Auditor Independence an international perspective.pdf

Managerial Auditing JournalAuditor independence: an international perspectiveRocco R. Vanasco

Article information:To cite this document:Rocco R. Vanasco, (1996),"Auditor independence: an international perspective", Managerial Auditing Journal, Vol. 11 Iss 9pp. 4 - 48Permanent link to this document:http://dx.doi.org/10.1108/02686909610150386

Downloaded on: 20 September 2014, At: 05:08 (PT)References: this document contains references to 214 other documents.To copy this document: [email protected] fulltext of this document has been downloaded 4950 times since 2006*

Users who downloaded this article also downloaded:Rocco R. Vanasco, Clifford R. Skousen, L. Roger Santagato, (1997),"Auditor independence: an international perspective",Managerial Auditing Journal, Vol. 12 Iss 9 pp. 498-505Jenny Stewart, Nava Subramaniam, (2010),"Internal audit independence and objectivity: emerging research opportunities",Managerial Auditing Journal, Vol. 25 Iss 4 pp. 328-360Diana Mostafa Mohamed, Magda Hussien Habib, (2013),"Auditor independence, audit quality and the mandatory auditorrotation in Egypt", Education, Business and Society: Contemporary Middle Eastern Issues, Vol. 6 Iss 2 pp. 116-144

Access to this document was granted through an Emerald subscription provided by 546149 []

For AuthorsIf you would like to write for this, or any other Emerald publication, then please use our Emerald for Authors serviceinformation about how to choose which publication to write for and submission guidelines are available for all. Pleasevisit www.emeraldinsight.com/authors for more information.

About Emerald www.emeraldinsight.comEmerald is a global publisher linking research and practice to the benefit of society. The company manages a portfolio ofmore than 290 journals and over 2,350 books and book series volumes, as well as providing an extensive range of onlineproducts and additional customer resources and services.

Emerald is both COUNTER 4 and TRANSFER compliant. The organization is a partner of the Committee on PublicationEthics (COPE) and also works with Portico and the LOCKSS initiative for digital archive preservation.

*Related content and download information correct at time of download.

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

http://dx.doi.org/10.1108/02686909610150386

[ 4 ]

Managerial Auditing Journal11/9 [1996] 4–48

© MCB University Press [ISSN 0268-6902]

Auditor independence: an international perspective

Rocco R. VanascoDirector, Centre for Internal Auditing Studies, National-Louis University, Chicago,Illinois, USA

Examines the role of profes-sional associations, govern-mental agencies, and interna-tional accounting and audit-ing bodies in promulgatingstandards to foster auditorindependence domesticallyand abroad. Focuses specifi-cally on the role played by theAmerican Institute of Certi-fied Public Accountants, theInstitute of Internal Auditors(IIA), the Securities andExchange Commission andthe US Government Account-ing Office. Also looks at otherprofessional associations inbanking, industry, and manu-facturing sectors dealing withsensitive issues of auditors'involvement in such mattersas management advisoryservices, operating responsi-bilities, outsourcing, opinionshopping, auditor rotation,and other conflicts of interestwhich may impair auditorindependence.

IntroductionNo person is an island unto himself and thatindependence is always a relative term.That is greater or less, but never absolute[1].

The American Institute of Certified PublicAccountants (AICPA), The Institute of Inter-nal Auditors (IIA), the American AccountingAssociation (AAA), the Securities andExchange Commission (SEC) and severalprofessional associations nationally andabroad have emphasized that auditor inde-pendence is both an ethical and aprofessional issue crucial to auditors. Inde-pendence has been viewed as “a deeply feltprofessional credo”. It is believed that part ofthe solution in solving ethical dilemmasregarding potential and perceived threats toauditor independence is to place moreemphasis on professional ethics[2]. TheEthics Committee of the International Feder-ation of Accountants (IFAC) has also empha-sized the concept of independence as an ethi-cal issue in its guidelines on auditor indepen-dence.

Several authors have come with philosophi-cal, sociological, behavioral, and legal defini-tions of independence and what leads to itsimpairment. Elijah Watts Sells[3] emphasizedthe importance of the auditor’s independencevis-à-vis the auditee: “The position of thepublic accountant with respect to corpora-tions and their management is always anindependent one. Unlike attorneys, accoun-tants are not expected to make out a case. Thecharacter of the service they render is imper-sonal”. Early in 1928, an editorial in the Jour-nal of Accountancy highlighted the existenceof a conflict of interest when an auditor is astockholder, officer, or director of the organi-zation. It stated: “The accountant should beutterly divorced from financial or other par-ticipation in the success or failure of anundertaking under audit that no one couldever point an accusing finger, howeverunjustly, and allege the possibility of bias”[4].

Mautz and Sharaf[5], in their Philosophy ofAuditing, advocated recognition of threedimensions of auditor independence whichcan minimize or eliminate potential threatsto the auditor’s objectivity:

1 Programming independence includes: • freedom from managerial interference

with the audit programme; • freedom from any interference with

audit procedures; and • freedom from any requirement for the

review of the audit work other than thatwhich normally accompanies the auditprocess.

2 Investigative independence encompasses: • free access to all records, procedures,

and personnel relevant to the audit; • active co-operation from management

personnel during the audit examination; • freedom from any management attempt

to specify activities to be examined or toestablish the acceptability of evidentialmatter; and

• freedom from personal interests on thepart of the auditor leading to exclusionsfrom or limitations on the audit exami-nation.

3 Reporting independence includes: • freedom from any feeling of obligation to

modify the impact or significance ofreported facts;

• freedom from pressure to exclude signifi-cant matters from internal audit reports;

• avoidance of intentional or uninten-tional use of ambiguous language in thestatement of facts, opinions, and recom-mendations and in their interpretations;and

• freedom from any attempt to overrulethe auditor’s judgement as to either factsor opinions in the internal audit report.

Carey and Doherty[6] came up with threemeanings of auditor independence:

First, in the sense of not being subordinate,it means honesty, integrity, objectivity andresponsibility. Second, in the narrow sensein which it is used in connection with audit-ing and expression of opinions on financialstatements, independence means avoidanceof any relationship which would be likely,even subconsciously, to impair the CPA’sobjectivity as auditor. Third, it means avoid-ance of relationships which to a reasonableobserver would suggest a conflict of interest.

Michael Barrett[7] indicated that the auditprofession’s ethical notion of apparent inde-pendence can be defined in a sociological role

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 5 ]

Rocco R. VanascoAuditor independence: an international perspective


construct, whereas its conception of realindependence can be defined as a personalityconstruct. Professional audit independence,according to Barrett, has two constructs:1 Interpersonal independence describes func-

tional situations which promote or dys-functional situations which impair theprofession’s auditor image as perceived byreasonable observers, and

2 Intrapersonal independence is the secondorder factor containing three operationalcontent variables. It is assumed that audi-tors – who are field analytical rather thanglobal field types, who evidence a lowsocial approval need rather than beingapproval motivated, and who prefer todescribe themselves in terms of indepen-dent rather than intermediate or depen-dent personality typologies – tend to pos-sess a high degree of intrapersonal inde-pendence as characterized by their behav-ior in test and non-test situations.

Shockley[8] examined the effects of competi-tion in the audit profession, managementadvisory services (MAS), and size of the auditfirm in third-party perceptions of the exter-nal auditor independence. His results showthat all the variables significantly affectedthird-party perceptions of auditor indepen-dence. Knapp[9] also examined the effects of anumber of variables that could affect third-party perceptions of the auditor’s ability toresist management pressure in an audit con-flict situation. His results indicate that thenature of the conflict, the financial conditionof the client, and competition, affected theperceptions of the auditor’s ability to resistmanagement pressure.

Lawrence Sawyer[10] speaks of two kinds ofindependence for internal auditors:1 Practitioner independence: when the inter-

nal auditor, by reason of a sufficiently highreporting status in the organization, canmaintain an objective attitude in formingopinions and preparing reports.

2 Professional independence: the image thatinternal auditors bring to minds of people,a feeling of trust that evidence has beengathered without bias, and opinions havebeen expressed freely.

Pasewark and Wilkerson[11] suggested thatauditors examine the following factors whenconsidering independence: • whether the auditor and the client have

certain financial relationships, and • whether the auditor can be considered part

of the management or an employee undermanagement control.

They mention five sources of power that havethe potential to influence the auditor’s inde-pendence: 1 authoritative power;2 expertise power;3 control over rewards;4 coercive power; and 5 personal power.

When evaluating a specific client or potentialclient, the auditor should consider theclient’s potential to influence auditor inde-pendence. As an aid in performing such anevaluation, they recommended the following: • Consider the client in terms of the five

sources of power. • Assess the probability that the client might

exercise the power possessed. • Consider how the probability of the use of

the power might influence auditor indepen-dence.

• Accept or reject the engagement on thebasis of the evaluation.

