This is an assignment to discuss the case about the importance of maintaining independence by auditors in discharging their audit duties. Can an auditor be truly independent in fact and in appearance if the payment of fees is dependent upon the management of the company being audited or not. Discuss the undue dependence on an audit client, family and other personal relationships, beneficial interest, loans gifts and hospitality, overdue fee that affect auditor's independence. Lastly, explain the audit process.
Independent Auditor refer to a certified public accountant who examines and reviews the business activities or transaction and the financial record of a company to identify, resolve discrepancies or provides a company with an accountant's opinion but that he is not affiliated with the company. Independent auditor is typically used to investigate potential fraud or theft, to avoid conflicts of interest and to ensure the integrity of the auditing process with applicable regulation. Independent Auditor is also called External Auditor.
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DISCUSS THE IMPORTANCE OF MAINTAINING INDEPENDENCE BY AUDITORS IN DISCHARGING THEIR AUDIT DUTIES.
The main purpose of independent auditor is to independently identify of the information of the company or institution an overall picture which is essential to develop and the overall of whole company's control system. The second purpose of independent auditor is to identify any weaknesses or administrative flows which otherwise would not be identified due to unwillingness by insider of the company.
The auditor's report is a formal opinion issued by an independent auditor as a result of an independent auditor after reviewed and checked all the financial statement of the company and their control system. The report is used to provided to external user such as government, company, general public, creditor, investment advisers or potential shareholder, with credible information that result in public trust or faith of the company, as an assurance service in order for public user to make decision based on the auditor's report.
Since many third-party or users prefer the financial information to be certified by an independent auditor for them to feel confidence or faith to the company. These can also help in building enhancing trust or accountability in the public user. Many auditees rely on auditor reports to certify their financial statement or other information in order to obtain loans and to attract investor after issued new share.
"Public confidence would be impaired by evidence that independence was actually lacking, and it might also be impaired by the existence of circumstances which reasonable people might believe likely to influence independence" SAS No.1 States
As a result, auditor's report is for user to make right decision and for them to feel confident to the company. The client company hiring auditor to do an audit is to be transparent to its shareholder and public user. Therefore, to maintaining independence by an auditor in discharging their audit duties is also very important. Independence is an important standard for auditor. Auditor independence is essential to the process of providing integrity and an objective, non-biased manner to review of management's representation in a company's financial statement, even when the auditor's decision may be against the interests of management of an audit client company. The concept requires the auditor to carry out his work fairly and in an objective manner. If the auditor were not independent in both appearance and fact of the client, the public user such as creditor or investor may lose confidence in the auditor's ability to report truthfully on the company's control system and financial statement, those reports would not be credible and loses its value. To be credible, an auditor's opinion must be based on an objective, unbiased assessment of whether the financial statement are presented fairly in according to generally accepted accounting principles and standard. Independent auditor are not to be corrupt or bribed, even when they are not that closely tied, but the same go for auditor, that may have any family tied or monetary interest. The public's perception of the credibility of financial reporting by a company is influenced significantly by the perceived effectiveness of independent auditor in examining and reporting on financial statement. From an agency perspective, if the principle knows that the auditor is not independent, the owner will not trust the auditor's report. Thus, the agent will not hire the auditor because the auditor's report will not be effective in reducing information risk from the perspective of the owner.
Always on Time
Marked to Standard
Independence, both historically and philosophically, is the foundation of the public accounting profession and upon its maintenance depends the profession's strength and its stature. "American Institute of Certified Public Accountants (AICPA) in a statement adopted in1947"
CAN AN AUDITOR BE TRULY INDEPENDENT IN FACT AND IN APPEARANCE IF THE PAYMENT OF FEES IS DEPENDENT UPON THE MANAGEMENT OF THE COMPANY BEING AUDITED?
Yes, auditor can be truly independent in fact and in appearance. Auditor need to be independence in fact and in appearance no matter what is happen, even the fees is pay by the audit client. There are some safeguards that can protect the independence of an auditor and make sure the auditor can be truly independent when they are performing audit.
