Question

The external auditor has a responsibility to make a statement of independence to ‘those charged with governance’ for inclusion in the corporation’s reports. Essentially, this question pertains to the types of measures that can and should occur within the corporation to enhance external auditor independence rather than just relying on the auditor’s statement. Based on the above statement, what are some measures the board can undertake to enhance the likelihood of external auditor independence being achieved? Formulate your answer. (Please provide four reasons to support your answer).

Answer 1

Independence is defined in the IRBA Code of Professional Conduct (the Code) as comprising two elements:-

• Independence of mind

• Independence in appearance

Independence of mind is the state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgement, thereby allowing an individual to act with integrity as well as exercise objectivity and professional scepticism.

Independence in appearance is the avoidance of facts and circumstances that are so significant that a reasonable and informed third party would be likely to conclude, weighing all the specific facts and circumstances, that a firm’s, or a member of the audit or assurance team’s integrity, objectivity or professional scepticism has been compromised. The working environment of professional auditors can make a threat to independence. In particular, the corporate governance of the auditing company has the greatest influence on auditing independence.
The external auditor plays a critical role in lending independent credibility to published financial statements used by investors, creditors and other stakeholders as a basis for making capital allocation decisions. Indeed, the public’s perception of the 3 credibility of financial reporting by listed entities is influenced significantly by the perceived effectiveness of external auditors in examining and reporting on financial statements. While any consideration of the effectiveness of external audits involves a wide variety of issues, it is fundamental to public confidence in the reliability of financial statements that external auditors operate, and are seen to operate, in an environment that supports objective decision-making on key issues having a material effect on financial statements. In other words, the auditor must be independent in both fact and appearance.

Code of Ethics for Professional Accountants of the International Federation of Accountants provides a useful analysis of potential threats to an auditor’s independence under the following headings:-

• Self-interest, where an auditor could benefit from a financial or other form of interest in or relationship with the company being audited, e.g., an investment in the company or undue dependence on fees from assurance or non-assurance services

• Self-review, e.g., performance of services for an audit client that result in the audit firm auditing its own work

• Advocacy, e.g., acting as an advocate for an audit client’s position in dealings with third parties

• Familiarity, e.g., long association of an audit engagement partner or other key engagement personnel with a particular client or a recent former partner or senior staff member of an audit firm serving as CFO or in some other key management role at an audit client

• Intimidation, e.g., threat of replacement of an auditor over a disagreement on the application of accounting principles.

Safeguards that may eliminate or reduce such threats to an acceptable level fall into two broad categories:

1.Safeguards created by the profession, legislation or regulation

2.Safeguards in the work environment.

Safeguards in the work environment / Measures by Board:-

–The firm’s leadership stressing compliance with fundamental principles

–Policies and procedures to manage reliance on revenue from a single client

–Rotating senior assurance team personnel

–Using different teams for non-assurance work

–Prohibiting individuals who are not team members from influencing the outcome of the engagement

–Policies and procedures encouraging staff to communicate to senior management of any ethical compliance issue that concerns them

–Advising staff of independence requirements in relation to specific clients

–Disciplinary measures

–Strong internal controls

–Whistleblowing provisions