Bartlett[12] suggests that the extensive bodyof literature and research concerning auditorindependence has centred mainly on allegedthreats to perceived independence or threatsto actual independence. Whenever the inde-pendence concept in accounting isquestioned, there is a tendency to be defen-sive by citing a kind of “semi-spiritual incan-tation” such as: • No instance can be found in which an audi-

tor’s independence is lacking. • Surveys indicate that the CPA profession is

held in the highest regard by those whoknow what CPAs do.

• If more constraints are placed on the profes-sion’s activities, it will not be able to serveclients properly, leading to significant coststo the public.

• Independence is a mental state for profes-sional accountants and not subject toempirical observation or quantification.

Bartlett believes that these “semi-spiritualincantations” serve as a poor justification forthe actual existence of independence. If themission of the profession is public welfare,and if the members of the profession are con-vinced that independence actually exists,then it is time to revise and restate a conceptof independence that can be observed.

The auditing profession has come underconstant scrutiny regarding the auditor’sperceived independence. Forbes[13] publishedan editorial questioning auditor indepen-dence by raising the following: “Since audi-tors are selected and paid by management,are they truly independent?” and the WallStreet Journal[14] published another editorialin which a shareholder criticized a $1.6

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 6 ]



million loan by the bank to the company’sauditors on the ground that such loan consti-tuted a conflict of interest and jeopardized theauditors’ independence. The harsh criticismby the public and private sectors on auditors’apparent and perceived independence has ledthe AICPA, the IIA, the SEC and internationalaccounting bodies to formulate rules regard-ing independence and adopt procedures toenforce them.

Part I – Professional assocations,government, and management

The role of the AICPABecause it is an attitude or state of mind,independence is difficult to assess objec-tively; only an auditor’s actions can be usedby observers to evaluate independence[15].

CPAs perform the attest function on commu-nication of economic data by one party toanother. The attest function adds credibilityto the communication only if CPAs are inde-pendent and competent. The AICPA has dealtwith the delicate issue of auditor indepen-dence on several occasions. The followingchronology details the evolution of this con-cept of CPA independence and affirms thehigh priority given it by the AICPA. Indepen-dence has become the cornerstone of theauditing profession.

The AICPA’s predecessor, the AmericanAssociation of Public Accountants (AAPA),established in 1887, did not recognize inde-pendence in its constitution and by-laws. In1907, its bye-laws were amended expressingthe desirability of avoiding incompatiblefunctions. In 1916, the AAPA was renamed asthe American Institute of Accountants (AIA).Both the AAPA and AIA did not appear to beactively concerned with auditor indepen-dence until 1930. In 1931, the AIA recognizedthe importance of the auditor’s independencewhen CPAs assumed the dual roles of bothdirector and auditor for a company. To pre-vent such incompatible functions, the AIAintroduced the following:

RESOLVED, that the maintenance of a dualrelationship, as director or officer of a corpo-ration, while acting as auditor of that corpo-ration is against the best interests of thepublic and the profession and tends todestroy that independence of action consid-ered essential in the relationship betweenclient and auditor[16].

The AIA’s Council also recognized that aconflict of interest may arise when CPAscertify financial statements of companies inwhich they have a substantial interest. Toprevent such situations, the following wasadopted at the 1934 AIA annual meeting:

RESOLVED, that no member or associateshall certify the financial statements of anyenterprise financed in whole or in part bypublic distribution of securities if he ishimself the actual or beneficial owner of asubstantial financial interest in the enter-prise or if he is committed to acquire suchan interest[17].

In 1940, the financial independence rulebecame part of the Code of Professional Ethics.The AIA adopted the following rule on audi-tor independence:

A member or associate shall not express hisopinion on financial statements of anyenterprise financed in whole or in part bypublic distribution of securities, if he him-self is the actual or beneficial owner of asubstantial financial interest in the enter-prise or if he is committed to acquire suchan interest; nor shall a member or an associ-ate express his opinion on financial state-ments which are used as a basis of credit, ifhe is himself the actual or beneficial ownerof a substantial interest in the enterprise orif he is committed to acquire such interest,unless he discloses his financial interest inhis report[18].

In 1942, the AIA amplified this rule andaligned itself with the 1937 SEC positiontaken in the ASR # 2. The AIA added the fol-lowing clause specifying that the auditor’sindependence is impaired:

if he (auditor) owns or is committed toacquire a financial interest in the enterprisewhich is substantial either in relation to itscapital or to his own personal fortune[19].

In 1947, the AIA’s Committee on AuditingProcedures published a special report titledTentative Statement of Auditing Standards.Their Generally Accepted Significance andScope in which independence in fact isdescribed as:

Independence in the last analysis bespeaksan honest disinterest on the part of theauditor in the formulation and expression ofhis opinion, which means unbiased judg-ment and objective consideration of facts asdeterminants of that opinion. It implies notthe attitude of a prosecutor, but the judicialimpartiality that recognizes an obligationon his part for fair presentation of factswhich he owes not only to the managementand the owners of a business but also to thecreditors of a business, and to those whomay otherwise have a right to rely upon theauditor’s report as in the case of prospectiveowners or creditors[20].

The 1948 Statement on Auditing Procedures(SAP) No.23 describes the ten generally-accepted auditing standards (GAAS). Thesecond general standard required that “in allmatters relating to the assignment, an independence in mental attitude is to be

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 7 ]



maintained by the auditor”[15]. In 1950, theAICPA published Audits by Certified PublicAccountants: Their Nature and Significanceemphasizing that “Independence, both histor-ically and philosophically, is the foundationof the public accountant”[21].

In January 1962, the AICPA adopted thefollowing rule on independence as part of theCode of Professional Ethics:

Article 1: Relations with Clients and thePublic:1.01 Neither a member or associate, nor afirm of which he is a partner, shall expressan opinion on financial statements of anyenterprise unless he and his firm are in factindependent with respect to such enter-prise.

Independence is not susceptible to precisedefinition, but is an expression of the profes-sional integrity of the individual. A memberor associate, before expressing his opinionon financial statements, has the responsibil-ity of assessing his relationships with anenterprise to determine whether, in thecircumstances, he might expect his opinionto be considered independent, objective andunbiased by one who had knowledge of allthe facts.

A member or associate will not be consid-ered independent, for example, with respectto any enterprise if he, or one of his part-ners, (a) during the period of his profes-sional engagement or at the time of express-ing his opinion, had, or was committed toacquire, any direct financial interest ormaterial financial interest in the enterprise,or (b) during the period of his professionalengagement, at the time of expressing hisopinion or during the period covered by thefinancial statements, was connected withthe enterprise as a promoter, underwriter,voting trustee, director, officer, or keyemployee.

In March 1962, the AICPA moved to prohibitthe “direct financial interest or materialindirect financial interest” in an enterpriseunder audit by a member[22]. In 1972, theAICPA, in its Restatement of the Code of Pro-fessional Ethics, stated that “independencehas always been a concept fundamental to theaccounting profession, the cornerstone of itsphilosophical structure” and adopted newrules of conduct regarding auditor indepen-dence[23].

In November 1972, the AICPA Committee onAuditing Procedures issued Statement onAuditing Standards (SAS) No. 1 which empha-sizes auditor independence both in fact andappearance and states:

To be independent the auditor must be intel-lectually honest; to be recognized as inde-pendent, he must be free from any obliga-tion to or interest in the client, its manage-ment, or its owners[24].

In the 1980s, several critics of the professioncharged that the AICPA Code of ProfessionalEthics did not serve the public interest. Inresponse to these charges the AICPA formedthe Anderson Committee in 1983 to reviewthe Code. This resulted in 1988 in the estab-lishment of a new Code of Professional Con-duct. The following issues were reviewed: • limited liability;• client confidentiality and whistleblowing;

and • auditor independence.

Collins and Schultz[25] argue that a numberof issues still remain unresolved orconfounded by the new Code and that, in eacharea, the AICPA promoted a position that ispotentially harmful to the public good.

SAS #58, Reports on Audited FinancialStatements attempted to close the expecta-tions gap by revising the auditor’s standardreport which explicitly labels the report asthe “Independent Auditor’s Report” toemphasize the auditor’s independence. Theexpectations gap refers to the significantdifference that existed between the level ofconfidence perceived by financial statementsusers and the level of confidence provided bythe auditor[26].

SAS# 65, Considering the Internal AuditFunction in an Independent Audit of FinancialStatements states that when external auditorsuse internal audit information to reducetheir own work, they are obligated to investi-gate the internal auditors’ independence bylearning about their organizational statusand lines of communication in the company.SAS #65 was based on the theory that inde-pendence is enhanced when internal auditorsreport to the highest level of managementand the audit committee.

