Auditor independence
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Auditor Independence. Group Member: Lim Tien Ming109738 Lim Yin Chern 109744 Khoh Saw Yoong109812 Liew Wen Ying109820. CONTENT. INTRODUCTION ISSUES CONCLUSION. Introduction.

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Auditor Independence

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Auditor Independence

Group Member:

Lim Tien Ming109738

Lim Yin Chern 109744

Khoh Saw Yoong109812

Liew Wen Ying109820






  • ENRON –- the largest bankruptcy and other accounting scandals sparked the issues on auditor independence.

What is Auditor Independence?

  • Independent – Free from outside control; self governing or separate. (Oxford English Dictionary)

  • Auditor independence – Auditor free from control; separate.


Know how and why undue management influence, “guanxi” and how provision of non audit service to audit client will undermine auditor independence


Undue Management Influence On Auditors’ Independence

“Although external auditors' independence is protected to some degree, they still face many of the same issues as internal auditors when it comes to undue management influence.”(Frederick Gallegos, 2004)

Impact of management to auditors’s independence in 3 areas:


  • Regardless of the integrity of the internal and external auditors, the fact remains that management continues to have great influence on the compensation and retention of both parties.

  • Audit committees typically rely on the advice of senior management in evaluating the audit team's performance.


Management can influence the scope of work of both internal and external auditors.


  • an unintended consequence of corporate governance reform is the diversion of internal audit resources and the change of priorities to supporting Sarbanes-Oxley Section 404.

  • Too many CAEs have the added responsibilitty of managing the Section 404 project.


  • The recent accounting and auditing failures like Enron, WorldCom have significantly changed auditing policy, practice, and procedures

  • And as result of the scandals, auditors – and the companies they audit – face increased pressure to behave ethically, and to report financial data fairly.

  • One of the most significant auditor’s independence issues currently happen is how guanxi may threaten the progress made in improving financial management and reporting, and may undermine auditor independence, audit quality, and the quality of financial reporting.

When I say ‘guanxi’What is the first things that comes to your mind?

What is guanxi?

  • In the Chinese language, “guanxi” is the term for a personal relationship.

  • It refers to the networks of informal relationships and exchanges of favors that dominate all business and social activities that occur throughout China.

  • Guanxi is nurtured by the exchange of gifts and favors. It is a common and acceptable business practice in China.

  • However, such gifts strike ethical nerves in Western society, and are contrary to at least the spirit if the not the letter of the S-O Act.

  • Since guanxi is widely practiced, there is no doubt that any US firm, whether an operating business firm or an auditing firm, will be directly under the exposure of guanxi.

  • US auditors must understand their potential audit risk and potential violation of ethical standards that may occur when operating in a society of guanxi – especially in this post Enron, post-financial scandal era.

  • US auditors must also understand the potential issues concerning disclosures, particularly regarding contingencies, that may exist for companies operating under the exposure of guanxi.

The correlation between guanxi and auditor’s independence

  • Guanxi can have a significant impact on the auditor’s judgement.

  • In their study of auditors in Hong Kong, Au and Wong (2002) find a correlation between an auditor’s level of guanxi with an audit client and their ethical judgment during an audit engagement.

  • However, they also find that the impact of guanxi connections on auditor independence is minimized when the auditor holds high levels of ethical principles.

  • To avoid the minefield created by guanxi, auditors must ensure that high levels of ethical principles are inculcated in their firmand knew how guanximay undermine auditor independence.

  • Auditors must also be aware that guanxi creates potential for violations of both the S-O Act and the FCPA.

  • Finally, auditors must be aware that guanxi creates the potential for errors and omissions in the reporting of contingencies.

ISSUE 3 : Non-audit services(NAS)

Do you think accounting firms should be banned from providing non-audit services to their clients?

Example: NAS

  • Bookkeeping

  • Financial information systems design and implementation

  • Human resources

  • Tax services

  • Expert services unrelated to the audit

  • Broker-dealer, investment adviser

Theoretical perspective

  • Produce efficiencies for the auditee (and its shareholders)

    -more understand the operations of the company

  • Research Literature

    - “knowledge spillover”

    - means that knowledge gained in the audit engagement , can be undertaken quickly and efficiently.

The joint provision of audit and NAS cause the threat to independence is potentially considerable!

Literature Review

  • Wide range threats to independent : Self-interest, self review, advocacy, familiarity (Beattie and Fearnley)

  • Undermines the appearance of auditor independence (Beattie and Fearnley, Canning and Gwilliam, and Mori).

Large non-audit engagement

  • Harder to be objective

  • Difficult to make judgment that works against the audit client interest

  • Case of Enron collapse,

    NAS provision> Audit

    $27m> $25m


  • All 3 issues discussed – all of them will seriously undermine auditor independence.

  • Impossible for auditors to be completely independent – bound with personal or monetary terms.

  • All shall play a part in ensuring auditor independence.

  • Let us hope that with all the actions taken, Auditor Independence could be safeguarded and Enron like disaster will not happen again.

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