Importance of Independence of Auditor in Ensuring Effective Audit

This assignment discusses the importance of independence of auditor in ensuring effective and correct audit. It includes case studies like Enron Scandal and regulatory attempts to improve quality of audit in Australia. It also talks about the use of machine language by accountants and dependence of auditors on companies for fees.

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Audit
2018

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By student name
Professor
Date: 21 May, 2018.
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Executive Summary
Independence of auditor refers to the point that the work of auditor must be free from all kind of
biasness from all sources possible and there should not be any element within the management or from
external sources that might influence the decision of the auditor. In this assignment we will discuss how
important is independence of auditor to ensure that the audit is effective and correct. In this assignment
the overall independence of auditor is discussed, their dependence on specific matters have been taken
into consideration. Important case studies have been discussed and conclusion have been given based
on that.
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Contents
Introduction...........…………………………………………………………………..........…..4
Analysis.......................……………….......................................................................................4-7
Conclusion.......................………………...................................................................................8
Recommendation.......................………………........................................................................9
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Introduction
Independence of the auditor refers to the independence from external and internal source that
might be having any sort of financial interest in the company. Audit is an independent examination of
the financials of the company and the investors depends upon the audit report to take important
decisions with regards to the company hence it is important that the audit report must be free from all
kind of error. There are various factors that might affect the independence of the auditor, it is difficult to
comprehend which factors to consider and which to not and in that case the personal integrity of the
auditors comes into picture. In this assignment we will discuss the independence of the auditor with
respect to some famous case study.
Enron Corporation Scandal
Enron was one of the largest energy trading company that was involved in one of the biggest
corporate scandals of America. It was successful in fooling people with fake stake holdings for years
which was later reported as huge losses to the investors. It is one of the largest corporate scandals of
that time and it was said that along with the management the auditors were equally responsible for
such a situation. With the change in corporate governance rules and the introduction of the
accountability concept, the responsibility of the management as well as the auditors have increased
manifold. The stakeholders be it internal or external see the audit report being issued by the company
as the reasonable assurance of the conduct of affairs of the company and that the same is representing
the true and fair view of the company. All this has been introduced as a result of the corporate scams
and scandals that have took place in the past and have increased the concerns for the stakeholders. One
such major corporate scandal was Enron Scandal. It was a financial scandal which eventually led to the
bankruptcy of the company. The company at that time was being audited by one of the five major audit
firms in the world, Arthur Anderson. The company was found to have stated the wrong financial results
in the annual report of the company and was found to hide billions of debt balances which were a result
of the failed deals. During the 2000 ear, Enron share prices rocketed to the all-time high of $ 90.56. In
2005, the CEO of the company got replaced and Enron repots a major loss of $137 Mn due to which
analysts feared of the company’s internal financial status and dropped the rating due to which the share
prices fell to the a 52 week low of $ 39.95. In October 2001, the company reports a further loss of $ 618
Mn and $1.2 billion of assets write off and the share prices slumped further down to $ 33.84. All this
continued and finally amidst the falling share prices to $ 20.75, the company announced in the public
media that the company has been inflating the income since 1997 to the tune of $ 586 Mn and thereby
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Arthur Anderson as an accounting and audit firm for Enron becomes another casuality. Finally, in 2002,
the cout convicts and declares the firm Arther Anderson as obstructing the justice and be a privy to the
falsified financial statements being released by the company. What did the company actually do? The
company used the fraudulent accounting practices in order to hide the losses and then show the same
as profits by the means of subsidiaries accounting. It kept on transferring the debt on paper to its
subsidiaries and recognizing the revenue from the fully owned subsidiaries showing that it was doing
much well than the company was actually performing. All these happened under the nose of the auditor
but the auditor di not bother to take the necessary steps to stop it or to detect and discuss it with those
charged to governance. Due to all this saga, Sarbanes Oxley Act was introduced and the disclosure of
corporate governance activities gained momentum. It is due to this act and many other corporate frauds
and aggressive accounting practices where the auditors have been involved that the significance of audit
has increased manifold in the past. Therefore, auditor are the custodian of the financial statements of
the company and the internal control being maintained at the company (Wang, Chiu, li, & Hsiao, 2018).
