Audit and Assurance Services: Auditor Independence and Risk Analysis

This report provides a comprehensive analysis of audit and assurance services, focusing on the critical aspects of auditor independence and the associated audit risks. It explores the various factors that can undermine auditor independence, including financial interests, long tenure, and intimidation threats. The report delves into the consequences of compromised independence, discussing the impact on audit quality and the potential for financial misstatements. Furthermore, it examines the corporate failures of Enron, Worldcom, and Lehman Brothers, highlighting the lessons learned by accounting professionals from these scandals. The analysis covers the manipulation of financial statements, accounting fraud, and the role of auditors in detecting and preventing such misconduct. The report emphasizes the importance of strong corporate governance, adherence to accounting standards, and the need for auditors to maintain objectivity and professional skepticism to safeguard investor interests and prevent future financial crises.

Running head: AUDIT AND ASSURANCE SERVICES
Audit and assurance services
Name of the university
Name of the student
Authors note

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Table of Contents
Introduction:....................................................................................................................................2
Discussion:.......................................................................................................................................2
Auditor independence and audit risks:............................................................................................2
Situations leading to creation of threat to auditor’s independence:.................................................4
Reviewing the literature of Enron, Worldcom and Lehman brothers and lessons derived by
accounting professional from such collapses:.................................................................................6
Conclusion:......................................................................................................................................8
References list:...............................................................................................................................10

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Introduction:
The report is prepared to analyze the literature review on key audit risks and threats to
auditor’s independence lying. It deals with further discussion on the factors that exactly
undermines the independence of auditors. Moreover, analysis of literature review on the cases of
Enron, Worldcom and Lehman Bros has been done for generating information’s on the lessons
that have been learnt. Independence is considered as critical issue in the auditor’s profession as it
has considerable impact n audit quality. There is a possibility of auditors impairing audit quality
if they are not independent as they are less likely to report irregularities. Establishment of
relationship between independence and risk helps in identification of where the key audit risks
and threat to their independence lies. Audit activity is considered as holistic activity where the
independence in fact, issues of competence and audit risks are linked inextricably (Appelbaum &
Vasarhelyi, 2017). Quality of audit is determined by auditor’s independence and it is regarded as
one of the fundamental causes of many corporate failures and leading to their collapse and
triggering global economic meltdown of the middle 2000.
Discussion:
Auditor independence and audit risks:
Independence is one of the most crucial attributes and it is measured by the honesty of
auditors in measuring material misstatements in the financial statements of any organizations.
Several factors are responsible for undermining the independence of auditors and independence
can be impaired depending upon circumstances. The possibility of being perceived as not being
objective increases by lack of independence of auditors (Arens et al., 2016). Auditor’s impaired
evidence results in poor quality of audit and allows for greater earning quality and greater
earning management.

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Audit risks are defined as framing an inappropriate audit opinion of financial statement of any
particular organization. There are three components of audit risks and it comprises of control
risk, inherent risk and detection risks. Control risks is defined as risks of the possibility of
occurrence of misstatement that cannot be prevented, detected and corrected on timely basis by
internal control and accounting system. Inherent risk is the susceptibility of the class of
transactions or account balances to material misstatement and it is irrespective of internal control
system. Detective risk is the risk of auditors failing to detect the materiality of misstatement by
using its substantial procedures. Auditors’ independence on other hand is defined as state of
mind of provisioning an opinion that does not affect the influences of compromising personal
judgment, professional skepticism, exercising objectivity and allowing an individual to act with
integrity (Knechel & Salterio, 2016).
The factors affecting independence of auditors have often been debated and there are
basic factors that lead to threats of auditor independence and cause and effect on quality of audit.
Framework for research in audit quality and audit independence:
(Source: Schmidt et al., 2015)