Research results indicate that the Big Eightauditors, non-Big Eight CPAs, bank loanofficers, and certified financial analysts dif-fered significantly in the extent of their sup-port for the policies discussed in the CohenCommission Report as a means to enhanceauditor independence[27]. On many occa-sions auditor independence has been ques-tioned by the SEC and the media which ledthe AICPA to conduct seminars and publishits views on auditor independence.

In March 1993, the AICPA Public OversightBoard (POB) published a report, In the PublicInterest: Issues Confronting the AccountingProfession, expressing concern about theindependence and objectivity of the account-ing profession. The POB appointed an advi-sory panel to look into this matter. The advi-sory panel, after interviewing 77 professionalaccountants, business executives, attorneys,academics, and others, concluded there are

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 8 ]



important steps that should be taken to betterassure the integrity and objectivity of audi-tors’ judgement[28].

In June 1993, the AICPA’s board of directorsissued a statement entitled, Meeting theFinancial Reporting Needs of the Future: aCommitment from the Public Accounting Pro-fession[29]. The AICPA endorsed all the rec-ommendations of the Public Oversight Boardand proposed several accounting reforms inorder to:• improve fraud detection; • strengthen auditor independence; • enhance the usefulness of financial reports;

and • discourage unwarranted litigations

through congressional tort reform[30].

In 1993, the AICPA issued Ethics Ruling 97stating that external auditors:• cannot perform management functions or

make management decisions; • cannot be part of the client’s approval

process; or • cannot be part of the internal control sys-

tem without impairing theirindependence[31].

In 1994, the AICPA’s Professional Ethics Divi-sion published a proposed interpretation ofthe profession’s Code of Professional Conductto sharpen the distinction between clientadvocacy and client service. Firms and indi-vidual CPAs should exercise professionalindependence before committing to clientpositions on accounting or financial report-ing issues. The AICPA Statement on AuditingStandards and the Code of Professional Ethicsboth emphasize independence as a precondi-tion in expressing an opinion on financialstatements. The General Standards of SIASNo. 1 state that “In all matters relating to theassignment, an independence in mental atti-tude is to be maintained by the auditor orauditors.”

Rule 101 of the Code deals with auditorindependence and states that: “A member inpublic practice shall be independent in theperformance of professional service asrequired by the standards promulgated bybodies designated by Council.” Interpretationof Rule 101 provides examples of situationsthat would impair an auditor’s independence:

Independence shall be considered to beimpaired if, for example, a member had anyof the following transactions, interests, orrelationships:

A During the period of a professionalengagement or at the time of expressingan opinion, a member or a member’sfirm:

• had or was committed to acquire anydirect or material indirect financialinterest in the enterprise;

• was a trustee or executor or administra-tor of any estate if such trust or estatehad or was committed to acquire any“direct or material indirect financialinterest” in the enterprise;

• had any joint, closely held businessinvestment with the enterprise or withany officer, director, or principal stock-holders thereof that was material inrelation to the member’s net worth or tothe net worth of the member’s firm; and

• had any loan to or from the enterprise orany officer, director, or principal stock-holder of the enterprise. This proscrip-tion does not apply to the following loansfrom a financial institution when madeunder that institution’s normal lendingprocedures, terms, and requirements:

– Loans obtained by a member or amember’s firm’s that are not materialin relation to the net worth of suchborrower;

– Home mortgages; and– Other secured loans, except loans

guaranteed by a member or by a mem-ber’s firm which are otherwisesecured.

B During the period covered by the finan-cial statements, during the period of theprofessional engagement, or at the timeof expressing an opinion, a member or amember’s firm:

• was connected with the enterprise as apromoter, underwriter, or voting trustee,a director or officer or in any capacityequivalent to that of a member of man-agement or of an employee; or

• was a trustee for any pension or profit-sharing trust of the enterprise”.

The AICPA Code of Professional Ethics statesthat a CPA “shall not express an opinion onfinancial statements of an enterprise unlesshe and his firm are independent with respectto such enterprise”. An opinion on the fair-ness of presentation of financial statementsshould be issued only if he or she is indepen-dent of the client both in fact and appearance.In other words, independence must be per-ceived by third parties.

In February 1994, the POB and the SECPractice Section (SECPS) appointed a three-member “advisory panel on auditor indepen-dence”. The panel’s charge was to determinewhether the SECPS, the accounting profes-sion or the SEC should take steps to betterassure the independence of auditors and theintegrity and objectivity of their judgementson the appropriate application of generally-accepted accounting principles to financialstatements.

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 9 ]



One month later, on 16 March, 1994, the POBannounced the formation of a “special panel”to inquire into matters relating to auditorobjectivity and independence. This was inresponse to the criticism made by Walter P.Schuetze, chief accountant of the SEC[32].The panel recommended appropriate steps tobolster the professionalism of the indepen-dent auditor, and to assess the working rela-tionships among the profession, the SEC, andthe FASB[33]. On 13 September, 1994, thePOB’s advisory panel on auditor indepen-dence issued its report entitled Strengtheningthe Professionalism of the IndependentAuditor[34]. The panel made the followingrecommendations: • The independence of boards of directors

must be enhanced to protect the interests ofcorporate investors.

• The auditor must consider the board ofdirectors to be its audit client.

• There should be more timely, morefrequent, more open, and more candid com-munication between the auditor and theboard.

These recommendations were aimed atimproving auditor independence andstrengthening corporate governance. Theadvisory panel also published its suggestionsand recommendations on such matters as: • the need for additional rules on auditor

independence; • the role of auditing in public accounting

firms; • strengthening the relationship between the

board of directors and the independentauditor; and

• the relationship among auditors, standardsetters, and the SEC[34].

In the report, the panel urged the accountingprofession to look to the board of directors asthe audit client, not management. It called fora direct interface between the board and theauditor at least annually, and an expandedinterface with the audit committee[35].

Donald J. Kirk, chair of the advisory panelon auditor independence, stressed that theauditor’s role is not a seller of other services,by putting to work the skills and judgementsgained in dealing with control systems andcomplex accounting issues to promote addedvalue. Auditor independence is enhancedwhen the auditing professional steps into therole of commenting on the quality of report-ing practices[36].

The role of the Institute of InternalAuditors

The professional internal auditor must haveindependence to fulfil a professional obliga-tion, to render a free, unbiased, unrestricted

opinion and to report matters as they arerather than as some executives would like tosee them[10].

The Institute of Internal Auditors (IIA) wasfounded in 1941. On 15 July, 1947, The IIAissued its first Statement of Responsibilities ofthe Internal Auditor[37] which defined inter-nal auditing as “an independent appraisalactivity within the organization for thereview of the accounting, financial, and otheroperations as a basis for protective and con-structive service to management. It dealsprimarily with accounting and financialmatters but it may also properly deal withmatters of an operational nature”.

Ernest Meyers[38] reported that early in the1950s the internal auditors’ role of influenceand independence was limited because offour majors factors: 1 Internal auditors did not have access

throughout the corporation and could notquestion higher management decisions.

2 The majority of internal auditdepartments lacked trained professionalaccountants.

3 Most internal audit departments wereallowed to concern themselves only withmatters of accounting and financialnature.

4 The majority of internal auditdepartments reported to lower-level man-agement.

Gupta[39] observed that management soonstarted to realize that the reason why theirinternal audit staff were not able to makelarger contributions to the entity was due totheir lack of stature in the organization. Byallowing internal auditors to report to thehighest echelon of the organization, manage-ment enhanced internal auditors’ indepen-dence as well as their stature. Sawyer[40]believes that the enhanced internal auditorindependence is not only attributed to themanagement’s recognition of the major con-tributions internal auditors bring to the orga-nization, but also to the IIA’s posture inexpanding considerably the role of the inter-nal auditor by:• departing from the traditional image of an

internal auditor as an accounting clerk;• extending the role of the internal auditor to

operational activities; and • having the internal auditor report to the

highest echelon of management to enhanceauditor independence.

To professionalize the discipline of internalauditing and recognize its expanded indepen-dence, the IIA amended and refined the State-ment of Responsibilities of Internal Auditors in1957[41]. The new definition of internal

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 10 ]



auditing elevates internal auditors to a part-nership with management. Internal auditingis defined as “an independent appraisal activ-ity within an organization for the review offinancial accounting and other operations asa basis for service to management. It is amanagerial control, which functions by mea-suring and evaluating the effectiveness ofother controls”. The Statement was furtherrefined in 1971, 1974, and 1981 to reflect significant changes in the internal auditingprofession.

In the 1970s, the board of directors of majorcorporations and professional associationssuch as the AICPA, the American AccountingAssociation (AAA), the Financial ExecutivesInstitute (FEI), the National Association ofAccountants (NAA), and the InternationalFederation of Accountants (IFAC) recognizedthe changing role of internal auditors, therelevance of the internal auditing function,and the professionalism of internal auditors.Internal auditors were reporting to the auditcommittee and independent auditors were co-ordinating their audit efforts with internalauditors[42]. In 1978, the IIA issued the Stan-dards for the Professional Practice of InternalAuditing (SPPIA)[43] thus broadening itsscope and reaffirming internal auditor inde-pendence as the most important aspect of theinternal auditing profession.

