserving an impartial, objective state of mind (Porter et al., 2003).

The auditor is presumed to have no motivation related with financial statements to be dishonest, the external auditor is assumed to be independent of both the organsiation being audited and of its managers. Auditor independence means a lack of partiality in establishing judgements, so that the auditor can be employed to report on the reliability of the organisations' financial statements (Mautz and Sharaf 1961). Independence is the only validation for the survival of accounting firms that provides external auditors; if it were not for the assertion of independence, there would be no reason for external auditors to exist, since their purpose would be terminated with that of a firm's internal auditors (Moore et al. 2006). The ISB (2000) defines independence as freedom from pressures and other factors that weaken, or are seen to weaken, an auditor's willingness to exercise objectivity, integrity and neutrality when carrying out an audit.

Furthermore, independence can be described as an expression of professional integrity of the external auditor. Independence necessitates avoidance of circumstances which would tend to weaken objectivity or permit personal bias to affect the opinion of the external auditor. (Hemraj, 2003).

Importance of independence