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Main threat to independence of auditors arise from auditor client relationships as clients
and auditors in different level and in different firms have diverse incentives resulting in different
perceptions and its impact on auditor independence. The quality of audit is likely to be impacted
considerably by threats such as non-audit services, auditor tenure, client importance and
affiliation of client with firm (Byrnes et al,. 2014). However, it is difficult to determine the
threats of quality of audit on their influences on dependence. Normally, the independence of
auditors are reduced by threats and the net effect between independence and auditors capabilities
helps in determining the impact of independent threat on audit quality.
Auditor tenure may also lead to impairment of auditor independence as auditors tent to
develop close relationship with clients if the auditor client relationships lengthens and they are
more likely to act in favor of management and thereby reducing audit quality and objectivity
(Ahmed & Anifowose, 2015). In some of recent corporate scandals that occurred simultaneously
involved auditors and the lack of auditors, independence was attributable to occurrence of such
scandals. There are certain situations that results in creation of threat to auditor’s independence
as deduced by reviewing literature.
Situations leading to creation of threat to auditor’s independence:
Threats’ arising from self interest- It is a type of threat that incorporates self-interest or
any other financial conflicts and including a direct and indirect financial interest, motivation of
retaining the client and dependence on non-audit and client fees. Auditor’s independence could
be impaired by auditor fee dependence. They would try to retain their clients in order to secure
future revenues. Intuitively, auditors will be depending upon clients to a greater degree if they
generate higher revenue. In order to retain the clients, auditors will be hesitating in taking actions

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that would have any adverse impact on them. It has been argued that auditor independence will
decrease by a greater share between auditors and their clients.
Familiarity and advocacy threat arises from audit tenure and long-term consecutive
assignments with the same clients. The longer auditors conduct auditing for the same clients,
there will be more impairment of auditor independence. Long tenure lead to impairment of
auditors independence due to auditors experiencing a belief perseverance syndrome that lead to
failure of auditors in revising the appropriateness of assertion of management even though there
has been change in conditions and facts (Leung et al., 2014).
Furthermore, auditors might be deterred to exercise their professional skepticism and act
independently due to threat that are caused by intimidation and that arises on management part.
Threat of replacement is one of the common types of intimidation threat. Due to imbalance of
power and asymmetrical relationship between auditors and their clients, auditors are considered
in weak position. In a conflict situation, auditors are vulnerable to intimidation by clients in the
events when there occurs disagreements between auditors and clients over accounting issues
such as appropriateness of accounting principles applied by clients, any sort of adjustments in the
financial statements and inadequacy of disclosure of financial statements (Caya, 2016).
In association of above discussed points, various other factors can lead to impairment of
independence of auditors. One of such point is social pressures that can be exerted by any
individual within authority in a hierarchical context such as upper level of management.
Conformity pressure and obedience pressure are the two types of social pressures. Conformity
pressure is a pressure that is exerted by colleague or peers and upper management in an
organization exerts obedience pressure. These two pressures can impair Independence of audit
when the independent principle is contracted by suggestions or command of auditor’s colleagues

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or superior. Recognition of audit risk existence is incorporated in the description of functions and
responsibilities of independent auditors (Knechel & Salterio, 2016). Therefore, it can be seen that
there are various factors that poses threat to auditor’s independence
Reviewing the literature of Enron, Worldcom and Lehman brothers and lessons derived by
accounting professional from such collapses:
Enron Corporation being the seventh largest company in United States misguided its
shareholders by engaging them in fraud and reported its profit unfaithfully. Organization
manipulated its financial statements along with financial strategy when they started facing
financing difficulties. Collapse of Enron was preceded by three major violations of the principles
of GAAP. Another accounting fraud principle is attributable to mark to market method that
helped in pumping up the stock prices for gaining capital investments that was regarded as
immoral and illegal. Derivative manipulation was another violation that helped in concealing
derivative loss from investors (Messier et al., 2015). Several potentially fraudulent acts and
unusual transactions were discovered and investigated by the auditor of Enron. Financial
outcomes that was attributable to this organization resulting from poor accounting policies for
recognition of revenue, lack of financial policies and improper segregation accounting duties
(William et al., 2016). It has been ascertained after the failure of Enron that there has been
increase in compliance costs with the internal costing systems with the largest accounting firms
have increased over time.
Lehman brother failure was one of the largest bankruptcies in United States. Business
model used by this bank was mainly to rely on short-term loans and assets was predominantly
long-term when they were largely large short-terms. Factors that accounted for the failure of the
organization was poor choice of management accompanies with some unethical practices.