Bradford Cadmus[44] eloquently stressedthat independence is essential to the effective-ness of an internal auditing programme. Thereason why independence is so important isthat it permits internal auditors to renderimpartial and unbiased judgements. Indepen-dence for internal auditors differs from thatfor external auditors. Internal auditors, asemployees of the entity, do not have the“financial” independence of an external audi-tor[45].

The SPPIA[43] requires that internal audi-tors be independent of the activities theyaudit. Two important factors contribute toindependence: 1 The organizational status (110.01) of the

internal auditing department should besufficient to permit the accomplishment ofits audit responsibilities. Internal auditorsshould have the support of top manage-ment and the board of directors so thatthey can gain the co-operation of auditeesand perform their work free from interfer-ence. Internal auditors should not reportto divisional management, line managers,or other persons with a stake on the out-come of their findings. Independence isthus enhanced when auditors do not audittheir bosses. Independence is enhancedwhen the director of the internal auditingdepartment is responsible to an individual

in the organization with sufficient author-ity to promote independence and to ensurebroad audit coverage, adequate considera-tion of audit reports, and appropriateaction on audit recommendations.

2 Objectivity is an independent mental atti-tude which internal auditors should main-tain on performing audits (120.01). Objec-tivity requires internal auditors to per-form audit in such a manner that theyhave an honest belief in their work productand that no significant quality compro-mises are made (120.02). Thus internalauditors should be excluded from lineoperations and involvement in the decision-making process. Objectivity isquestioned when internal auditors reportto divisional management, line managers,or other persons with a stake in the out-come of their findings.

The SPPIA underscores the importance ofindependence by stating: “Independencepermits internal auditors to perform theirwork freely and objectively. Without indepen-dence, the desired results of internal auditingcannot be realized.” The SPPIA alsodescribes several means of meeting its stan-dards. The guidelines for the independencestandards are: • The director of the internal auditing

department should be responsible to anindividual in the organization with suffi-cient authority to promote independenceand to ensure broad audit coverage, ade-quate consideration of audit reports, andappropriate action on audit recommenda-tions.

• The board of directors should concur inthe appointment or removal of the directorof the internal auditing department.

• The purpose, authority, and responsibilityof the internal auditing departmentshould be defined in a formal written docu-ment (charter). The director should seekapproval of the charter by management aswell as acceptance by the board.

The charter should:• establish the department’s position within

the organization; • authorize access to records, personnel, and

physical properties relevant to the perfor-mance of audits; and

• define the scope of internal auditing activi-ties [43].

Independence is so relevant to internal audi-tors that the IIA issued eight interpretationsin its Professional Standards Bulletins(PSBs). PSB 85-6, Independence of InternalAuditors vs External Auditors[46] notes thatthe greatest single issue concerning the

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 11 ]



independence of internal auditors is that theyare “inside looking in”. All auditors, when incompliance with their standards, are equallyindependent; therefore, all internal and exter-nal auditing organizations strive to maximizemanagement’s knowledge and understandingof, and agreement with, standards governingtheir efforts. In this way, practical indepen-dence is enhanced. PBS 85-6 emphasizes thatas long as the internal auditors subscribe andadhere to the standards and do not haveresponsibility or accountability for opera-tions subject to review, they may be as inde-pendent as any other entity providingappraisal services to an organization.

PSB 88-4, Steps to Foster Independence,stresses that the organizationalindependence of the internal audit depart-ment has the greatest impact on both actualand perceived independence. To foster inde-pendence PSB 88-4 suggests that the followingadditional criteria be considered by the direc-tor of the internal audit department: • an audit charter, outlining the

department’s responsibilities signed bythe audit committee which precludes out-side interferences or reprisals;

• periodic meetings between the audit direc-tor and the audit committee with immedi-ate access in time of special need;

• balanced audit scope and plan approved bythe audit committee;

• adequate budgetary resources; • strong staff qualifications, experience, and

continuing educational requirements; • rotation of staff members assigned to

audits; and • the level and organizational position of

management responsible for the perfor-mance appraisal and compensation of thedirector.

The evolution of internal auditing in the last50 years has been in tandem with theexpanded concept of internal auditor inde-pendence. The new role assumed by internalauditors requires an “unrestricted” indepen-dence in order to perform a variety of dutieswithin the organization they serve. The inter-face with the audit committee and other con-stituencies confirm that auditor indepen-dence is paramount in the internal auditingprofession.

The role of the SECIf investors were to view the auditor as anadvocate for the corporate client, the valueof the audit might well be lost[47].

The Securities and Exchange Commission(SEC) has tried to define independence in aseries of rules and regulations which hasplayed a prominent role in fostering auditor

independence. Over the years the SEC hasissued several pronouncements related toauditor independence. It was the SEC’s insis-tence on strict observance of specific rulesdefining independence that led to the inde-pendence clause in the AICPA Code of Profes-sional Ethics.

On 6 July, 1933, the SEC adopted the follow-ing resolution:

The Commission will not recognize anysuch certified accountant or public accoun-tant as independent if such accountant isnot in fact independent. Unless the Commis-sion otherwise directs, such accountant willnot be considered independent with respectto any person in whom he has any interest,directly or indirectly, or with whom he isconnected as an officer, agent, employee,promoter, underwriter, trustee, partner,director, or person performing similar func-tions[48].

The Securities Exchange Act 1934, Section78(1), requires SEC-registered companies toinclude audited financial statements in theirannual reports to shareholders and to pro-vide other financial information in an annualfiling to the SEC. In 1936, the SEC amendedthis rule with respect to independence andadopted the AICPA’s position prohibiting anysubstantial interest[49]. On 6 May, 1937, theSEC issued Accounting Series Release (ASR)#2[50] and took the position that an auditor’ssignificant investment in the companyaudited would impair independence:

The Commission has taken the position thatan accountant cannot be deemed to be inde-pendent if he is, or has been during theperiod under review, an officer or director ofthe registrant or if he holds an interest inthe registrant that is significant withrespect to its total capital or his own per-sonal fortune.

In 1937, the Commission refused to hold anauditor as independent because of his sub-stantial investment in the company:

In a recent case involving a firm of publicaccountants, one member of which ownedstock in a corporation contemplating regis-tration, the Commission refused that thefirm could be considered independent forthe purpose of certifying the financial state-ments of such corporation and based itsrefusal upon the fact that the value of suchholding was substantial and constitutedmore than 1 percent of the partner’s per-sonal fortune.

In 1939, In the Matter of Interstate Hosier, Inc.,4 SEC 706, 717, the SEC found that a staffmember of a CPA firm had been maintainingclient accounting records. Further, the finan-cial statements had been falsified by the staffmember. Clearly, this dual role of the internal

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 12 ]



accountant and independent auditor resultedin defeating the purpose of the audit[51].

On 14 March, 1941, the SEC issued ASR#22[52] prohibiting any immunity from liabil-ity provided to the auditor by the auditedcompany. William W. Wernts, SEC chiefaccountant, commented thus:

When an accountant and his client, directlyor through an affiliate, have entered into anagreement of indemnity which seeks toassure to the accountant immunity fromliability for his own negligent acts, whetherof omission or commission, it is my opinionthat one of the major stimuli to objectiveand unbiased consideration of the problemsencountered in a particular engagement isremoved or greatly weakened. Such condi-tion must frequently induce a departurefrom the standards of objectivity and impar-tiality which the concept of independenceimplies.

On 7 November, 1942, the SEC issued ASR#37[53] and pointed out that in determiningauditor independence due consideration isgiven, not only to the relationships but also tothe practices involved in rendering suchservices to the corporation by the indepen-dent auditor. On 25 January, 1944, the SECissued ASR #47[54] and provided some sce-narios which impair independence:

• Both an accountant and a business asso-ciate made loans to the registrant. Fur-ther, a son of the accountant was an offi-cer of the registrant.

• The accountant advanced funds to theregistrant for financing a new depart-ment.

• The registrant was unable to pay theaccountant’s fee and the registrantpledged shares of its own stock to assurethat such fee would be paid. In addition,it had given the accountant an option topurchase the pledged security at marketprice at the option date.

• The accountant was the treasurer and ashareholder of a company which soldsome of the registrant’s products.

• The son of a partner was serving as assis-tant treasurer and chief accountant of aregistrant. The son resided with hisfather.

• The accountant audited cash reportsprepared by the client’s staff, enteredthem in a summary record, posted suchdata to the general ledger, and madeadjusting entries each month.

