Auditor Independence

The collapse of the energy trading firm Enron has focused mainly on auditor independence (Arthur Anderson), and whether he was also responsible for the collapse of Enron and if so to what extent was he reliable in the collapse of the company. It is still argued that in the auditing profession that auditor independence is a serious problem and indeed to an extent with the Enron case. Third parties, such as investors, the general public and regulators, regard a quality audit to be one that is truly independent and of a fair and true view. But there is a problem that compromises independence as explained by Parker in the following paragraph;

"There is widespread concern that auditor independence has been compromised by audit firms keen to secure lucrative non-audit work from clients" (Parker, FT 04/11/02) 

If an auditor is seen to be independent the credibility of the financial statements are supported. Historically, auditors are assumed to have no incentive to be dishonest, but there are arguments to suggest that auditors may no longer be truly independent, which could lead to fraud, company collapses or even falsified reporting, which in many cases can lead to a business being declared bankrupt.

In the case of the auditing firm Pricewaterhousecoopers, who were the auditors for Barings Bank – whereby they falsified the banks account from 1993 to 1994, the auditors were held liable but to what extent, solely or jointly liable for the bank collapse. At the time of the collapse of the bank auditors had signed off four separate sets of accounts each ones as being certified as being "genuinely true and fair". The accounts showed the bank had made a profit of over 78m at December 1994, when infact it had made a huge loss of 174m.

When this case was being investigated by the KPMG, the blame initially went solely to the auditors, but further evidence showed that a director and a rogue trader Nick Leeson had been liable for the business collapse hence liability being shared equally. The Barings case study shows of the agency theory – whereby the audit sees 

the rules to gain the desired result. One piece of evidence will always remain; Enron had overstated its income for more than four years before its collapse. The question is whether this was of negligence or intent to defraud. The agency theory can once again be applied to the audit in this case. For Arthur Andersen there is no concrete evidence to suggest that he was solely responsible for the collapse or for financial gain but I believe there were more other factors involved to the collapse.

Perception Of Auditors Independence – A Problem?

It is clear that perception is a serious problem in auditing, and many shareholders also believe that independence cannot be guaranteed which seriously can affect the audit and could lead to information being misused. Another problem with independence is the nature of how auditors are paid and appointed. 

S390A of the Companies Act 1985 states "the remuneration of auditors appointed by the company shall be fixed by the company in general meetings or in such a manner as the company "shall determine". In accounting practise this simply means that management appoint and pay the auditors.

So in order to keep the auditing "clean", there is an incentive to act in a manner to keep management happy and not at all truly independent, jeopardising not just the "fair and true" aspect of auditing but also the company in question, certainly if it is at risk, because if the company does collapse due to negligence from not only auditors giving a fair and true view, then directors who do not act upon this will also be responsible for the collapse of the company. 

Conclusion In conclusion, the role of an audit is to provide an assurance on what is being audited following thorough standards and legislation. Financial statement credibility will always be under question, if they are any doubts or certainly if a business does collapse. 

As demonstrated in this document, we should not shy away from the fact that auditors are never on most occasions solely responsible for business collapses – directors, management, fraudsters are just as liable. Where evidence suggests independence and liability does not only concern auditors but must involve directors and company seniors too.

Because of the blame and external pressures put on auditors on various companies that have collapsed, certain industries or companies which are The profession must address the problem of independence before confidence in financial statements can be restored. According to Moizer, (1997) actions, which could be taken include:  1) Rotation of audit appointments.  2) Peer review  3) Independent audit appointing and free settling body  4) Limiting the size of the auditors' economic interest. 

Given the problems associated with audit quality it is not surprising questions are being raised of the credibility of the financial statements which the audits are intended to support. Serious questions must be asked when it can be argued that the ICAEW definition of audit quality, (independent, reliable and supported by adequate evidence (ICAEW: 11)) cannot be met. The most important question should be what can the profession do to solve these problems and can new practices such as the business risk assurance model overcome these difficulties.