They are the ones who should be applying all the measures, be it analytical or substantive procedures to
verify the accuracy of what the management is reporting in the annual accounts. They should also be
verifying the internal control and the accounting practices being used by the management of the
company. All this will ensure the quality of reporting and transparency of the financial statements.
Regulatory Attempts to improve quality of audit in Australia.
There are various regulations that have come up in the recent times to improve the overall
quality of audit in Australia. There has been various standards that have been set that aims to improve
the position of the auditors and encourage them to work more effectively. If we see closely the basic
areas in which the improvement is required is improving communication between the auditors and the
management and other people who depend on the audit report to take important decision with regards
to the company and its finances. The basic ways in which companies can change this scenario and follow
a more quantitative approach is by seeing the auditors are applying these standards in practice. The
code of ethics have been established that states what the auditor has to follow and that includes his
integrity, his professionalism and his independence. The new standards like AASB 107 have been
introduced that focuses on informing key matters of audit to the management and mentioning it in their
audit report. Key matter includes those areas in which there is certain element of risk which the
company might face and people who are investing in the company needs to be aware of it. Like in case
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of Enron if the auditors have applied this principles then the audit report would have been more better
and with lesser errors. The Sarbanes Oxley Act was formed post this scandal that focuses on
independence of the auditor in taking their respective decisions and seeing that it is free from all kind of
influence. The auditor needs to see his own personal interest is not hampering his work in any ways
(Tadros, 2017). Therefore rules have been established where auditors who are related to the companies
as per the prescribed guidelines of the law cannot be appointed to work as per their auditor, there is
also a cooling period between specific terms during which the auditor can work for the company. In
case the auditor is found guilty then he would be penalized and his license would also get cancelled. The
various accounting standards and principles sees to it that the overall financial statements have been
prepared in the best ways possible and there is no issues involved with them (Eisemann, Parker, &
Alstyne, 2017). The main aim of the audit report is to show the true face of the financials of the
company, in case of Enron they showed stock which dint exist and the auditors agreed to the same and
thus people ended up investing their hard earned money in the company and suffered huge losses. So
from this it can be judged how important it is to have a balanced correct and figurative ethical approach
while conducting audit and there should not be any negligence from any part. Thus, these regulatory
standards that have been introduced in recent times have played a very important role in making the
audit simple, cooperative and free from errors and has provided the auditors with a base which they can
follow to get best results. The overall aim is to improve the quality of audit and that can only be
achieved from the auditor maintains effective amount of diligence from his end and thus that is where
these standards comes to play and tell the auditor what he should do and what he not. Thus, the
investors can then depend on these audit report that are framed based on such standards to take
important decisions about the company and their overall investment (Explaining auditors’ propensity to
issue going-concern opinions in Australia after the global financial crisis, 2017).
Use of Machine language by Accountants.
Artificial Intelligence is the key of today, everything is moving towards automation and in that case, it
has become comprehensive on how this can be of any use to the auditors. The realm of artificial
intelligence is very big, and if seen closely it could be of great help in providing quality audit work.
Machine learning is just a part of the Computer Assisted Auditing Tools and Techniques (CAATTs). ). The
auditors can use this to reduce a lot of manual work, they can push the entire ledgers for analysis
through these tools instead for opting for sampling. Machine language comes into play in suggesting
extra additions that can be made in the exceptions mentioned by the auditor based on the exceptions
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that the machine language has updated (Shimamoto, 2018). In this way the auditor would be able to
detect those areas in which he requires more changes. In more advanced circumstance, a set of data can
be provided to the machine language and it can identify the normal set of transactions and that would
help in finding any peculiar changes that is not normal as per that set. The machine language would thus
help in identifying elements of fraud that might be there. So in all cases we see that the machine
language can do a lot of work but in no situation can it comprehend to a human auditor, the need for
that would always be there. But machine language do one thing is that they can make the work of the
auditors easy and they can help in finding certain errors that the auditors might have missed on, so in
that way it would be great if it comes in picture. The changes in technology would always specify better
uses of machine language for the auditors and thus we can see how automation has made life easier
and also the overall quality of the audit work that is delivered would also improve based on that
(Alsagoff, 2010).
