Auditor Independence: Regulatory, Ethical Obligations - Semester 1

This essay discusses the critical importance of auditor independence in maintaining the integrity and objectivity of financial reporting. It explores the historical evolution of auditor independence, from its roots in the 19th century to the present day, highlighting key events and regulatory changes that have shaped the profession. The essay examines the role of accounting bodies, such as the SEC and AICPA, in establishing and enforcing ethical standards and regulations aimed at safeguarding auditor independence. It also addresses the impact of corporate scandals, such as Enron, on the regulatory landscape and the subsequent enactment of legislation like the Sarbanes-Oxley Act. Furthermore, the essay considers the auditing landscape in New Zealand and Australia, emphasizing the Corporations Act of 2001 and the auditing standards it provides. This student-contributed assignment is available on Desklib, a platform offering a wide range of study tools, past papers, and solved assignments.

[the profession of auditing]
2019

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Introduction
The auditors have to provide an objective and impartial report to their clients which is not
affected by any prejudice, conflict, compromise and bias. This requires them to observe
independence of auditors with respect to their client so that they are free from relationships and
situations which could hinder the quality of the reporting to their clients and to the stakeholders
who shall be using the reports generated by the auditors. Measures have been taken by the
different accounting bodies operating at the national and international level to ensure the
independence of the auditors in their work. Apart, large corporation also have their set of rules
and regulations for ensuring independence of the auditors is maintained as it directly impacts the
quality of the audit report and this impacts the reputation of the company for their stakeholders.
Importance of independence in auditing
Many authors have given definition for the auditor’s independence. Independence of
auditors has been described by Jamal, K., & Sunder, S. (2011), as the observance of complete
objectiveness, impartiality and unprejudiced, and this observance is not compromised by the
outcome or consequence and is free from any influence which could affect the quality of the
auditing. The independence of auditors has been debated right from the point it was practiced as
it has importance for the client and for the public who put their stakes in the company. According
to the European Federation of Accountants and Auditors (EFAA), the independence of auditor is
considered to be headline-concept which encompasses a number of concepts of truthfulness,
intellectual honesty, professional integrity, competence, absence of conflicting interests and
objectivity. It is not only a technical concept rather it has cultural and cognitive factors too which
defines the independence of an auditor according to Wolnizer, P. W. (1995). However, still the
independence of the auditor remains imprecise, unclear and equivocal. But in practice it is an
attitude of the auditors mind to serve the best interest and not compromise on the truthfulness
and quality of the financial reports being generated by him for a company.
The need for independence of the auditor stems from needs of the financial reports users
want the information of the company’s financial position and performance for making their
investing decisions and for putting their stakes in the company. The independence in the auditing
enhances the quality of the audit report and thus provides assurance to the parties involved that
the concerned auditor will perform his duties objectively and correctly. The independence of the

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auditor is particularly important for the external auditors as it need standards like integrity,
objectivity and independence in the practice of performing financial audit of companies as noted
by Swanger, S. L., & Chewning Jr, E. G. (2001). One of the important constituent of corporate
governance is the financial audit which allows the management accountable to their
shareholders. As the shareholders want to have information about their invested money and how
efficiently it had been used by the management for development activities and in the business.
However, these external auditors also have their commercial interest as they also charge high
fees for their auditing services to the companies.
Auditor’s independence holds chief importance for the auditing done by external
auditors. It has been found that the auditing companies take fees for non-auditing services which
have been estimated to be more than the fees given for auditing services by the client company
according to DeAngelo, L. E. (1981). And this practice is called as low balling where the
accounting services providing firms charge less for auditing than the market price and more for
the non-auditing services to make up the deficit in the cost of their services. This entails that
some of the accounting services who are providing auditing services have also commercial
interests in the client company. There arises a conflict of interest where the auditors’ interest for
protecting the shareholders of the company and his own interests in the company can conflict
with each other and this impacts the audit quality.
There exists a relation between the auditor’s independence and auditor’s performance and
audit quality. The concept of auditor’s independence is related to performance of the auditors in
their profession of conducting audit. As there are many stakeholders who rely upon the
truthfulness and objectivity of their services. The independence of the auditor and its concept and
notion has been of importance for the last hundred and fifty years. It holds significance in
auditing as it governs the audit quality. The audit quality is defined by DeAngelo, L. E. (1981) as
the probability of an auditor uncovering an act of breach and also bringing it to notice or in
simple sense reporting the breach. If the independence of the auditor is not observed then the
irregularities are bound to happen in the financial audit reports and hence the quality of the report
is deemed to be hampered. Therefore, the auditor’s independence is of critical concern to the
profession of accounting as stakeholders of a company rely upon the quality of their services for
making investing decisions.