Audit committee is a subcommittee from the board of director, they are an independent body answerable directly to the board of governors and charged with oversight financial reporting and disclosure. Audit committee member is non-resident and they do not receive any remuneration from the company, therefore, they can be truly independence and objective to all the financial reporting of the company. The primary objective of the audit committee is to assist the Board of Director in fulfilling its statutory duties and responsibilities relating to accounting and reporting practices of the group and enhance corporate governance. In addition, the audit committee will evaluate the quality of the audit conducted by either the internal or external auditor.
Auditor rotation also one of the safeguard of independence, the main propose of auditor rotation is to avoid potential conflict of interest between an audit client and the auditor. The auditor might be too willing to trust an audit client's executive because the firm has a benefit interest incentive to continue the audit engagement. If an auditor audit too many years to a specific audit client, they may become friend, this can affect the independence of an auditor. Therefore, audit firms required to change or rotation every five years the person who is audit for each public company client.
Peer review is the evaluation audit performance by other audit firm in the same field. This is the safeguard to make sure the auditor independence and unbiased to the audit client when they are performing audit. Peer review also can maintain the quality of the auditing performance. The reviewer should be independence and unbiased, therefore, reviewer are not selected from among the close colleagues or friends. After finish audit work, the auditor should give their work to outside review or check by another accounting firm.
Quality control use to be an assurance to an independence of an auditor. A firm should set the policies, organizational structure, and procedures established to provide it with reasonable assurance that the auditor can comply with the professional standards and legal requirements. Quality control allows the auditor to have an independent evaluation of the financial statement by the quality department of an audit client's company, reports issued by the firm are appropriate in the circumstances. The auditor should work by following a set of rule and regulation, in order to be independence.
Safeguard of independence of an auditor is also included restrict non-audit service. To avoid unfair and bias action, auditor cannot provide any service related to the accounting records of audit client, financial information system design, valuation services or contribution-in-kind reports, or internal audit outsourcing services when they are in an audit engagement with the audit client.
In order to be independence and fair, all auditor or accountant should perform by follow a set of ethical rules by MIA. MIA by-laws set the standards of professional conduct and ethics for all accounting member in view of the professional responsibilities. MIA established a set of rule and regulations to prevent of unlawful and dishonor practices of the profession and for the advancement of the accounting profession. The main objective of MIA by-laws is to make sure that the accountants exhibit the highest standards of ethics, and professional conduct that are expected of the profession. As an accountant, they may have the responsibility to update themselves and ensure that they understand and implement the requirements in these MIA by-laws.
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DISCUSS THE THREATS OR FACTORS THAT AFFECT AUDITOR'S INDEPENDENCE
Auditor should be independence, but there are certain threat creating risk or affect to the independence of an auditor.
UNDUE DEPENDENCE ON AN AUDIT CLIENT
When the total fees from an audit client or a group of connected represent a large proportion of the total audit income of an audit firm, the overall of the financial most dependence on that audit client, the concern over losing the prestigious client or fee income taken for non-recurring assignment, may give rise to dependency, impair objective and independence, and a self-interest threat. Auditor may also bias to the audit client's company when they are auditing to the company, auditor may not qualify the audit report when qualification required, this will upset client may move to other audit firm, the firm have a desire that not to lose a prestigious client and loss the significant income. If the self-interest threat created by the fee dependency is other than insignificant, the firm should take steps to reduce such dependency on the client or implement external quality control reviews or consults a third party. For assurance or non-assurance services combined paid by one client or a group of connected clients, should not exceed 15% of the firm's annual gross income. To avoid this, the firm should reduce non audit work to particular client to control the gross income. If this case happens, the firm would be required to decline or withdraw from the audit engagement.