In 1950 the SEC revised its rule on indepen-dence by deleting the word “substantial”from the clause “substantial interest” thusreaffirming its original position taken in 1933in which there was a prohibition against theaccountant having any direct financial inter-est in his client. On 11 December, 1958, theSEC issued ASR #81[55] and highlighted 34

cases in which independent auditors were notindependent. In 1962, the SEC decided that aCPA firm was not independent because one ofits partners also acted as the client’s legalcounsel[56]. On 21 May, 1963, the SEC issuedASR #97[57] and discussed the situationabout a CPA who lacked independence sincehe was one of the three stockholders and wasan officer of the company.

On 26 June, 1972, the SEC issued RegulationS-X. On the issue of auditor independence,Rule 2-01 of S-X states:

The Commission will not recognize anycertified public accountant or publicaccountant as independent who is not in factindependent. For example, an accountantwill be considered not independent withrespect to any person or any of its parents,its subsidiaries, or other affiliates (1) inwhich, during the period of the professionalengagement to examine the financial state-ments being reported on or at the date of hisreport, he or his firm or a member thereofhad or was committed to acquire, any directfinancial interest or any material indirectfinancial interest, or (2) with which, duringthe period of his professional engagement toexamine the financial statements, he or hisfirm or a member thereof was connected asa promoter, underwriter, voting trustee,director, officer, or employee, except that afirm will not be deemed independent inregard to a particular person of a formerofficer or employee if such person isemployed by the firm and such individualhas completely disassociated himself fromthe person and its affiliates, and does notparticipate in auditing financial statementsof the person or its affiliates covering anyperiod of his employment by the person. Forthe purposes of Rule 2-01 the term “mem-ber” means all partners in the firm and allprofessional employees participating in theaudit or located in an office of the firm par-ticipating in a significant portion of theaudit.

The SEC has moreover emphasized an impor-tant facet of factual independence stating:

Perhaps the most critical test of actuality onan accountant’s independence is thestrength of his insistence upon full disclo-sure of transactions between the companyand members of its management as individ-uals; accession to the wishes of managementin such cases most inevitably raises a seri-ous question of whether the accountant is,in fact, independent.

On 5 July, 1972, the SEC issued ASR #126[58]and provided some guidelines for accoun-tants in determining the existence or lack ofindependence. It stated: “The concept of inde-pendence, as it relates to the accountant, isfundamental to this purpose because itimplies an objective analysis of the situation

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 13 ]



by a disinterested third party”. ASR #126provides samples of situations in which theauditor’s independence could be impaired. Asto bookkeeping and EDP services, the ASRstated: “Systems design is a proper functionof the qualified public accountant. Computerprogramming is an aspect of systems designand does not constitute a bookkeeping ser-vice. However, where source data is providedby the client and the accountant’s work islimited to processing and production of list-ings and reports, independence will beadversely affected if the listings and reportsbecome part of the basic accounting recordson which, at least in part, the accountantwould base his opinion”[58]. The release alsolists the following as an example of a situa-tion that impairs auditor independence:

A client prepared and forwarded to the CPAtapes to be read on an optical scanner. TheCPA merely sent those tapes to a servicebureau and forwarded print-outs of thefinancial statements and general ledgersback to the client. Due to the appearancethat the service bureau was acting as theCPA’s agent, independence is impaired. Ifinstead, the client dealt directly with theservice bureau, no such impairment wouldresult.

In contrast the AICPA sees no impairment ofindependence in offering bookkeeping ordata processing services. Attempts to alignthe differences between the SEC’s views andthe AICPA’s rules in this area have beenunsuccessful. The SEC has developed a num-ber of independence rules, including thepreclusion against the auditor’s owning stockin a client.

On 23 May, 1973, the SEC issued ASR #144and determined that the independence of alarge firm has been impaired because part-ners and employees of the branch officereceived payments from the general partnersof the client company “in the guise of profitsfrom participation in the purchase and sale ofhot issues”. In December of 1977, the SECissued ASR # 234 and set forth the guidelinesfor resolving independence questions. TheSEC had taken a more restrictive view ofindependence until the July 1972 change in S-X reporting guidelines for public companies.

In January 1994, Walter P. Schuetze, chiefaccountant of the Securities and ExchangeCommission, made a presentation titled “Amountain or a molehill?” at the AICPA’sNational Conference. He questioned the inde-pendence and objectivity of external auditorswho “are not standing up to their clients infinancial accounting and reporting issueswhen their clients take a position that is, atbest, not supported in the accounting

literature or, at worst, directly contrary toexisting accounting pronouncements”[32].

In March 1994, the Office of the ChiefAccountant (OCA) of the Securities andExchange Commission published a comprehensive Staff Report on Auditor Inde-pendence. The report concludes: “The OCAbelieves that the combination of the extensivesystems of independence requirementsissued by the Commission and the AICPA,coupled with the Commission’s activeenforcement program, provides to investorsreasonable safeguards against loss to theaudits by accountants that lack independencefrom their audit clients”[59].

Further differences between the SEC andAICPA on auditor independence are includedin the section of cases dealing with outsourc-ing, MAS, and other auditing issues.

The role of the US General AccountingOffice

There is a global tendency for the govern-ment audit function to transcend the tradi-tional parameters of financial attestationand legislative compliance in order toespouse broader notions relating to auditorindependence, auditing accountability, andaudit mandate[60].

Since its inception in 1921, the US GeneralAccounting Office (GAO), an independentauditing agency of the federal government,has been charged to perform comprehensiveauditing of the federal government agencies.In the 1930s and 1940s, the federal governmentmandated that accounting be used not merelyas a bookkeeping function but also as aninstrument of management control. Auditswere conducted to assess whether govern-mental agencies properly spent andcontrolled their appropriation and compliedwith appropriate laws and regulations. In the1950s, the US Congress began requestinginformation on the efficiency of performanceby management at the various federal agen-cies. The purpose was to determine whethermanagement was using personnel, property,funds and other resources in an economicaland efficient manner. In the 1960s and theearly 1970s, the GAO expanded its scope andbegan evaluating the effectiveness of a totalprogram. Such evaluations needed indepen-dent nonadvocate auditors.

In 1972, the GAO issued Standards forAudits of Governmental Organizations, Pro-grams, Activities, and Functions which setforth audit standards for auditors in all levelsof government. Such comprehensive govern-ment auditing includes three categories:1 Financial and compliance auditing to

assess whether the entity has compliedwith laws and regulations of the legislative

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 14 ]



body and whether financial statementsfairly present the financial position andthe results of operations in accordancewith the generally accepted accountingprinciples (GAAP);

2 Economy and efficiency auditing to assesswhether the entity is managing and utiliz-ing the resources economically and effi-ciently and to determine the causes ofinefficiencies; and

3 Program results auditing to assesswhether the desired results or benefitsestablished in the legislating body havebeen achieved and whether the agency hasconsidered alternatives that might yielddesired results at a lower cost[61].

The 1972 GAO standards were revised in 1988,and again in 1994. There have been substan-tive changes over the years regarding inde-pendence.

Studies conducted by the GAO indicatesubstantial deficiencies in the quality ofaudits in the public sector. The GAO hasurged some 100,000 public entities receivingfederal assistance to organize and use auditcommittees to enhance auditor independenceand to move forward in pursuit of qualityaudits[62].

The role of the government auditor and therelated independence issue have evolved inthe last 50 years owing to the GAO’s changingmission. The General Standards of the GAOStandards for Audits[61] require that govern-ment auditors be independent:

In all matters relating to audit work, theaudit organization and the individual audi-tors, whether government or public, shouldbe free from personal and external impair-ments to independence, should be organiza-tionally independent, and should maintainan independent attitude and appearance.

The interpretation of this standard is thatgovernment auditors shall be certain theirattitudes and beliefs allow them to be com-pletely objective and there is nothing thatwould lead others to doubt their indepen-dence[63].

Government auditors, like external andinternal auditors, hold independence as agoal. Auditors of governmental units arepresumed independent when they are:• free from sources of personal impairment; • free from sources of external impairment; • organizationally independent; • independent under the AICPA Code of Pro-

fessional Conduct; • elected or appointed reporting to a legisla-

tive body of government; or• auditing in a level or branch of government

rather than the one to which they are nor-mally assigned[64].

Internal auditing in the federal governmentis done by the Offices of the Inspectors Gen-eral[65], which were established by theInspectors General Act 1978. Anthony Carrollo, Inspector General of the Environ-mental Protection Agency (EPA), brought toour attention that the independence of gov-ernment auditors is more in line with thepublic’s perception of what auditor indepen-dence is or should be, rather than the actualindependence of CPAs or CIAs (Memoaddressed to R. Vanasco, 11 March, 1996).

The AICPA has acknowledged that stategovernmental auditors, although governmentemployees, were sufficiently “independent”to express audit opinions that were accept-able by the federal government in meetingmandatory audit requirements for the pur-pose of qualifying for revenue sharing funds.From time to time, the GAO’s independencehas been questioned. An editorial wrote:“GAO has been functioning lately not as Con-gress’s watchdog but as its lapdog”[64].