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Changing landscape of auditors’ independence
The concept of independence of the auditor goes back to the nineteenth century during
the period of British rule and during this period, the principal duty of the auditing professionals
was to find out the investments of the absentee owner listed in the British colonies. Even then it
was maintained that the auditors cannot invest in the companies which have been audited by
them and also cannot be regular employees of such company. It was also established a
professional cannot have any type of professional or any personal relationship with the client for
whom the auditing is being done. However, during this was allowed for them to keep the
financial books of the companies audited by them and prepare their financial statement according
to Reiter, S. A., & Williams, P. F. (2005).
After this with rapid industrialization in the 20th century the stock exchanges were
established. Reiter, S. A., et al. (2005) noted that the influential work of the Berle and Mean’s
gave new direction to the independence of the auditor as their work on agency implication for
separate management and corporate ownership pointed out that the accountants role is to value to
collective proprietary interest of the company and so as to serve its needs rather than the specific
absentee owner. The creation of stock market led the interests of the general public in buying
shares of the company and hence have a stake in the company. During these times the
independence of the auditor were not adequately formulated into specific guidelines and rules.
The accountants had the role of assuring the stock market integrity only according to Turner, L.
E. (2006). This is where the roots of present day independence of the auditor concept started as
the importance of the auditing increased because people were becoming stakeholders of the
companies and therefore wanted to know of their invested money. In the early 20th century the
corporate and income tax laws were formulated by many countries. The services of tax-
accounting thus became one of the non-audit services of the auditors which has today
vociferously decried.
Sikka, P. (2009) noted that the accounting profession grew quickly after the end of great
depression and for the following decades the independence of the auditors was only restricted to
his mental attitude of not indulging in any unethical practices. And this was the basis of actual
independence of the auditors. The lack of independence of the auditors can potentially harm the
participants in the market, hurt investors’ confidence and impact negatively on the larger market

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because of increased cost of capital. In the early 1970s the Securities and Exchange Commission
(SEC) played an important role in assuring independence to the auditors not only in practice but
also in appearance. The Financial Accounting Standards Board (FASB) was collaborated with
the Generally Accepted Accounting Principles (GAAP) and was set up in the year 1973.
Asthana, S., Balsam, S., & Kim, S. (2009) noted that serious change in the landscape of
auditor’s independence was at first driven by growing rates of scandals and collapses of the
corporates. One such example is Enron a company which played with the financial statements to
show itself as a profitable company to the stakeholders however, it was depicting a false picture
and had fooled the investors of their investments. The company was shut down and many people
suffered, lost their jobs, pensioners got financially hurt and integrity of the accounting profession
was brought to focus. In this case, it was found that the company officials and the accounting
firm used force to influence the auditors to furnish false reports which depicts a profitable
financial position of their company. It had also to come to light that the auditors were not even
allowed to leave the company premises until they have furnished the reports as per their demand.
And this was a clear incident on hampering the independence of the auditor for conducting the
audit.
The US congressional hearing during 2001 uncovered many frauds which impaired the
market and therefore formulate the landmark Sarbanes-Oxley Act in 2002 (“SOX”). The
accounting firm involved in the popular Enron case had to face criminal prosecution. The big
five accounting firms which had been providing auditing services to major companies of the
world were not reduced to four. These four big accounting companies which provide auditing
and tax services to the different companies are Deloitte & Touche, PricewaterhouseCoopers
(PwC), KPMG and Ernst & Young. Together these companies take away ninety percent of the
auditing contracts and are the largest accounting firms in the world. The current landscape of
accounting firms is restricted to these four major player and an increased regulations because of
the evident collapse of corporations.
These events have affected the independence of the auditors as there are less companies
where they can be hired and there is an increased degree of regulations as they are now held
more accountable for their services given to their client. The SEC gave out regulations for the
auditing profession and professional ethics were given by AICPA (American Institute of

