The Importance of External Auditor’s Independence
According to Gillespie, Lewis and Hamilton (2004:221) an audit is: “a scrutiny of the accounts by a qualified auditor who carries out checks on the figures so as to establish whether the accounts show a true and fair view of the results and the financial position of the entity.” According to Wikipedia (2011a), auditor independence refers to “an attitude of mind characterized by integrity and an objective approach to the audit process”. Independent auditing has been an important part of the corporate monitoring system since the mid-1930s, when it became a legislation requirement after the Great Depression. This was caused by reckless spending by corporations in the late 1920s (Kim, Nofsinger, Mohr, 2010a). However in recent times it has become even more important after a number of firms have become bankrupt due to fictitious accounting methods, the most infamous one being the Enron scandal of 2001. This has led to the new legislation that has emphasised the importance of external auditors to be independent from the corporations they audit. Although it is not a legal requirement for a public company to be audited internally, many corporations tend to have their own internal audits. These can be very beneficial to the corporation as they check for accuracy in “financial record keeping”, “implement improvements” and can be used to “detect fraud” at an early stage. Internal auditors can actually “enhance a corporation’s accounting and internal control efficiency” (Kim, Nofsinger, Mohr, 2010b). However arguments are still being poised as to whether this is a necessary exercise as internal auditors may not be entirely independent of their employer. However WorldCom showed the importance of internal auditors. The company’s chief financial officer and their controller (at that time) were said to have claimed $3.8 billion in regular expenses as capital investment (Tran, 2002). Their internal auditors are said to have been the first to spot these misallocated expenses. However it is a legal requirement for all public companies to be audited by an external auditor. In the early days of financial auditing, many of the auditing firms offered both audit and consultation services to the same corporation. This was an attempt to solidify their relationships with the corporation’s management therefore maintaining them as clients. However this led to many auditors failing to be completely honest in their work in order to refrain from aggravating their relationships with the corporations they audited and consulted. Legislation had to be put in place that made sure that the auditing firms could only either offer auditing services or consultation services to a corporation (Kim, Nosfinger, Mohr, 2010c). This meant that external auditors could do their jobs without being biased, therefore making financial audit reports more reliable for investors, government bodies and the general public. The primary role of an external auditor is to present an independent and unbiased audit report of a firm’s financial position. This is a critical report because the information obtained from it will give guidance and support to investors, government bodies and the general public as to whether the corporation is adhering to the correct financial and accounting practices (Wikipedia, 2011b). It is extremely important that external auditors be independent of the corporations that they audit. This means that there is no conflict of interest and no reason for auditors to not comply with the financial accounting standards. A lack of independence between auditors and the corporations led to one of the biggest scandals in financial history. Enron Corporation was an energy company in the US who doctored their books to show large incorrect profits using “sophisticated and complicated methods to generate inflated reported earnings” (Kim, Nofsinger Mohr, 2010d:36). However in late 2001 the business filed for bankruptcy...
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