FAMILY AND OTHER PERSONAL RELATIONSHIP
Family and personal relationship between auditor and an officer or shareholder of the audit client may give rise to self-interest or intimidation threats that may affect an auditor's independence and objective as he had a conflict between maintaining professional standards and personal relationship. Independence of an auditor may be impaired if the auditor has a close relative who could exercise influence over the financial, operating, accounting policies or internal control. There are family member, "immediate family member" are the spouse or dependent and "close family member" refer to parent, child or sibling. If an immediate family member is an officer of the audit client and he is in a position significant influence over the accounting policies or operating of the audit engagement, the relationship between then is such that the threat to independence can only be reduced by removing themselves from the audit engagement. When the case happened on a close family member, threats to independence may also arise. If the threat is considered significant in the circumstances, the auditor should either remove themselves from the audit engagement or structure the responsibility of the assurance team so that the auditor does not deal with matters that are within the responsibility of the close family member.
An auditor should not have a Personal Equity Plan which had among its investment and audit client, this is very serious case to independence audit. A beneficial interest may let to the unfair or bias audit, the independence of an auditor, and also may give rise to a self-interest threat. When an auditor is holding the financial instrument of the audit client, he may disregard adverse events and not qualify the audit report when qualification is required, because the audit report can affect the share price of the company. For all audit engagement, a threat arising from holding a direct financial interest or a material indirect interest in the audit client is considered as significant. To avoid unnecessary conflict, the beneficial interest which the auditor holding should be disposed of at the earliest before performance of the audit engagement. An auditor can be a shareholder, but not hold more than the minimum number of shares necessary to comply, if an auditor holding the indirect financial interest, auditor need to reduce it to an extent that is not material. Or the auditor should disengage from the audit engagement. The shareholding should be disclosed in the director's report or auditor's report.
A loan or a guarantee to or from an audit client may also give rise to self-interest threat. To respect of an audit client, auditor should not accept any loan or make any loan from the audit client and guarantee borrowings, unless it is an arm's length transaction in the normal course of business. If a loan or guarantee provided is made under normal lending procedure and terms from an audit client that is a bank, and the amount of the loan is immaterial to the firm and the client is accepted. Because of the loan or guarantee from bank is made under normal commercial terms to all public, therefore, the loan and guarantee from a bank to an audit team member or their immediate family would not create a threat to independence. But, if a loan from an audit client that is not a bank or similar institution would create a threat to independence, because it will affect the going concern of the client and may be unable to pay the loan. In this case, the auditor should disengage with those audit assignment.
GIFTS AND HOSPITALITY
Gift and services hospitality form an audit client may create self-interest or threat to objective and independence is impaired. Sometimes, audit client may offer some gifts, product or service to a professional accountant, auditor or his family members. This gift or services by audit client to an auditor was strictly prohibited. A professional accountant or auditor in public practice should not accept such gift or hospitality, unless the value of any benefit is modest or made in the normal course of business without intention to influence auditor to obtain favor. The significant of such threat will depend on the value and intent behind the offer. Excessive gift or hospitality can be free holiday trip, expensive dinner or expensive car. The safeguard to independence is not to accept undue gifts and hospitality.
If the fees due from an audit client for professional services remain unpaid for a long time, that can be a threat of appear to be a threat to objectivity akin to that of a loan. If there have overdue fees from an audit client, the auditor may perform in unfair way when they are auditing to the client's company. A audit firm should collect or attempt to obtain payment of the overdue fees before the audit report is issued for the following period, if the audit engagement is for recurring period. Professional fees that remain unpaid for a long time may be regarded as being equivalent to a loan, the firm should consider whether it is appropriate for the firm to be re-appointed to provide the assurance service.
Audit process is the process of accumulating and evaluating evidence engagement conducted by an independent auditor. It includes examining quantifiable information of a company, on a test basis, evidence supporting the amount that disclosures in the financial statement of the company for the purpose of determining and reporting upon the degree of correspondence between the quantifiable information and establish criteria, as well as evaluating the overall financial statement taken as a whole are free of material misstatement.
The auditor must first obtain a thorough understanding of the whole company control system, and it business. Armed with this understanding, the auditor plans to procedures that will produce evidence helpful in supporting and developing an opinion on the financial statement.