Dependance of the Auditors on the Companies for fees.
In all ways auditors are employees who are working for the management of the company and delivering
what is expected out of them. As all employees the auditors also need some remuneration in return for
the work that they do and thus in that case they need to depend on the management of the company to
deliver them what they need. So in that case there are all possible situations and chances in which the
management can lure the auditors for extra money in return to changing the audit reports and also can
offer them less or more remuneration based on how much they allow the management to comprehend
the audit reports. Thus we see that there is a dependence on part of the auditor on management of the
company to give them what they need. There may be situations where management can take undue
advantange of the situation of the auditor financially and can force them to work as per them, thus in all
that cases it becomes important that auditor should get good return and timely returns for their work
delivered and there work must be safeguarded from the management of the company. It should be seen
that management is not harassing the auditor in any way for remuneration in such cases the auditor can
raise the issues to the compotent authority (Boghossian, 2017). But this is a big threat to the
independence of the auditor in that respect. It was witnessed in case of Enron also, the company had
given auditors a lot of money to deviate them from providing correct audit report and work as per the
management of the company. Thus in all these situations the personal integrity of the auditor comes
into play, the auditors need to understand that they should be ethically responsible towards their work
and should not let any undue sources to influence what they are delivering to the client, they have
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authorities to whom they can raise concerns when they feel that there is any threat to their
indepedance (Shikha, 2009). In situations where they give in to the management and it is caught they
would be heavily penalised and it is against the work ethics (Cayon, Thorp, & Wu, 2017).
Conclsuion
Thus on going through the entire analysis we can say that being independent when conducting audit of
any entity is very important in all ways. It helps in providing quality work to the people who depends on
these audit report. Audit is a very independent judgement based work and thus there should be no
influence whatsoever. If ever the aduitors feels that his independence is being charged he can raise a
question to the management, to those who are charged with governance but in no situation he should
be involved in any kind of fraud, thus we see how important it is to do proper due diligence on once part
when they go through an audit report. It is important that auditors should depend on such standards
that can help them in conducting the audit in a more effective manner. There are several changes
occurring every new day and all is regulated towards improving the kind of work that the auditor is
delivering so that such fraud cases do not happen again.
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References
Alsagoff, N. (2010). Microsoft Excel as a tool for digital forensic accounting.
Boghossian, P. (2017). The Socratic method, defeasibility, and doxastic responsibility. Educational
Philosophy and Theory, 50(3), 244-253.
Cayon, E., Thorp, S., & Wu, E. (2017). Immunity and infection: Emerging and developed market sovereign
spreads over the Global Financial Crisis. Emerging Markets Review.
Coate, C., & Mitschow, M. (2017). Luca Pacioli and the Role of Accounting and Business: Early Lessons in
Social Responsibility.
Eisemann, T., Parker, G., & Alstyne, M. (2017). STRATEGIES FOR TWO SIDED MARKETS.
Explaining auditors’ propensity to issue going-concern opinions in Australia after the global financial
crisis. (2017). Accunting and Finance, Carson,E;Fargher,N;Zhang,Y;.
Shikha, P. (2009). Financial crisis and the silence of the auditors. Accounting, Organizations and Society,
34(6-7), 868-873.
Shimamoto, D. (2018, JANUARY 29). Why Accountants Must Embrace Machine Learning. Retrieved from
global-knowledge-gateway:
https://www.ifac.org/global-knowledge-gateway/technology/discussion/why-accountants-
must-embrace-machine-learning
Tadros, E. (2017). 'Appalling' audit quality could lead to next Enron: ASIC's Greg Medcraft. Financial
Review.
Wang, Z., Chiu, Y., li, Y., & Hsiao, L. (2018). Performance appraisal for the operation and management of
listed and OTC Taiwanese companies with DEA benchmarking models.
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