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Certified Public Accountants). It was done to grant protection to the stock market and guard
against the collapse of corporates and big frauds. This has resulted in majority of the countries
including Australia to revise their standards and implement ethics for accounting profession to
acknowledge the importance of independence in this profession.
Bratton, W. W. (2003) noted that the formulation of SOX affected the independence of
the auditors. First is that it gave provisions and regulations and rules for the accounting
profession. Secondly, it provided for structural reform like the establishment of Public Company
Accounting Oversight Board (PCAOB). This organization was a non-profit organization aimed
at overseeing the provisions of auditing services given to the public traded companies. It gave
out substantive provisions for the independence of the auditor. It also gave rules for the listing on
the stock exchange in terms of process of auditing. It has focused itself on the process of auditing
in the companies in three ways. It at first prohibited the services provided by the auditors. The
public company needs to have audit committee and requirements which have to be pre-approved.
The provision for rotation of audit partner and management of conflict of interest. The
establishment of regulations for protecting the independence of the auditor by the SEC was also
followed by other countries like Australia.
Auditing landscape in New Zealand
The regulations that have been made by the country related to accounting practices were
formed as a result of collapse of big companies because of false financial reports. The law which
directs the profession of accounting in Australia is the Corporations Act of 2001. The standards
of auditing are provided in this act under the section 336 as given in Australian Government,
Auditing and Assurance Standards Board (n.d.).
The collapse of corporations have threatened the regimes of corporate governance and
this included the independence of the auditor. In order to address the lower level of auditor’s
independence in Australia the country formulated the Corporate Law Economic Reform Program
(Audit Reform and Corporate Disclosure) Act 2004 (Cth) which is referred to as CLERP given
by Commonwealth of Australia (2004). Also an Auditor Independence Supervisory Board
(AISB) was created for implementing the requirements of auditor’s independence in Australia.
This is body is an independent body and has an important role in ensuring and assuring the
confidence of the public in the auditor’s independence. It is done through the implementation of

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new regimes, compliances and international development in the field of independence of
auditors. Audit committees is to be established according to the regulations for ensuring the
independence of the auditor in a company. The presence of an audit committee has been
mandatory by regulations of the country for the listed companies. Porter, B. A., & Gendall, P. J.
(1998) mentioned that it reflected the international best practice in conducting an audit.
The present regulatory environment in Australia for the auditor’s independence can be
termed as co-regulatory according to Miller, M. C. (1995). An important part is being played by
the accounting bodies overseeing the profession of accounting by establishing the requirements
of the profession and code of ethics for accounting profession. The independence of the auditors
is also observed by the ASIC (Australian Securities and Investments Commission. As it enforces
provisions given in the Corporations Act of 2001 particularly the section 324 to ensure the
auditing independence in the country. Companies Auditors and Liquidators Disciplinary Board
(CALDB) also ensures that professional auditors working in the country can carry out their
profession independently and it this organization deals with the matters of discipline for the
auditors according to Ramsay, I. (2001).
As the globalization has penetrated the country, the complexity in the manners in which
the businesses were conducted have changed, the accounting standards and rules have also been
changed to remain relevant in the present context. And according to Ramsay, I. (2001) the recent
changes in the independence of auditing has also taken place because of the scandals and global
financial crisis. There are international standards for accounting and as accounting is based on
standards it is important to align with the standards of the world so as to avoid to
misrepresentations and provide quality audit reports. Particularly in New Zealand changes have
been seen as it has absorbed the accounting standards of used at an international level and these
are referred to as the International Financial Reporting Standards.
Fisher, C. (Oct 13, 2017) noted that because of the increasing globalization, there has
been a growing demand to achieve uniform characteristics and harmonization in the process of
auditing and financial reporting and also in the ethical practices of this profession. The most
essential rules of ethics in accounting and auditing profession are those which deals with the
independence of the auditors and hence it is demanded that the circumstances must be made
conducive for establishing independence of the auditors.