Several countries are establishing govern-mental auditing offices similar to the USGovernment Accounting Office and are issu-ing auditing standards to safeguard theirstate auditors’ independence. In 1988, Egyptestablished the Central Auditing Organiza-tion (CAO) as an independent body that helpsparliament to oversee public funds. CAO lawsrequire that state auditors maintain an inde-pendent perspective. To protect their inde-pendence, CAO laws have incorporated thefollowing safeguards: • senior auditors have immunity privilege,

and • they can be relieved from their positions by

a presidential decree requiring theapproval of the majority of members of thePeople’s Assembly[66].

In January 1995, the Estonian parliamentestablished the State Audit Office (SAO). Thelegislation authorizes the SAO to order inde-pendent audits to be performed by authorizedindependent state auditors. The lawaddresses state auditors’ independence byallowing them unlimited access to documentsand files[64].

The role of the audit committeeRegular communication with the boardassures independence and provides a meansfor the board and the director to keep eachother informed on matters of mutual interest[43].

The New York Stock Exchange (NYSE), theSEC, and the AICPA have led a concertedeffort to persuade corporations to establishaudit committees comprising independentmembers of the board of directors to enhance

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 15 ]



audit independence. The argument is thatoutside directors can preserve a higherdegree of independence from managementinfluence. To emphasize independence frommanagement, many corporations follow thepractice of having internal auditors report tothe audit committee. In addition, the externalauditors are appointed by the committee andelected by the stockholders[68].

More than 80 per cent of publicly-tradedcompanies in the USA now maintain auditcommittees. The Treadway Commissionstressed their importance, and many firmsare working to revise and expand their auditcommittee charters. Fraudulent financialreporting is more likely if issues related toaccountant independence and preservation ofinternal auditor independence have beenomitted from the charter[69]. Independence,however, is enhanced when the board concursin the appointment or removal of the directorof the internal auditing department[43, 100.3].

In 1987, Knapp examined several factorsaffecting audit committees’ perception onauditor independence. His results show thataudit committee members’ background (cor-porate managers or non-audit managers),audit firm size class (Big Eight and non-BigEight), objectivity of professional standards,and the financial condition of the auditeesignificantly affected the extent to whichcommittee members were willing to supportexternal auditors[70].

Internal audit independence and objectiv-ity depend greatly on the internal auditor’sreporting relationship with the organization.A survey of chief internal auditors showsthat a strong majority of internal auditorsindicate that vesting the hiring-firing author-ity with the audit committee would enhanceinternal auditor independence, improveoversight by the audit committee, andimprove the ability of the internal auditor toget action on audit findings [71].

In 1993, a comprehensive study, ImprovingAudit Committee Performance: What WorksBest, prepared by Price Waterhouse for theIIA, stressed that the credibility of financialreporting has been increasingly questionedand urged all parties involved in the financialreporting by providing, on behalf of the boardof directors, oversight of the financial report-ing process as well as internal controls[72].

In 1994, the AICPA advisory panel on audi-tor independence recommended that insteadof legislating audit committees functions, thepanel should place responsibility on the inde-pendent auditor to be more forthcoming incommunicating with the audit committeeand the board of directors. Stronger, moreaccountable boards will strengthen the pro-fessionalism of the auditor, enhance the value

of the audit, and serve the investing public[73]. Some practices that lead toindependence include:• the frequency of audit committee meetings

with the internal audit executives; • the length of the audit committee member

terms of office; and • the appraisal of internal audit executive

performance by the audit committee.

Although these situations may constitute anideal situation, it must, however, strike abalance between total independence frommanagement and the risk of alienating man-agement and isolating the internal auditingdepartment[74].

The interchange between audit committeesand internal auditors is more frequent in theUSA, the UK and Canada than in Japan. Arecent survey shows that US firms’ auditcommittees meet with internal auditors fouror more times a year, whereas Japanese auditcommittees meet with auditors twice ayear[75]. The Canadian Institute of CharteredAccountants study group on audit commit-tees reported that corporate audit commit-tees enhance auditors’ perceived indepen-dence, making it easier for them to be objec-tive and not be subject to undue influence bymanagement.

A recent survey conducted by ArthurAndersen LLP shows that about 56 per cent ofcompanies around the world have no auditcommittees. The analysis reveals large dis-parities between traditions in Canada, theUSA and the UK and those in other countries.Many audit committees around the worldhave no resemblance to American, Canadian,or British audit committees[76].

The role of managementTrue audit independence is still elusive. Toooften we have to temper our opinionsbecause of political issues[77].

Management can do much to establish anattitude of independence by allowing auditorsample freedom in selecting the operations forstudy and by informing those responsible forthe operations under study that the investiga-tion is fully sanctioned. One of the dangersfor the internal auditing function is the lossof top management support. Should manage-ment or the board unduly interfere with theauditor or fail to support the audit function,there is a danger that the auditors will losethe necessary independence to perform theirduties[63].

The internal and external auditors mustremain independent of operations and thedecision-making process of the organization,and should remain independent of undueinfluence by management. Audit objectivity

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 16 ]



could be jeopardized by any perceived or realintimidation by management personnel whomight be affected by audit findings[78].

A research project sponsored by the IowaChapter of the Institute of Internal Auditorsshows that although independence is a neces-sity for the internal auditor, absolute inde-pendence may not be achievable. The respon-dent’s apparent concerns in this area mayreflect some discomfort with the politicalaspect of the internal auditor’s position andthe ethical dilemmas that result[77].

Chadwick[74] reported that at an IIA con-ference, 12 chief internal audit executives ofmajor publicly-held companies were askedthe following three questions: 1 What if the chief executive officer (CEO)

asked you not to audit certain manufactur-ing operations – even though the auditengagement had already been specified inthe plan approved by the audit committee?

2 What if the CEO asked you not to discusswith the audit committee a highly embar-rassing financial exposure related to haz-ardous waste dumping identified duringan audit of a subsidiary? and

3 What if your vice president of salesrestricted auditor access to his or hertravel and expense reports? What wouldyou do?

None dared to report the above situations tothe audit committee – because they would befired and would probably never find anotherjob as senior internal audit official. Thissituation led Chadwick to suggest eliminat-ing the joint reporting relationship of inter-nal audit departments to both senior manage-ment and audit committees. To prevent man-agement influence and create a truly inde-pendent relationship, the director of internalauditing should report solely to the auditcommittee[74]. John J. Mickevice, director ofinternal audit of the American Bar Associa-tion and former president of the IIA ChicagoChapter, commented on Chadwick’s findings:

Chadwick’s comments are of great interest.This does not bode well for the internalaudit profession. I did not realize the chiefexecutives are so weak-willed!! No wondermany of their peers have been outsourced!What is the relationship of these chiefs totheir Audit Committee? If the chiefs feel it isunwise to tactfully report these impair-ments on their scope, how can an effectiverelationship be established with theirrespective Audit Committee? This is a sig-nificant area of internal auditor indepen-dence. If the chiefs are too afraid to addressthese items, what is their long-term value totheir organization? (Memo addressed to R.Vanasco, 15 March, 1996).

Whittington et al.[79] shows that there isevery reason to believe that auditors do notcarry out their work with complete indepen-dence from management. This arises fromthe anecdotal evidence of directors puttingpressure on audit partners, and audit part-ners applying pressure to technical partners,to secure their approval for schemes that takecreative accounting to, and sometimesbeyond, the limits permitted by accountingstandards. Some degree of auditor liability isessential in the absence of complete auditorindependence.

Hosseini and Rezaee[80] elaborate on the“partnership concept,” the shifting from thetraditional role of the internal auditing asone of policing the various units to the orga-nization to the collaborative approach byproviding a broad range of assistance to man-agement, including proactive decision-mak-ing and problem-solving functions. The keyargument against the partnership concept isthat it may impair internal auditors’ indepen-dence if not properly implemented. This sortof “participative auditing” was previouslydiscussed by Sawyer[10]. This approach toauditing brings the auditee into the auditprocess as part of a “co-operative venture”.He warns, however, that participative auditsmust be dealt with very carefully since theymay impinge upon auditor independence.

Part II – The industry sector

The banking sectorIndependence is perhaps the single mostimportant attribute that the CPA brings tothe client-CPA relationship. Independenceand the appearance of independence mustbe preserved at all costs[81].

Third parties often rely on the work of inter-nal auditors, so their professional objectivityis an important issue. A study was under-taken to determine whether a firm’s manage-ment can influence the professional objectiv-ity of the firm’s internal auditors. A sample of58 internal auditors from three banks partici-pated in a decision-making exercise involvinginternal control systems. The results indicatethat management did have the ability to influ-ence the internal control system evaluationsreached by internal auditors. IIA member-ship is an important determinant of internalauditors’s professional objectivity[82].

