Auditor Independence

Audit failures are often connected with the independence issue. In order to create assurance
regarding financial statements towards firm’s stakeholders (or users of the statements) the
auditor must be independent or at least appear to be independent.  But can the auditor be
independent?

Independence of mind and appearance

IFAC Code of Ethics for Professional Accountants identifies two different categories of
independence[1]:  

Independence of mind:

The auditor’s needs to be in a state of mind that allows them to express opinions about the
auditee without feeling that they are under pressure due to independence issues and feel that they
are allowed to act with integrity, conducting their audits objectively and with professional
skepticism. Independence of mind is also referred to as “independence in fact”.[2]

Independence in appearance:

Independence in appearance relates to a third party’s perception regarding the auditor’s

independence. If the third party doesn’t think that the auditor appears to be independent, even
though the auditor is independent in his mind, the third party don’t trust the auditor due to certain
circumstances or relationships which are incompatible with independence and the promise of the
assurance that the auditor is supposed to provide is lost.  [3]

Threats and risks

The auditor independence is threatened by the different kinds of pressures that exists and
influences the auditor’s ability to remain objective. These threats normally fall into one of these
five types;

Self-interest threats:  this threat stems from the possibility that the auditor may in some way
chose to act in its own self-interest, rather than performing an unbiased audit. This self-interest
may come from the auditor’s financial, emotional or other personal interest in the auditee. A
concrete example would be an auditor owning stock in the auditee, auditor’s business
relationship with an auditee or auditor’s family relationship with the auditee.[4]

Self-review threats: self review threats exist because the auditor may have a bias when
evaluating his own work or that of his firm. These threats arise when audit firms offers other
services then the audit service to an auditee, e.g. if a member of the audit team has helped the
auditee prepare accounting records or when members of the audit team previously served as a
director in the auditee.[5]

Advocacy  threats: which arise if the auditor has promoted or advocated for or against the
auditee. For example, auditors promotes securities of an auditee or auditors acting as an advocate
for the auditee in a litigation case.[6]

Familiarity  threats: which may arise when the auditor have a close relationship with the auditee,
this threat may stem from auditors having a close personal relationship or a long-standing
business relationship with the client causing them to lose objectivity.[7]

Intimidation threats: arise when the auditor is overtly or covertly coerced by the auditee or other
interested parties, e.g. if the audit firm is threatened with replacement because of a disagreement
about the application of an accounting principle.[8]

Reduction of Threats and Risks

To deal with these threats the accounting firms, business community and regulators have
developed safeguards to protect and maintain independence of auditors and audit firms. These
safeguards exist to mitigate threats to auditor objectivity and one safeguard may deal with
several threats simultaneously. The safeguards can be broadly classified in three types, those
created by regulation, the profession and litigation, those safeguards that exist in the auditor and
the audit firms own systems and procedures and lastly those crated and maintained within the
auditee.[9]

The auditor must consider if the independence risk is at an acceptable level, otherwise the auditor
must apply further safeguards, refrain from activities that severely threaten independence, e.g.
abstain from having a direct financial interest in the auditee or decline to serve as a director in
the auditee. If the safeguards undertaken still doesn’t reduce the independence risk to an
acceptable level the auditor should decline the contract.  As an example IFAC has developed and
published the IFAC Code of Ethics for Professional Accountants where they define both ideal
principles and what acceptable behaviour is for auditors. The codes focus is on the behaviour and
actions of the individual auditors while the standards of quality control are concerned with the
firms monitoring of its own practice. [10]

The code serves as a tool to help auditors identify different threats to e.g. independence and also
propose different safeguards to counter these threats. Frameworks such as the IFAC Code can be
used by all who have an interest in the independence issue, e.g. regulators can use it to analyse
independence issues and if needed prohibit certain relationships or prescribe mandatory
safeguards, it can help investors and other users of financial information understand the nature,
significance and limitations of auditor independence. It also provides clients with an insight into
how auditors apply safeguards to mitigate risks and finally it serves as a way to focus debate and
provide a common language for discussions regarding auditor independence.[11]

Concerns regarding audit firms independence  

Jeppesen discus the changing nature of auditing, which he claims have changed to incorporate
more of a consulting approach, with a higher focus on adding value to the auditee. In his article
Reinventing auditing, redefining consulting, and independence he writes:
 “Auditing in itself is not considered to be of value to the auditee. Something extra has to be
delivered, and this extra comes in the form of spin-off advisory services[12].”

When distinguishing auditing from consulting the most important issue is the absence of
economic interest in the auditee. However, when the audit firms starts to provide consulting
services to their auditees their independence is threatened because the audit firm as a whole
obtains an economic interest in the firm. Jeppesen draws the conclusion: “that the auditor cannot
be independent because auditing is no longer independent.”