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The concept of auditing independence is a fundamental concept in auditing and if it fails
then questions on the quality and integrity of the report arises. As the aim of the auditing is to
enhance the financial report credibility by expression of any opinion which is independent of any
prejudice and biasness. The auditors are regarded as an independent entity which provides
credible and correct opinion on the financial reports. Because of their independence they are able
to provide an audit which is free from any external constraints. The auditing independence needs
freedom from personal interest, susceptibility towards an undue pressure and influence, biasness,
prior commitment to any interest or any other factor which could form the perception and belief
that the given opinion of the audit was incorrect and it does not refer the facts of the audit alone.
Particularly in Australia the role played by auditors in reflecting the true financial picture
of a company is judged from the corporate collapses which had occurred in the first half of 2001.
It was found that these collapses could have been avoided if independence of the auditors could
have been observed by these companies and by the companies which provided the auditing
services.The development taking place internationally in the field of audit independence have
been considered important in Australia. It has been given prominent place by the release of
proposals for the updating its ethical requirement as given by the International Federation of
Accountants (IFAC) on the auditing independence.
The measures which are formulated for ensuring the independence of the auditing
profession is provided in the Corporations Act 2001. Apart from it, the Code of Professional
Conduct (which are established by both ICAA and CPAA) also oversees the auditing in the
country. Statement of Auditing Practice (AUP) in this country also works for the establishment
of the independence in the auditing. With respect to auditing work the section 32 of this practice
is used for ensuring independence of the audit.
There is a range of legislative provisions for ensuring independence of the auditor’s in
Australia. The standards for financial reporting and auditing are also recommended to merge
with International Financial Reporting Standards (IFRS) so that the Australian business can
compete on an international platform and attract investments from foreign countries as investors
with an internationally recognized standards can better understand the financial report and can
decide to invest in the Australian businesses.

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Audit independence in New Zealand
The governing body in New Zealand which oversees the accounting profession and
practices is the Institute of Chartered Accountants. Another name given to it is and it is also
known as the Chartered Accountants Australia New Zealand or CA ANZ. This organization over
the last few years have been very active in reviewing the works of the chartered accountants
working with it as its members. This was done to ensure that the audits performed by them are
competent and are in compliance with the relevant standards and regulations established by law
in the country. This also ensures that the profession of accounting is not exposed to the risk of
loss of reputation by the investors and other stakeholders in the country. It thus maintains that the
accounting professionals have to adhere to the rules and standards for the companies which they
serve irrespective of their size. That is they are expected to perform well and produce a high
quality and correct financial report and generate correct opinions on the financial report.
The standards of auditing in New Zealand are formulated by the board which is known as
New Zealand Auditing and Assurance Standards Board (NZAuASB). And it is a part of the
External Reporting Board (known as XRB), and this is given under the Financial Reporting Act
of 2013. The New Zealand Accounting Standards Board (NZASB) is the other subsidiary of the
board and is responsible to set the standards of accounting in the state. The standards given by
them are instrument of law and are subjected to disallowance.
The statutory setting of the audit standard was resisted in New Zealand for a long time.
However, it was realized that it was necessary because of the introduction of the regulations in
auditing as given under the Auditor Regulation Act of 2011 and Financial Markets Conduct Act
2013 (FMC Act) in the seventh part. The auditors got the license for carrying out the audits of
the Financial Markets Conduct reporting companies. And with this the auditors can audit the
listed issuers and many other different companies. However, it was maintained that it has to be
done in accordance with the standards of auditing and assurance whichever are applicable and
these are mentioned in the sections 416D and 416F of the FMC Act of 2013. The section 12(b)
of the FMC act also gives standards for auditing and assurance. And these standards also
promote the XRB to formulate standards for the Auditor Regulation Act. The auditors have also
to follow the standards of auditing and assurance formulated by NZAuASB and are used for a
wide range of purposes which are non-statutory purposes.

