Threats To Auditor Independence

What Are The Threats To Auditor Independence?

Threats To Auditor Independence refer to the risks faced by the auditor due to inefficiencies affecting the quality of the audit report. Such threats may arise from constraints imposed by the client or auditor's close relationships with the senior executives.

There are five potential threats to auditor independence. They bring a certain level of uncertainty and inaccuracy to the audit results. It also leads to material misstatements and audit risks in the process. Moreover, they pose legal liabilities to both the client and the auditor. However, implementing certain precautions and safeguards can minimize the risk level.

• Threats to auditor independence refer to the threats that suppress the auditors during the auditing process. Thus, it hampers the efficiency and authenticity of auditors and audits.
• The concept of auditor independence dates back to the late 1990s and early 2000s. In 1997, the SEC and AICPA formed the Independence Standards Board (ISB).
• The ISB establishes rules and regulations for auditor independence. Also, they monitor any threats faced by the auditors from clients.
• Five threats include self-interest, self-review, advocacy, familiarity, and intimidation. Safeguards released under ISB No. 3. are crucial in mitigating these threats and ensuring the integrity of audit processes.

Threats To Auditor Independence Explained

Threats to auditor independence are various threats that an auditor encounters during the auditing process. It occurs due to the client's pressure, financial ties, close relationships with clients, the type of audit services, and others. Other factors include external factors like the type of regulatory environment and audit period.

These five threats to auditor independence could affect the auditor's efficiency. Let us look at them:

#1- Self-interest Threat

When auditors create some interest in the client firm, it might affect their credibility and authenticity. It can be a direct or indirect financial interest within the firm. Thus, the auditor might have to please the client and, thus, lose their independence. For instance, the auditor might present a favorable audit report to get the pending fee.

#2 - Familiarity Threat

This threat arises from close relationships between the auditor and the client. For instance, if the auditor's relative is holding a top position in a firm, there is a chance of errors and fraud. As a result, the auditor’s work may be biased.

#3 - Self-Review Threat

This potential threat arises when the auditors themselves audit or self-review their work. Here, there may be biased reports presented by the auditor.

#4 - Advocacy Threat

The advocacy threat occurs if the auditors promote the client's work. For instance, if the auditor helps the client during mergers and acquisitions, the auditor's objectivity and efficiency hampers.

#5 - Intimidation Threat

Sometimes, the clients pressurize or force the auditor to create a biased report. In such situations, intimidation arises. For instance, if a particular firm is a long-term client, they may intimidate the auditors to follow their instructions.

Evolution of Auditor Independence Standards

The popularity of such threats and possible remedies started during the early 2000s. The Sarbanes-Oxley Act passed in 2002 brought glory to auditor independence. Additionally, the Arthur Anderson-Enron case brought more awareness to the issue as Arthur Anderson attempted to destroy the audit documents. As a result, the independence and authority of the auditors were disrupted.

However, the rules for auditor independence were laid out in 1997. The Securities and Exchange Commission (SEC) and the American Institute of Certified Public Accountants (AICPA) collectively formed the Independence Standards Board (ISB). The ISB aimed to regulate auditor independence and associated risks. It also defined the threats and safeguards to protect the auditor's independence.

Examples

Let us look at some examples to comprehend the concept better:

Example #1

Suppose Andrew owns an audit firm with a few clients across the network. XYZ Ltd., in particular, has a close relationship with Andrew. As a result, during the audit process, the client tried to bribe the auditors to conduct a lenient audit. Thus, a few material misstatements gave rise to audit risks.

Additionally, XYZ Ltd. still needed to pay the outstanding fee. Auditors received their due amount after presenting a clear audit. But, in the later stage, the regulatory body examined their reports. Had the auditors refused such compromises, the integrity of the audit process would have been preserved, and threats that would hamper the auditor’s independence would have been mitigated.

Example #2

In March 2023, the AICPA Professional Ethics Executive Committee (PEEC) released a revised draft to match the Code of Conduct with the internationally defined standards. Notably, this update addressed fee structures to avoid any fee-related or potential threats to auditor independence. It is defined under the section Determining Fees for an Attest Engagement. These changes demonstrate the profession's dedication to maintaining ethical conduct and ensuring the accuracy of financial reporting procedures.

Safeguards

ISB Standard No. 3 introduces various safeguard measures to address the five threats to auditor independence and possible remedies. Moreover, the conceptual framework also provides insights into it. Here are the measures:

• Auditors can restrict themselves from creating any financial interest within the client's business.
• Permitting any relationship with the client during the audit process.
• Managing the revenue streams from all the clients; any significant income from one client must divert or stop.
• Auditors, including the engagement team, can receive independent internal auditors' confirmation to avoid a self-review threat.
• The audit firm must disclose the type of audit services, fees, regulations, and other relevant information to senior management.
• Providing training to other team auditors at regular intervals. The authority of the lead auditor should also rotate among the members.
• Constant monitoring of the team to ensure high-quality audit results.
• The auditors should also resolve conflicts of interest with the client for smooth auditing. Also, they must ensure that no event causes threats.

Frequently Asked Questions (FAQs)

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