Name: Nguyen Thi Hong My
Library card number: 33237972
Word count: 1304 words
AcF 100 Introduction to Accounting and Finance
Lent Term: Individual Coursework Essay
Why is it important for external auditors to be independent? Relate your answer to the primary role of external auditors. Give examples of specific ways the lack of auditor independence may impact adversely on an audit.
In 2001, there was an event that had shaken the whole business world. The crash of Enron in US, followed by worldwide collapse of its auditor, Arthur Andersen. It was a greatest corporate failure uncovered in business history. Follow the Enron-Andersen scandal, massive organizations like WorldCom, Xerox and Waste Management confront a similar fate. The debate rested on the issue of audit independence , that is found to be one of the major contributors to crashes like Enron. It is explained that the impact of lack of audit independence is extremely great to the audit quality (Abdullah, 2004). This essay, is trying to define what is 'independence' and discuss about the relationship between independence and quality of external auditors.
First of all, it is good to know what is the external auditors and its primary role. External auditing is an observation of annual financial reports of a corporation, for example, Balance Sheet, Profit and Loss account and cashflow statement. It is done by someone independent of that business, who play no part in day-to-day running of the organization and must not be controlled by the management of that corporation (St Helena Audit Service, 2006). The external auditors perform a key role in developing internal control, however, they do not have any benefits of working with company on every basis. The role and process vary from country to country, due to the developments of Financial Accounting Standards Board (FASB) merging with International Accounting Standards Board (IASB).
The primary role of an audit is verifying the financial statement, detecting and preventing of fraud (Ojo, 2006). In other words, the auditors are the police and jugdes of financial public affairs. Auditing is an important part of capital market framework. It not only reduces the cost of information exchange between shareholders and managers, but it also provide a signalling mechanism to markets that information which management is providing is trustworthy. In addition, the move to verification of financial statements has risen from growing investment in some industries such as railway, insuarance and banking. It is suggested that this situation happened in these particular industries, the shareholding was more dispersed and more priority given to financial performance rather than the management's honesty. After failures of some banks like BCCI and Johnson Matthey, it made us to think once again about the objective of an audit including the detection and prevention of fraud (Ojo, 2006).
Secondly, it is useful to clarify the meaning of 'independence'. The concept of independence is not easy to define. A number of researchers and studies has tried to interpret this word, for instance, DeAngelo (1981a), Knapp(1985), Magill and Previts (1991) and AICPA (1997). It is argued that the need of independence arises when, in many cases, the users of financial statements and other third parties do not have enough information to enable to judge whether auditors are objective. Audit ought to lose value when independence which gives credibility to financial statements, is undermined (Ojo, 2006).
Audit independence is and has been as essential to the validity of external audit (Sucher and Bychkova, 2001. According to Mautz and Sharaf (1961), the importance of independence in the work of independent auditor is so well formed that just little explanation is needed to establish this notion as one of the cornerstones in any framework of auditing theory. The AICPA Special...
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