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Apart from it, in New Zealand there are the International Standards on Auditing for
controlling the quality of the audits for the auditors. Other international assurance standards and
code of ethics practiced internationally also has to be observed while doing auditing of the
international firms located in Australia. All these standards setting bodies comes under the
International Federation of Accountants (known as IFAC).
Buchana, R. (September 01, 2017) suggested that New Zealand is a taker of standards
and adopts all the applicable standards formulated either by the national or the international
bodies to maintain high quality of its audit. It does not adopt these standards by doing any
amendments except when there is sufficient and enough reason to do so. Moreover, any
amendment is done to strengthen it and not to weaken the standard. So that it could reflect the
practices and conditions of regulations at the local level too.
Safeguarding independence of auditors
The given regulations for ensuring the auditor’s independence is being implemented by
the different boards and organizations. However, the auditors need to keep a check on their
independence in conducting the audit of their client companies. Ye, P., Carson, E., & Simnett, R.
(2011) suggested that there are threats to the auditing independence which needs to be identified
and the auditor has to safeguard himself against it using the legislative means or any method
which is applicable in the given circumstance.
There is a framework which has been provided by the standard setters of Europe for the
identification of the threats to the auditing independence. These threats can be put into following
categories.
Self-interest- when an auditor is acting for getting some emotional, financial or any other
type of personal gains then this occurs.
Self-review- when auditing is done by a professional on his own work or his colleagues
work then this issue arises.
Advocacy- when advocacy is observed by an advocate for his client or against him then
it occurs.

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Familiarity (trust)- when the professional are being influenced by close relations this
threat takes place.
Intimidation- the professional believes or he is being in true sense, overtly or covertly
compelled by the client or by any other interested party.
For safeguarding against the above threats the auditors need to apply certain safeguards
which are given below. There is framework provided in the Code of Ethics by APES 110 which
is meant for the professionals in this field and according to this a template has been provided
which documents the threats to the independence of auditors.
 Identification of the threat.
 Evaluation of the importance of the threat
 Finding the safeguards for addressing the threat.
The safeguards are defined as those actions or measures which aim to uproot the threats
or altogether reduce them to an extent which is acceptable. The safeguards measures can range
from complete to partial prohibitions to the situations which are threatening the auditing
procedures and the independence of the auditors.
There are two broad measures which can be used by the auditors for the protection of
their independence and these are: approaches which are rules based (RBA) and approaches
which are based on concepts or principles (PBA). The role of government is important in the
PBA as principles and rules guides the kind of actions which are permitted and which are
prohibited. And it has been adopted. Safeguards in the works further entails that a firm-wide and
engagement specific safeguards are put in place for protecting the auditor’s independence. The
code of ethics of accounting profession requires that wherever possible the threats must be
reduced to an acceptable level. The accountants who are practicing in public companies must
decline the contracts of auditing which have a client relationship. The code has identified three
classes of safeguards. Safeguards which are established by the regulations, legislations and
profession. Second the safeguard created by the attest clients. Third the safeguards which are
implemented by the firm like procedures and policies for observing regulatory and professional
requirements.

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Apart from it, Parker, A. (January 6, 2015) noted that the auditors can also protect their
independence by using safeguards like having an external reviewer to assess certain files and this
external reviewer can be partner or any ex-staff with the former employees. However, as
suggested by Blay, A. D. (2005), each circumstance is unique and the auditors have to use their
professional judgement to identify the threat and then use appropriate safeguard.
Conclusion
Auditors’ independence is an essential element in the process of auditing which grants
quality to the financial reports. They have accountability to the clients as well as to the different
stakeholders of the company who shall be making use of financial data published in these reports
for their investing decisions. Therefore, the countries have laid down rules and accounting bodies
have provided standards which must be followed by the corporates to provide high quality of
audits. New Zealand has also imbibed the rules for ensuring independence of the auditors by
adopting the International Standards on Auditing, International assurance standards and code of
accounting ethics. The protection of independence is also the responsibility of the auditors and
steps must be taken by them to use appropriate safeguard for the conducting an independent
audit.