Auditing Theory and Practice: Threats to Auditor Independence Report

This report provides a detailed analysis of the importance of auditor independence and objectivity in auditing practice. It explores the crucial role of the auditor-client relationship in maintaining audit report quality, highlighting potential biases and erroneous reports that can arise from compromised independence. The report identifies various threats to auditor independence, including self-interest, familiarity, management, and intimidation threats, as defined by the Irish Auditing and Accounting Supervisory Authority (IAASA). It further discusses specific scenarios where these threats can manifest, such as financial interests, family relationships, and long-term auditor-client associations. Furthermore, the report outlines practical steps to mitigate these threats, including the hiring of independent auditors, rotating senior personnel, and avoiding non-audit services to clients. The report emphasizes the need for maintaining auditor independence to safeguard shareholder interests and ensure the reliability of financial reporting.

Running head: AUDITING THEORY AND PRACTICE
AUDITING THEORY AND PRACTICE
Name of Student
Name of University
Author’s Note

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EXECUTIVE SUMMARY:
This report provides complete insight about the importance of the independency and objectivity
of the auditor. The report also showcased about the significance of the auditor-client relationship
in the quality of the report. The report also discussed about the auditing threats that may arise
when the company hires an external auditor. In order to safeguard the shareholder’s interest the
company needs to take certain steps, which will mitigate the auditing risk. This report discusses
such steps as well.

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Table of Contents
INTRODUCTION:..............................................................................................................3
INDEPENDENCE AND OBJECTIVITY OF AN AUDITOR:..........................................3
IMPORTANCE OF AUDITOR INDEPENDENCE IN AUDITOR-CLIENT
RELATIONSHIP:............................................................................................................................4
Biased Audits:..................................................................................................................4
Erroneous Report:............................................................................................................5
DISCUSSION OF THREATS:............................................................................................5
Self-interest Threat:.........................................................................................................5
Familiarity Threat:...........................................................................................................6
Management Threats:......................................................................................................6
Intimidation Threat:.........................................................................................................6
STEPS TO REDUCE THE AUDITOR’S INDEPENDENCE THREATS:........................7
Self-Interest Threat:.........................................................................................................7
The audit firm, its partners or staff have a financial interest in the audit client:.........7
There are family relationships between the firm, its partners, staff and the audit
client:.......................................................................................................................................7
Familiarity Threat:...........................................................................................................7
The audit firm has been the external auditor of the client for the past 10 years:.........7
Management Threats:......................................................................................................7
The audit firm provides non-audit services to the audit client:...................................7
Intimidation Threats:.......................................................................................................8
The audit firm is heavily financially dependent on one significant client:..................8
CONCLUSION:..................................................................................................................8
REFERENCES:...................................................................................................................9

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INTRODUCTION:
The process of inspecting the accuracy of the accounting statement of the company is
known as auditing. The entity that audits the financial report of the organisations and inspects the
accuracy based on the countries accepted standards, regulations and the laws is known as auditor.
The auditors present an independent opinion based on the accounting report of the business
entity. Ireland Auditing and Accounting Supervisory Authority (IAASA) is the Ireland’s
independent body who provides standards and regulations of auditing. This independent body of
Ireland also oversee the rules and regulations of the accountancy bodies in Ireland. The auditing
board of Ireland are responsible for the periodic financial reporting of the listed entities. This
board also focus on increasing the quality of the accounting standards of Ireland. Irish
accounting boards also acts as a special source of advice to the Minister of Jobs and Business
Enterprise. It is the Irish accounting board that also looks after the innovation in auditing and
accounting matters of the country. Irish auditors got complete independence over the inspection
of the financial records, financial statements and business transactions of a company. All these
are only possible if the auditor does not have any relationship with the client. Thus, this report
tries to investigate how the association between auditor and client affects the quality of the audit.
INDEPENDENCE AND OBJECTIVITY OF AN AUDITOR:
The primary purpose of an audit is to provide independent opinion on the annual report of
the company. The auditor is independent to provide opinion whether the annual report reflecting
true and fair value view of the company’s financial performance (Venkatadri et al 2018). An
auditor needs to have integrity, objectivity and scepticism while performing audit of a company.
The facts and circumstances related to the financial statements of the company may lead the
auditor to compromise the integrity, objectivity and the scepticism. The independency of an
auditor is considered as one of the most important part in the process of auditing (Abdullatif and
Kawuq 2015). The independency of an auditor is largely scrutinized based on the detailed rules
and regulations that are provided in the country’s accounting standard. The auditor independence
has evolved from principle based to rule based auditing. There are certain criteria, which can
determine the independency status of an auditor. The auditor should not hold any kind of

