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Financial statements act as a crucial part of reflecting a companys performance and financial status in todays modern business world. It is therefore a tool for investors to decide whether the company worth investing or not. As the financial statement may affect the stakeholder's judgments towards a business significantly, it should be true and fair and free from bias. External auditing is as a result to be created and to ensure the data could be trust. However, the credibility of those auditors could be in doubt. Other than the managers inside the company, no one really knows the figures published are true or fake. Thus, the independency of external auditors is deemed crucially important. The following essay would focus on the importance of external auditing. The discussion would begin from the role of external auditors, followed by the importance of different aspects of independence and finally some potential factors might weaken the independency of an audit
Role of External Auditors
An auditor is an official who is responsible for checking the accuracy of business records carefully. They have to ensure that financial records and statements are accurate and honest of an organization. (Investopedia, 2013) However, an external auditor, in contrast to an internal auditor, is independent of the organization's operation and management. Although external auditors are not a member of staff of the organization, they are able to assess the system and procedures used internally. (Albrecht, 2005)For instance, to interview with the company's employees, to check their transaction records and even to inform their customers or clients.
It is auditor's responsibility to detect frauds of an organization. According to the ISA 200 (International Federation of Accountancy, 2009), the objective of auditing is to reduce audit risk to an acceptably low level. By doing this, auditor should evaluate and analyze the risk whether accounting fraud could eventually lead to material misstatement. This explained why external auditors have to express his opinion and analysis regarding to the company's financial condition in the auditing report.
Importance of Different aspects of Independence
However, in order to protect external auditors from generating a fair report, there are generally three types of independencies auditors should retained: programming independence, investigative independence and reporting independence (Mautz, 1961)(Dunn, 1996).
Programming independence allows external auditors to adopted any strategies which they deemed the most suitable in order to conduct their audit. Thus, auditors are able to select whatever methods to investigate their client company while the company has no right to restrict them from adopting any methods. The separateness between the auditor and the organization allows auditors to discover frauds that the company intends to hide. As ICAA (2010) mentioned, it is also an auditor's responsibility to evaluate whether their clients are still "continue as a going concern in the foreseeable future". So, it is important for the auditors to design a strategy for a further investigation with respect to their doubt.
After choosing the appropriate strategies, external auditor has to get data from his client. Investigative independence protects the auditor from collecting evidences regarding to the auditing. As auditors need auditing evidences to generate their true and fair report, they have to collect many of these evidences. Moreover, some companies might try to avoid auditors from collecting problem evidences. However, once if the auditor has figure out the problems, the company cannot stop the auditor from retrieving any records from their company (ISO, 2011). Thus, without the independence of collecting evidences, the problem evidences could not be disclosed and eventually may affect the judgments of the auditor.
Eventually, auditor has the ability to disclose all kinds of information if they considered necessary (International Federation of Accountancy, 2009), which is known as reporting independence. This kind of independence ensure that the auditor to express his real attitude and opinions towards an organization. An independent relationship between clients and auditors could allow auditors to express their professional and detail opinion without any pressure to the general public. Without the company's interruption, the report of the external auditor could maintain its true and fair view.
That is why, an auditing report adds credibility to the financial statement, due to the fact that external auditors are able to access to the company inside and act as a detective. As a result stakeholders of the company may rely on their auditing and make decisions towards the business referring to the financial statements and auditor's opinions. Nevertheless, there are some factors in practice may weaken the independency of an auditor conducting an audit. Some of the major factors are illustrated below.
Factors Weaken the Independency of an Audit
Auditing and Consulting
Auditor's failure to detect misleading financial information could weaken the economic value of audit. It could eventually lead to damages towards all firms in the long run (Fearnley, 2005). Moreover, a lack of auditing independence is the one out of two factors leads to audit failure (Fearnley, 2005).
It is common to have auditor firms to provide consultant services. Nevertheless, some experts in this field criticize on the service. David Ellis, Pric's UK corporate governance manager (Inman, 2010), disagreed that auditing firms could provide auditing and consulting service to a client at a same time. He argued that there is a conflict of interest against the auditors and their clients. In order to keep customer, the consulting group may pressure their auditing departments not to be so strict. This may affect the independency, as the primary role of an auditor, and eventually weaken the quality of the auditing reports. There would be a discussion referring to a monumental example of auditing scandal in 2002 due to lack of audit independence in the following.
High Profit Motivation working with Big Firms
While Enron was one of the largest energy company in the US, they deceived shareholders by inflating their asset values, reporting untrue income figures and liability figures starting from 1997 (Bodurtha, 2003). However, Arthur Andersen LLP, as Enron's auditor and also was one of the Big Five accounting firm in the world (Kher, 2002), assisted them to hide their illegal acts. The auditing firm allowed Enron to use their questionable accounting practices and destroy illegal documents to cover up their previous trail (Nguyen, 2009). Nonetheless, Enron went bankrupted finally. Once it went bankrupted, the whole story was unfolded and Andersen ended up with bankruptcy due to the devastation of reputation (Bratton, 2002).
There are various reasons behind Andersen as an auditing firm to make that decision to cover up Enron, but the ultimate purpose is still making profit. Ken Brown and Ianthe Jeanne Dugan, journalist of The Wall Street Journal (2002), mentioned that
"Arthur Andersen himself originally built his business by putting reputation over profit"
They are trying to claim that Andersen's company aim is to make profit instead of maintaining the true and fair view of auditing, the primary role of auditing. That is why they give up the independency that they are supposed to have in order to earn huge amount of profit.
As a result of Enron and Andersen and a couple of auditing scandals in the early 2000s, the US investors lost confidences on the credibility of auditing (WiseGeek, 2013). Thus, the United State has prohibited accounting firms from providing both consultancy services and auditing services to the same client at the same time, according to the Sarbanes-Oxley Act (2002).
To sum up, this essay has introduced why external should be independent and the importance generally. We have discussed the role of external auditors are to check the accuracy of the financial statements and to detect accounting frauds of organizations. It is important for them to be independent of the company's management. Afterwards, we have analyzed the importance of three different types of independence that an external auditor should have. Understanding of the characteristics of different types of independences as well as their importance helps understand what an external auditor is expected to do during auditing, while the essay also explained why an auditing report tends to be true and fair. However, the essay has also provided some potential factors that might weaken the independency of an external auditor. It is important to understand that external auditing are not guaranteed to be completed free from bias and true and fair views, it is a procedure tries to reduce audit risks to a acceptably low level in order to protect investors and stakeholders. Finally, it is worth noting that the auditing industry keeps improving, the credibility of their audit is expecting to be higher in the future. (1400 Words)