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Liquidity crisis, financial leverage, complex capital structure, subprime mortgage crisis and
massive credit default swaps. Adversity in several organizations is reported by the collapse of
Lehman brothers as the failure led to depreciation in price of commercial real estates and
extinguishing billions of market value and market for trade receivables (Byrnes et al., 2015).
Collapse of failure of Lehman brothers was unthinkable and the lessons that were learned
from such failure are attributable to high hazard industries and preventing of such financial
accidents by adopting an equivalent approach for managing and understating risks in culture of
organization and control of management. Management of company was attributable to the failure
as they were involved in manipulating financial documents and financial transactions leading to
its ultimate collapse (Parwada et al., 2015).
Worldcom was engaged in accounting scandal and rapid erosion of profits that created
illusionary earnings. The accounting practices of organization were questionable and internal
auditors have uncovered an additional of $ 3.831 billion due to improper accounting (Knechel,
2016). Detecting errors is an easy task for auditors and sophisticated fraud involves earning
management that it can covert. Management requirement for asserting that accounts have been
prepared properly does not provide for any protections from entering into any fraud and deceits.
Auditors need to make the identification of presence of intention and it was found in the case of
Worldcom that there were changes in financial metrics due to accounting manipulations.
Operating margin was not regarded as satisfactory and for making earning stable; Worldcom was
engaged in accounting manipulations. The purpose of obtaining desired earnings in light of
accounting manipulations was mainly to boost up the stock price of company. Auditors miss this
elementary fraud conducted by Worldcom that ultimately led its failure (Duncan & Whittington,
2014).

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Failure of such business have affected large spectrum of business globally and such
collapse can be prevented by taking pro-active actions by management in spite of taking any
reactive measures. After the crisis, it becomes difficult for management to identify any right
solutions to curtail after effect of such crisis.
All the collapse of above-mentioned organization was attributable to their financial
failure due to manipulation of financial activities and engaging in the financial activities. This
has led to deterioration in quality of profits reported by company and the standards that have
been applicable to companies. Management of organizations should prevent engagement in
shoddy auditing; misleading accounts and appropriate measures should be taken to outright
frauds (Sirois et al., 2016). All such scandals entail organization to make their corporate
governance more stringent and taking adhering to all the principles of accounting standard
without violating them. From auditors perspective, it can be seen that failure of auditors to
conduct proper verification of all the related accounts and disclosing the same to public led to
fall of such organization and loss of investors money (Chambers & Odar, 2015). Therefore, they
should try to investigate into any sort of accounts that are misleading investors by providing
irrelevant financial information.
Conclusion:
From the analysis, it can be inferred that the threat of auditor’s independence arises from
multiple factors ranging from internal to external. Auditors are faced with several risks while
conducting audits and the failure of them to identify such risks would pose a threat to their
independence. Moreover, organization should operated and engage within the confines of
business jurisdiction and auditors should keep a blank eye on illegal and unethical activities of
organizations. For analyzing the liquidity issue of company, auditors should place careful

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consideration of indicators of cash flow that will help in preventing such problems. Stringent
policies must be initiated by different regulatory standards for addressing the failure to avert
occurrence of such financial collapses. Organizations are also required to adhere to practices of
good corporate governances. For auditors to discover such fraudulent activities, it is essential to
detect the main indicators of occurrence of such frauds. For avoiding the collapse of such firms,
it must be ensured by business international communities that ethical culture and high standards
should be held by businesses.

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References list:
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does internal assurance matter?. Managerial Auditing Journal, 31(8/9), 915-948.
Appelbaum, D., Kogan, A., & Vasarhelyi, M. A. (2017). Big Data and analytics in the modern
audit engagement: Research needs. Auditing: A Journal of Practice & Theory, 36(4), 1-
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services. Pearson.
Azibi, J., Azibi, H., & Tondeur, H. (2017). Institutional Activism, Auditor’s Choice and Earning
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Byrnes, P. E., Al-Awadhi, C. A., Gullvist, B., Brown-Liburd, H., Teeter, C. R., Warren Jr, J. D.,
& Vasarhelyi, M. (2015). Evolution of auditing: From the traditional approach to the
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Caya, E. (2016). Make the most of assurance: assurance maps can enable internal audit to team
with other assurance providers to visually convey how risk is managed. Internal Auditor,
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Chambers, A. D., & Odar, M. (2015). A new vision for internal audit. Managerial Auditing
Journal, 30(1), 34-55.

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Duncan, B., & Whittington, M. (2014, September). Compliance with standards, assurance and
audit: does this equal security?. In Proceedings of the 7th International Conference on
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