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financial interests with the organization. The independence of an auditor varies country to
country.
Objectivity of an auditor is considered as the motivation behind the decisions and
behaviours. Objectivity is much more concerned with the internal thought processes. Objectivity
does not deal with the prohibitions (Jespersen, Hohnen and Hasle 2016).
The best example can be seen in the case of Enron. In 2000, Arthur Andersen, who is the
auditor of Enron received $27 million for non-audit service of the company, which is
comparatively much higher in comparison to $25 million for audit service. This act raised
questions on the independency of the auditor. Thus, Enron and Arthur Andersen came under the
radar of law.
IMPORTANCE OF AUDITOR INDEPENDENCE IN AUDITOR-CLIENT
RELATIONSHIP:
As per International Standard on Auditing 220 (Para-9), the engagement of the auditor
with the partner shall remain vigilant as the observation and inquiries should not be biased. It is
the job of the auditor to view every business transactions that the company has completed in a
single accounting year. The auditor provides their view, so that the reality about the financial
transactions can be analysed by the shareholder and other investors of the company. This process
gets disrupted when the auditor of the company and the client’s company are in very good terms.
The increase association between the auditor and the client organization compromises the quality
of the audit report. There are many such problems that may occur due to the auditor and client’s
company relationship. They are as follows:
Biased Audits:
Auditors may pass the biased audits if the client threatens the auditing company with
taking their business to another audit company unless they provide favourable audit. If the audit
company is the profit making consulting service then the chances of passing impaired report is
high (Czerney, Schmidt and Thompson 2014). The best example can be found in the case of
Enron where they offered $52 million to Arthur Andersen for their auditing service. The auditing
company may felt threatened of losing such deal in future and thus passed biased audit report,
which ultimately compromised the shareholder’s or investor’s interest.

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Erroneous Report:
The auditors or the auditing company depends greatly on the report provided by the client
management. If the management provides incorrect data, in order to cover up their mistakes, then
the auditing report that will be generated by the auditor or the auditing company will have
incorrect deduction. Thus, the auditing report will be considered as an erroneous report. This
report will misguide the shareholders’ decisions (Chen and Lee 2017). On the other hand, the
auditing service and the auditor may lose their credibility in the area of expertise.
DISCUSSION OF THREATS:
Irish Auditing and Accounting Supervisory Authority provide ethical provisions over the
threats to the integrity, objectivity or independence of the firm. As per the nature of the threat,
Irish auditing board divided the independence and objectivity threat of an audit into various
parts, which include self-interest threat, self-review test, management threat, advocacy threat,
familiarity threat and intimidation threat.
Self-interest Threat:
As mentioned in the ethical provisions of Irish Auditing and Accounting Supervisory
Authority (Para 1.29) the self-interest threat comes into play when the staff or the partner of any
organization is the auditor himself or the part of the auditing team and the personnel starts acting
as per their own interest. The self-interests may include auditor’s emotional, financial or other
personal interests (Vinnari and Skærbæk 2014). In these scenarios the auditors favours the
organization consciously or unconsciously. Thus, self-interest compromises the audit’s quality.
If the audit firm is the partners or staff of the audit client and has a financial interest in
the audit client then audit report faces self-interest threats. The auditor’s report depends greatly
on the accounting statement of the company that are done by the management of the company
(Cohen, Krishnamoorthy and Wright 2017). If the auditor maintains some kind of interest or
relationship with the management of the company then the auditor is reluctant to commit
fraudulency activities. This act directly affects the independence of the auditor.
If the auditor holds any family relationship with the client’s company also increase the
chances of self-interest threats, which ultimately compromise the independence of the auditor.

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For example, if the auditor holds shares in the client’s company then it is possible that the
auditor may pass “unqualified opinion”.
Familiarity Threat:
As mentioned in the ethical provisions of Irish Auditing and Accounting Supervisory
Authority (Para 1.29) the familiarity threat rises when the auditor is working with the client’s
company for an elongated time period. This increases the relationship between the auditor and
the client’s company. This also provides complete knowledge about the client’s company to the
auditor. Thus, the chances of nepotism and favouritism increases, which results in the creation of
the biased audit report (Ţîrlea 2017). The long relationship between the auditor and their client’s
company comprises the independence of the auditor. This will also increases the cost of the
company.
If the audit firm remained the external auditor of the client’s company for 10 years then
the chances of familiarity threat increases. In this case the auditor may exploit their positions and
charge high amount from the client’s company. The chance of fraudulency also rises if the
auditor develops good relationship with the client’s company. Thus, the independency of the
auditor is being compromised in this situation.
Management Threats:
Management threats arise when the auditor gets involved in the decision taking activity
of the client’s company. As per the Section 5 of Part B of Ethical Standard (Para 5.155R), it is
unethical if the auditor lay-out non-audit services to the client’s company. The management
threats arises when the integrity, objectivity and independence threats of the company (Salsabila
and Sukirman 2017). If any personnel of audit firm are involved with the decision taking activity
of the company then the quality of the audit report compromised.
If the audit firm give non-audit services to the audit client then also the chances of having
management threats rises. This also compromises the independence of the auditor.
Intimidation Threat:
When the client’s company threatens the auditor for cancelling the contract due to some
issues the auditor faces intimidation threats. This reduces the objectivity of the auditor. The
problem may also arise when the audit firm depends the financially on the significant client.

