Auditing and Auditor Independence

Running head: AUDITING
Auditing
Name of the Student
Name of the University
Author’s Note

1AUDITING
Introduction
Auditing is considered as the process of the analysis and inspection of financial
reports of the business organizations with the aim to find any kind of material misstatements
in them (Louwers et al., 2015). While providing auditing services, the auditors and needed to
comply with different principles and standard; Auditor Independence is considered as one of
the. The principles of audit independence put the obligation on the auditors to stay
independent from the audit clients. During the years of 2002, the world witnessed the
collapse of many renowned business organizations; and it is believed that the absence of
professional skepticism and auditor independence played a crucial role in those corporate
collapse. In all of these cases of corporate collapse, failure can be seen from the auditors’ side
in maintaining the required professional skepticism and independence. The aim of this essay
is to discuss different requirements of independence in the audit profession by considering
two major corporate collapses.
Role of Auditors in the Collapse of Enron and Lehman Bros.
It can be seen in the collapses of both Enron and Lehman Bros. that the auditors
provided them with the unqualified audit opinion which stated that there was not any material
misstatements in the financial statements of these companies. However, it was not the actual
situation as the auditors of both these companies provided unqualified audit report in the
presence of their personal interest in the audit client which affected professional skepticism
and audit independence.
Arthur Anderson was the auditor of Enron at the time of their collapse. Enron paid
$25 million to Arthur Anderson for auditing services and additional $27 million for
consultation services. It can be seen that the fees for consultation services is higher than the
audit fees; and this aspect created the threat to audit independence. In the case of Enron,
Arthur Anderson was responsible for the internal as well as external auditing of Enron
(Ghafran & O'Sullivan, 2013). Implies that one part of Arthur Anderson was responsible for
preparing the financial statements for the company and the other part was responsible for
auditing the same. This aspect affected the professional skepticism of audit that puts the
obligation on the auditors to stay alert for the detection of material misstatements in the
financial statements. In case of Enron, Arthur Anderson did not spotted the material
misstatements in the company’s book as they prepared the financial statements of the
company in favor of Enron’s management. Arthur Anderson admitted that they destroyed

2AUDITING
certain documents before the investigating of Enron’s financial reporting practices by federal
regulators (nytimes.com, 2019).
The same aspect can be seen in the collapse of Lehman Bros. where Ernst & Young
(E&Y) was the auditors. The management of Lehman Bros. used REPO 105 transactions to
inadequately make their balance sheet look better while E&Y was fully aware of this policy
of the company related to REPO 105 (Mawutor, 2014). In the presence of personal benefits,
they assisted the company in portraying these transactions as sales. After the discussion with
Matthew Lee, the former senior vice president, E&Y decided to keep silent on this matter and
provided the company with unqualified audit opinion by not disclosing the material
misstatements (nytimes.com, 2019). These major accounting frauds with the assistance of the
company auditors contributed towards the collapse of these two companies in short time.
Effects of Fees Dependency on Auditor Independence
It needs to be mentioned that there is a relation between the fees of the auditors and
auditor independence due to the presence of the fact that the large size of audit fees normally
has association with the higher risk to lose auditor independence. This aspect indicates
towards the fact that large size of the audit clients in terms of fees can create doubts about the
independence of the auditor. According to APES 110, Section 291.151, when total fees of an
auditor signifies a large amount of the total fees of the Firm Expressing the conclusion, the
dependency of the audit firm on the audit client and the concern to lose the audit client can
lead to the creation of self-interest or intimidation threat (apesb.org.au, 2019). There are
certain factors on which the significance of the threat depends; they are the operating
structure of the company, whether the firm is established or not and the significance of the
audit client qualitatively or quantitatively on the firm (Blay & Geiger, 2013).
It can be seen in United States of America (USA) that the external auditors of the
countries directly collect the audit fees from the clients. For this reason, the possible negative
effect of collation of audit fees directly from the audit client on auditor independence is a
major concern (Tepalagul & Lin, 2015). The issue is related to the fact that whether the fees
earned from the audit fees to the auditors develops a situation where external auditor become
too closely connected with the audit client and starts losing objectivity at the time to express
audit judgment. It needs to be mentioned that the efforts of the auditor to retain the huge
amount of future fees is potentially as significant impairment to the auditor to maintain the
audit independence. Objectivity of the auditors has direct relation to the ability of the auditors