In Switzerland, all companies or branchesin the banking sector are subject to the sup-plementary auditing requirements of theSwiss banking law which entails a detailedaudit by a firm of specialized independentbank auditors recognized by the Swiss Fed-eral Banking Commission[83].

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 17 ]



The healthcare sectorProfessional competence is largely acquiredthrough the study of technical literature,but the information available that maypermit an auditor to be unequivocallyassured of independence is much moreuncertain[84].

Krishnamoorthy and Spruill[85] conducted astudy on the material departments of varioushospitals and concluded that operationalaudits are particularly beneficial to the hospi-tal material department because this depart-ment represents one of the major cost centresin the hospital. Such audits have the potentialto increase efficiency and lead to significantcost savings. It can be done by an internalauditor or by external consultants. Auditorindependence is an important considerationin either event. The internal auditor’s inde-pendence can be ensured if the auditor has nodirect connection to the material or any userdepartment. Dame[86] believes that opera-tional audits of material transportation activ-ities can help to reduce freight costs by identi-fying inefficiencies or ineffective practices.Any improvements of transportation opera-tions can result in a reduction of the cost topurchase material and substantial savings forthe organization.

The municipal sectorAuditors must appear independent to audi-tee managers if they are to be effective andefficient[87].

A study was undertaken to examine munici-pal internal auditors and the environment inwhich they function. The results of the studyindicate that internal auditors are indepen-dent to perform the task to the best of theirability. A potential weakness to this conclu-sion was that most of the respondents did notfollow the guidelines of the Institute of Inter-nal Auditors. They were in violation of theSPPIA (110.01):

the director of the internal audit depart-ment should be responsible to an individualin the organization with sufficient authorityto promote independence and to ensureboard audit coverage, adequate considera-tion of audit reports, and appropriate actionon audit recommendations.

Failure to meet this guideline impairs audi-tor independence and poses potential conflictin that the internal auditor reports to thosewho made the appointment[88].

The audit committee is believed to be themost logical avenue for local governments toenhance auditor independence and satisfythe growing demands for services with lim-ited resources. A survey of municipal officersof 164 cities revealed that the audit committee

activities ranked highest by administratorsinvolved: (a) facilitating the audit and (b)helping to maintain auditor independence.The need for a committee to act in a watchdogcapacity is not necessary in a municipal set-ting; rather, the driving issue seems to be thatof achieving efficiency and effectiveness incity government[89].

The insurance sectorAlthough independence is a necessity forthe internal auditor, absolute independencemay not be achievable[77].

Auditor independence is called for when aspecial industry sector undergoes crisis incredibility. The number of insolvencies in theinsurance sector has risen to a level thatdemands serious analysis. Given the tremen-dous investment in insurance company liabil-ities by employee benefit plans, independentcredit evaluation sources and auditor inde-pendence need to be re-evaluated[88].

Part II – the international arenaThe statement that professional accountantsin practice should be "independent in factand appearance” will be a puzzle in a collec-tive culture in which relationships andgroup membership are the cornerstone ofthe organization of society[90].

The Institute of Internal Auditors, in theintroduction to the SPPIA, states:

throughout the world internal auditing isperformed in diverse environments andwithin organizations which vary in pur-pose, size, and structures. In addition, thelaws and customs within various countriesdiffer from one to another. These differencesmay affect the practice of internal auditingin each environment. The implementationof these Standards, therefore, will be gov-erned by the environment in which theinternal audit department carries itsassigned responsibilities.

Thus, cultural differences may limit the effec-tiveness of auditor independence. They areimportant to our understanding of differ-ences in the perception of auditor indepen-dence and their values because they identifygenerally-held beliefs and norms of appropri-ate behavior in a country [91]. The concept ofindependence in China and Japan is tied upto their collectivist culture. Individualism isconsidered selfish and therefore evil. Theindividual’s self-interest is best guaranteedby maintaining the group wellbeing. In orien-tal cultures, individuals are driven not bytheir personal needs, but rather the need notto “lose face”. One loses face by failing to

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 18 ]



meet the social requirements deemed appro-priate to the social position one occupies[92].

Stamp and Moonitz[93] have identifiedprofessional independence as one of two keyareas of difficulty encountered in the international auditing field. It is their con-tention that the implementation of profes-sional independence in the multinationalcontext is difficult to implement. Theybelieve that “the steps taken are likely to bethose that will preserve the outward form ofindependence, objectivity and integrity with-out necessarily preserving its essence”. Toassess auditor independence worldwide, arepresentative group of internationalaccounting associations and several coun-tries in the various continents have beentaken as a sample to determine whether ornot: • governments and/or professional associa-

tions require that financial statements beaudited;

• statutes describe factors that impair audi-tor independence; and

• professional associations or societies ofaccountants have promulgated auditingstandards that define the concepts ofintegrity, objectivity, and independence.

The government often takes the lead in devel-oping auditing standards in countries that donot have a well-developed auditing profes-sion, as well as in some industrial countriesthat are very legalistic and prescriptive.

International Federation of AccountantsAuditor independence in developing coun-tries is important since the auditor by pro-viding credibility to financial statementsfacilitates the allocation of scarce capitalresources in financial and capital markets.Auditor independence is also necessary forformulating international harmonization ofauditing standards[94].

Founded in 1977, the International Federationof Accountants (IFAC) is a federation ofnational professional accounting bodies. Itsobjective is the development and enhance-ment of a co-ordinated world-wide accoun-tancy and auditing profession and the harmo-nization of accounting principles and audit-ing standards[95]. In 1977, IFAC issued theInternational Audit Guidelines (IAG)[96]. Oneof the guidelines defines independence as theability of the accountants to be and appear tobe free of any interest that might be regardedas being incompatible with integrity andobjectivity.

In 1994, IFAC’s International Auditing Prac-tice Committee (IAPC) issued InternationalAuditing Standard (IAS) No. 10 entitled Usingthe Work of an Internal Auditor which gives

guidance to the external auditors when theinternal auditing function is considered indetermining the nature, timing, and extent ofthe audit procedures in financial auditedstatements[97].

The role of the European Union (EU)Above all, we clearly uphold our indepen-dence and objectivit[98].

The EU Fourth Directive requires companies,whose annual accounts are required to beaudited, to appoint an auditor to examine theaccounts and express an opinion aboutwhether they present a “true and fair”view[99]. The Eighth Directive, adopted in1989 and implemented on January 1, 1990,deals with the qualifications of statutoryauditors, reciprocity, and independence[100].Independence is one of the areas of strongdisagreement in the draft of the Directive.Some countries felt that statutory auditorsshould do nothing but audit financial state-ments, whereas other countries felt that taxand advisory services could be performed byauditing firms without impairing indepen-dence. Since no agreement was reached onindependence, the Eighth Directive decidedto allow the individual member countries todetermine the condition for independence.The Commission may introduce a specificdirective on the independence of auditors[101].

Many problems identified in the currentdebate about possible EU legislation on audi-tor independence could be remedied if theprofession were given at least some self-regu-latory responsibilities. A single Institute ofAccountants in Europe is not the answer.Rather, the solution lies somewhere betweena single institute and the presentsituation[102].

The role of the IASCAuditor’s independence and objectivity maybe compromised in a collective culturewhere auditors have extended familyties[103].

The role of the International AccountingStandard Committee (IASC), which wasfounded in 1973, was to contribute toward thedevelopment and adoption of accountingprinciples and auditing standards that wererelevant and comparable internationally. TheIASC developed standards that allowed asubstantial degree of choice, presenting twoor more alternative accounting approacheswith respect to a transaction[104]. By the endof 1999, the IASC and the International Orga-nization of Securities Commissions (IOSCO)plan to have in place a core set of interna-tional accounting and auditing standardsthat will reduce reliance on national stan-dards[105].

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 19 ]



Asian countriesThe Chinese perspective

If culture influences a society’s norms andvalues, if it affects the behavior of groupinteractions, then audit independence inChina should have a considerably differentmien from that found in the West[106].

In China, issues of national importanceinclude promoting independent financialaudits of state enterprises. The national regu-latory authority for China’s CPA profession isthe Ministry of Finance. The Chinese Insti-tute of Certified Public Accountants (CICPA),which was established in late 1988, is theorganization that actually regulates the pro-fession. China does not have a private profes-sional standard board to set national auditregulations. Regulations are set by the gov-ernment and contained in the Audit Regula-tions of the People’s Republic of China 1989.The new audit regulations aim at improvingand strengthening the independence of audi-tors[107]. Audits are required under theincome tax laws and audited financial state-ments are therefore prepared for tax report-ing purposes. The audit requirements forforeign investment enterprises are containedin the Accounting Regulations of the People’sRepublic of China for Enterprises with For-eign Investments promulgated in July1992[108].