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STEPS TO REDUCE THE AUDITOR’S INDEPENDENCE THREATS:
Self-Interest Threat:
The audit firm, its partners or staff have a financial interest in the audit client:
When the audit firm or an auditor has any financial interests on the client’s company then
the audit report will represent biased opinion. The reason behind such biasness is the self-interest
threat. As per Irish Auditing and Accounting Supervisory Authority (Para-45) to mitigate such
threats the management needs to hire an external auditor who does not possess any financial
relationships with the company.
There are family relationships between the firm, its partners, staff and the audit client:
When the audit firm consists of an employee who also possess direct relationships with
the client’s company or the family member of the client’s company then the genuineness of the
audit report are being compromised. This type of threats is known as self-interest threats and it
can only be minimized if the management of the company hire different external auditing firm.
The management of the company can also convince the audit firm to dispose the employee from
the project (Almadhoob and Valverde 2014).
Familiarity Threat:
The audit firm has been the external auditor of the client for the past 10 years:
When the audit firm is the external auditor for the client’s company for the past 10 years
then there remains a chance of having familiarity threats in the audit report (Coetzee and Lubbe
2014). In order to reduce the familiarity threats the company should request the audit firm to
change the role of senior personnel. This step will increase the standard of the audit report
because the new appointed personnel will not pass the biased report as the personnel will not be
familiar with the auditor.
Management Threats:
The audit firm provides non-audit services to the audit client:
When the audit firm provides non-audit service to the client’s company then there is a
chance of having management risk. The mitigation of the management risk is not easy, as the top
executives of the firm, the client’s company and the audit firm is involved. In order to reduce the
chances of the management risk the company needs to change the audit firm.

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Intimidation Threats:
The audit firm is heavily financially dependent on one significant client:
In order to mitigate such risk the company needs to modify the assurance plan for the
assurance engagement (Kumar, Himes and Kritzer 2014). The quality of the internal audit should
be improved, so that the audit firm can get the genuine report. This will eradicate the chances of
intimidation threats as the chances of fraudulency in the financial statements will be reduced.
CONCLUSION:
After analysing the above discussion it can be stated that the independency and the
objectivity of the external auditor is one of the issues that determines the quality of the auditor’s
report. There are several threats that actually disrupt the auditing procedure and ultimately help
to reduce the quality of the report. There are several threats that may arises namely self-interest
threats, management threats, intimidation threats, familiarity threats, advocacy threats and self-
review threats. In order to mitigate such risks the company needs to adopt certain safeguards that
are present in Irish Auditing and Accounting Supervisory Authority (Para: 39-46). If the
company follows such steps mentioned by Irish Auditing and Accounting Supervisory Authority
then the company can safeguard the shareholder’s interests.

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REFERENCES:
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Almadhoob, A. and Valverde, R., 2014. Cybercrime prevention in the kingdom of Bahrain via IT
security audit plans. Journal of Theoretical and Applied Information Technology, 65(1), pp.274-
292.
Chen, L. and Lee, H.L., 2017. Sourcing under supplier responsibility risk: The effects of
certification, audit, and contingency payment. Management Science, 63(9), pp.2795-2812.
CIA, C. and Jim Pelletier CIA, C.G.A.P., 2016. Emerging Risks in Auditing and
Accountability. The Journal of Government Financial Management, 65(2), p.26.
Coetzee, P. and Lubbe, D., 2014. Improving the efficiency and effectiveness of risk‐based
internal audit engagements. International journal of auditing, 18(2), pp.115-125.
Cohen, J., Krishnamoorthy, G. and Wright, A., 2017. Enterprise risk management and the
financial reporting process: The experiences of audit committee members, CFO s, and external
auditors. Contemporary Accounting Research, 34(2), pp.1178-1209.
Czerney, K., Schmidt, J.J. and Thompson, A.M., 2014. Does auditor explanatory language in
unqualified audit reports indicate increased financial misstatement risk?. The Accounting
Review, 89(6), pp.2115-2149.
Iaasa.ie. 2020. Available at: https://www.iaasa.ie/getmedia/cc2cfaa6-ed87-4a1c-927a-
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Jespersen, A.H., Hohnen, P. and Hasle, P., 2016. Internal audits of psychosocial risks at
workplaces with certified OHS management systems. Safety Science, 84, pp.201-209.
Kumar, S., Himes, K.J. and Kritzer, C.P., 2014. Risk assessment and operational approaches to
managing risk in global supply chains. Journal of Manufacturing Technology Management.

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Salsabila, L. and Sukirman, S., 2017. Analysis of Premature Termination Factors on Audit
Procedures with KAP Quality Control as Moderating Variable. Accounting Analysis
Journal, 6(2), pp.207-218.
Ţîrlea, M.R., 2017. Practical Considerations Regarding The Activity Of Financial Audit
Planning. Knowledge Horizons. Economics, 9(1), pp.17-23.
Venkatadri, G., Andreou, A., Liu, Y., Mislove, A., Gummadi, K.P., Loiseau, P. and Goga, O.,
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