PRELIMINARY ENGAGEMENT ACTIVITIES
Preliminary engagement activities are the first phase of the audit process to the commencement of the fieldwork. The purpose of performing these activities is to help to ensure the audit and assurance professionals have considered any circumstances that may affect their ability to plan and perform the audit job. These activities include the procedures regarding acceptance and continuance of the client relationship and the audit engagement, evaluation of independence and other ethical requirements, and establishing the terms of engagement. Client acceptance is important to ensure that the audit firm will only undertake or continue with a client relationship after careful consideration of the client integrity, the firm is competent to perform the audit, and can comply with independence and other ethical requirement. If an auditor is work with a client who lacks integrity, the risk increases that material misstatements may exist and not be detected by the auditor. Therefore, to understanding the background of the client company is very important in the first stage. For a prospective new client, the auditor does not have any experience with the client company, the auditors are required to confer with the predecessor auditor and frequently conduct background check on top management.
Auditor should evaluate compliance with ethical requirements, and also the independence. To determine whether to continue the audit engagement, the audit firm should do evaluation to the auditor client relationship to make sure the member of audit team to be independence of the audit client.
Before the commencement of the audit, the auditor should establish an understanding of the terms of engagement, and this terms must be agree by both auditor and client, which including the type, scope, fees, and timing of the engagement. This agreement can reduce the unnecessary conflict between auditor and client, and reduces the risk that either party may misinterpret what is expected or required of the other party. An engagement letter should be send to the client to document and confirm the term of the engagement.
OBTAIN UNDERSTANDING OF THE ENTITY
After the preliminary engagement activities, will come to the second stage of the audit process which is obtain understanding of the entity. The audit process beings by obtain a sufficient understanding of the entity and its environment, including the internal control system. This stage is to enable the auditor to assess the risk of material misstatement of the financial statement whether due to error or fraud, and business risk faced by the company, then to sufficient design the nature, timing and perform further audit.
An understanding the entity and its environment provides the guideline to the auditor in understanding specified aspects of the company and components of its internal control system. The auditor must understand the industry, regulatory, and other external factors, including the applicable financial framework. This can help auditor to identify the risk of material misstatement. For example, we can know about the energy supply and cost of the audit client, and the regulatory framework for a regulated industry, and also the general level of economic activity. We can knowing the client's operation, the types of investments it is making and the way the entity is structured and how it is financed by understanding the nature of the entity, including the entity's application of accounting policies of the audit client. The auditor must also understand the objectives and strategies and the related business risks, including the entity's risk assessment process. Auditor also need to do a measurement and review of the entity's financial performance, this may include variance analysis, budgets, key performance indicators, departmental, or other level performance report. Lastly, auditor will also understanding the internal control of the company, this include the policies and procedures designed. The policies and procedures design may affect financial report and effectiveness and efficiency of operation, therefore to understanding the internal control is very important to an auditor.
ESTABLISH MATERIALITY AND ASSESS RISK
Most of the business risk may affect the financial statement. Therefore, auditor needs to identify business risk and understanding the potential misstatements that may result before the auditor plan the audit. The auditor must identifies risk by considering the entity and its environment, including control that relate to the risk, and by relating these risk to the classes of transaction and account balance in the financial statement, relates the identified risk to what can go wrong at the assertion level, considers whether the risks are of a magnitude that could result in a material misstatement of the financial statement, and also consider the likelihood that the risks will result in a material misstatement of the financial statements. After the assessed of the entity's business risk, the auditor should decide the responded to take or overcome given the risk assessment. Based on the assessed risks of material misstatement at the assertion level, the auditor must consider the timing, extent and also the nature of audit process.
PLANNING: SET OVERALL AUDIT STRATEGY & DEVELOP AUDIT PLAN
The effectiveness and efficiency work is depending on the proper planning, planning can also reduce the risk of material misstatement to an acceptably low level. Planning involves the developing and overall audit strategy and an audit plan that details the nature, timing and extent of the planned audit procedures. The overall audit strategy determines the scope, timing and direction of the audit, and guides the auditor in developing a more detailed audit plan. Consideration of the results of preliminary engagement activities and, where practicable, experience gained on other related service engagements performed for the entity is very important for a auditor to developing the overall audit strategy. Auditor need to determining the characteristics of the audit, its scope, the financial reposting framework, the reporting objective and the communications required with management and those charged with governance while setting of the overall audit strategy. In developing the overall audit strategy, the auditor has compiled his knowledge about the client's business objective, strategies and related business and audit risk.
TESTS OF CONTROL AND AUDIT BUSINESS PROCESS
Auditor assesses the risk of material misstatement by examining the entity's business process and internal control or accounting cycles and related accounts. The business process and internal control may directly affect to the financial statement, therefore, auditor should obtain an understanding to the whole internal control of the entity. Which is identify the control environment, entity's risk assessment process, information system and related business processes relevant to financial reporting and communication, control procedures and monitoring of control in order to plan the audit. Not only understanding the internal control, auditor also need to understand about the revenue process, purchasing process, human resource management process, inventory management process, financing process such as property, plant and equipment, prepayment, long-term liabilities, equity, income statement items, cash and investment of the entity.
COMPLETE THE AUDIT
After the auditor completed his examination of the related financial statement item, the sufficiency of the evidence gathered must be summarized and evaluated. In order to justify a conclusion on the true and fair view of the financial statement, the auditor must obtain sufficient appropriate evidence and the effect of detected misstatement on the financial statement. In this stage, auditor should evaluate the final analytical procedure, these may involve re-computing some of the ratio and comparison developed for risk assessment and other substantive resting purpose. After that, auditor should review of subsequent events and loss contingencies, this is used to refer to both events occurring after period end and the date of the auditor's report and facts discovered after the date of the auditor's report. Contingencies, in particular contingent liabilities, are disclosure items that do not appear in the fact of the financial statement proper but are found in the notes to the financial statement. Example, audit procedures including reviewing the contracts, loan agreements, income tax liability and inspecting other documents for possible guarantees. Examining related party disclosures, identification of related parties' transactions in early stage is important, so that the auditor will be alert for transactions between the reporting entity and its related parties during the course of the audit. Review of going concern issue is also important, auditor must identify such event and conditions which may cast doubt on the entity's going concern ability. Lastly, final evaluation of financial statement presentation and disclosure, should preferably be carry out by the more experienced and knowledgeable senior members of the audit team. The audit is conducted after the bulk of the substantive procedures have been performed. Auditors will have the final draft of the financial statements, which should be supported by appropriate and sufficient audit evidence.
EVALUATE RESULTS & ISSUE AUDIT REPORT
At the final phase of the audit work, audit should come out with a report to those financial statements of the company. An unqualified audit report is issued when the auditor concludes that the financial give a true and fair view according to applicable financial reporting framework and additionally, and the audit has been performed with the approved standards on Malaysia. The auditor aggregates the total uncorrected misstatements that were detected and determines, if the uncorrected misstatements to not cause the financial statement to be materially misstated, the auditor will issues an unqualified or clear audit report. The standard auditor's report on financial statement should contain few basic elements which is the report title, address, introductory paragraph, management's responsibility, auditor's responsibility, scope paragraph, auditor's opinion on financial statement, other reporting responsibilities, auditor's name and signature, date of the report and auditor's address.
These past few weeks of research and investigation to get some information about the Auditor independence and the whole system of audit have been extremely fruitful. My main objective was to understand and investigate the independence of an auditor and the threats that may affect auditor's independence. I believe I have achieved that objective.
Not only did I have a chance to study the Audit and Control System, but I was lucky enough to learn about how the auditors do their duties in independence and the audit process. The learning experience was tremendous.
Now I understood the role of an independence auditor when they are on duties and the audit process.
Overall it the experience was extremely informative and it allowed me to have a glimpse of how the auditor actually perform in the audit.