Article 3 of the Audit Regulations of thePeople’s Republic of China states: “The audit-ing organizations execute their auditingwork independent of any interference fromother government administrative organiza-tions, other social groups or individuals”[109].The audit bureaux are permitted by the newregulations to establish an internal auditdepartment to perform internal audits.

The Hong Kong perspectiveThe advocacy of weak and unsupportedclient accounting positions speak loudlyabout independence in fact. It is hoped thatthrough self-restraint independence issueswill be reexamined[110].

In Hong Kong, companies are incorporatedunder the Companies Ordinance and arerequired to appoint an auditor to audit theirfinancial statements. The Hong Kong Societyof Accountants has set forth guidance onprofessional ethics and independence thatare similar to those of the USA. The code ofethics warns auditors to exercise due care,objectivity, and integrity. They must avoidsituations that may impair their indepen-dence[111]. Managing directors share a con-sensus perception of the audit function as anindependent appraisal of the company’sinternal control system. More than 50 percent of top management believe that

independence of the internal auditors isenhanced when they report to an audit com-mittee[112].

The Japanese perspectiveThe history of some business failures inJapan illustrates the lack of fit of the Anglo-American focus on independence within theJapanese collective culture[113].

The construct of auditor independence iscentral to the Anglo-American auditing tradi-tion. The notion of an independent functionruns counter to the Japanese belief in thecentrality of the group and its resultingdesire for privacy[113]. CPAs and audit corpo-rations are required to be independent oftheir clients under both the CPA law and thesecurities and exchange law. CPAs or auditcorporations may not render continuous taxservices for a fee to audit clients. Tax returnpreparation services are instead provided bycertified tax advisers (CTAs). The by-laws ofthe Japanese Institute of Certified PublicAccountants (JICPA) include rules of profes-sional ethics and independence. Audit stan-dards are provided under the Auditing Stan-dards, Audit Procedures Rules and AuditReporting Rules issued by the EnterpriseAccounting Deliberation Council of the Min-istry of Finance[114]. The Japanese businesslaw requires the presence of a statutory audi-tor to look after stockholder interests, therelationship between the statutory auditorand the corporation is typically of indepen-dence between management and auditor. Inreality the financial and mental indepen-dence necessary for the objectiveperformance of the statutory auditor’s reviewand supervisory duties remain absent[115].Owing to the collective nature of Japaneseculture, auditors have little success in obtain-ing the specific documents necessary to inde-pendently assess the financial position of theentity audited. Internal auditors within theJapanese firms appear much less indepen-dent. They report to high-level managementand do not have an audience with the board ofdirectors[72].

The Malaysian pespectiveSince one’s usefulness as an auditor isimpaired by any feeling on the part of thirdparties that he is likely to lack indepen-dence, he has the responsibility of not onlymaintaining independence in fact but alsoof avoiding any appearance of lacking inde-pendence[116].

In Malaysia, the accounts of all companiesincorporated under the Companies Act 1965must be audited by an independent auditor.In order to qualify as auditor, a person mustbe approved by the Ministry of Finance. TheCompanies Act requires auditors to report to

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 20 ]



the Registrar of Companies any breach ornonobservance of any of the provisions of theCompanies Act[117].

The Singapore perspectiveClearly, if the internal auditors are going tofulfill the role of providing reassurances toboards of directors on the relevance andreliability of a company’s internal controlsystem, it is important that the internalauditors are as independent as possiblefrom the executive management[118].

Singapore requires that all registered compa-nies under the Companies Act have their finan-cial statements audited. The Singapore Audit-ing Guideline (SAG) #4, Basic Principles Gov-erning an Audit, requires auditors to be inde-pendent, honest, and sincere. They must notallow prejudice or bias to override their objec-tivity. Independence is impaired when:• members of the auditor’s immediate family

hold a significant beneficial interest in thecompany audited;

• the auditor was an officer or employee ofthe company audited; and

• the auditor has direct or indirect interest inthe company audited[117].

European countriesThe Danish perspective

Growing reliance on nonaudit services hasthe potential to compromise the objectivityor independence of the auditor by divertingsome leadership away from the publicresponsibility associated with the indepen-dent audit function[34].

All limited liability companies are requiredto be audited in Denmark by certified audi-tors licensed by the Ministry of Industry. Tothe Danes, the following constitutes animpairment to independence: • CPAs are not allowed to render an opinion

on the financial statements of a companythat has any kind of economic influence inthe form in which the auditor is anemployer.

• Auditors are not allowed to receive loans orguarantees from a company that they audit.

The following persons are precluded fromacting as auditors: • members of the board of directors of a com-

pany;• persons who are employed by the company;

and • persons who are related by marriage, adop-

tion, or family relation to the directors ormanagement of the company.

However, rendering consulting service doesnot prohibit an individual from acting as anindependent auditor[120].

The Dutch perspectiveThe concept of independence is at the centerof the audit function. The accounting profession has long recognized the need forauditor independence in both fact andappearance[121].

The financial statements of Dutch companiesare audited to meet statutory and stockexchange requirements. In 1984, the Dutchadopted the EU Fourth Directive whichrequires that the annual accounts be audited.The Dutch audit philosophy and practice issimilar to the US practice. The Code of Ethicshas a legislative status and gives guidance toits members on matters dealing with auditorindependence, due care, and professionalconduct. The requirement of objectivity andindependence is detailed in Article 20 of theCode. Auditors engaged in practice may notperform a service for a person, corporation,or institution if they have a vested interestthat may affect their objectivity[122].

The French perspectiveInternal audit departments cannot be inde-pendent of senior management because theydepend on them for the same operationalneeds as any other department in the orga-nization[71].

The accounting profession in France isdivided into two main bodies. The Ordre desExperts Comptables et des Contable Agréesincludes all qualified independent accoun-tants. The Institute of Statutory Auditors(Compagnie Nationale des Commissaires auxComptes) is the professional body of officialstatutory auditors. Statutory auditors arerequired to be independent of their clients.Any remuneration from the client companyother than that for the audit is prohibited.The auditing standards are similar to those ofthe USA[123]. In January 1996, the Federationof European Accounting Experts releasedThe Role, Position and Liability of the Statu-tory Auditor in the European Union whichprohibits the simultaneous provision of allnon-audit services by statutory auditors.

The Spanish perspectiveTo optimize the image of independence inpractice, an auditor must remain free of anyobligation or interest that would damageindependence in appearance[124].

In 1988, the Spanish government approved alaw requiring annual financial statements forall entities except small companies. A stockexchange regulation provides that companiesquoted on the stock exchange must appointindependent auditors. The Instituto de Con-tabilidad y Auditoria de Cuentos publishedthe auditing standards in its Gazette. Theauditing standards are similar to those of the

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 21 ]



USA and include guidelines on auditor’sindependence, integrity, and objectivity[125].

The Swedish perspectiveThe internal auditor is provided with theindependence and objectivity to look at thevarious operational activities in the light oftotal company welfare, and without the biasof specific interests[1].

In Sweden, the Institute of Authorized PublicAccountants has developed rules of profes-sional ethics similar to those of the US certi-fied public accountants that include guide-lines on auditor independence, confidential-ity, and professional conduct. The CompaniesAct prohibits the engagement of an auditorwho is not personally, professionally, andfinancially independent from the company.Both the Companies Act and the Institute ofAuthorized Public Accountants considerindependence in fact and appearance to be arequirement for any audit engagements[126].

Recently, a Swedish law has required thatinternal auditing of public authorities beperformed in accordance with the IIA Code ofProfessional Ethics and the generallyaccepted internal auditing principles as out-lined in the IIA Standards for the ProfessionalPractice of Internal Auditing (SPPIA). Thisinitiative proposed by the Swedish NationalAudit Bureau will not only enhance internalauditor independence but will also recognizeinternal auditing as an international profes-sion. Previously, the Swedish internal audit-ing had taken three forms: 1 The internal audit department served

mainly as a support unit for external audi-tors performing financial audit.

2 The internal audit department performedoperational audit and had no responsibil-ity for financial audits.

3 There was no internal audit service atall[127].

Internal auditors are required to provideaudit coverage and report the findings tomanagement.

The Swiss perspectiveThe concept of independence is notabsolute; no auditors can claim completeindependence of a client. Rather, indepen-dence is relative – a matter of degree[128].

In Switzerland, corporations are required tohave one or more auditors who must be inde-pendent of the board of directors and share-holders. They must also be independent ofcompanies belonging to the same group ofcompanies. Independent auditors report oncompliance with legal requirements andprovide support to business management onfinancial matters. The Swiss Institute of Certified Accounts and Tax Consultants

issued ethical rules dealing with auditor’sindependence and objectivity[83].

Anglo-Saxon countriesThe Australian perspective

Without independence, the value of anyauditor’s work to the client or to the invest-ing public is questionable. And neitherinternal or external auditors can claim to beindependent unless they have the ability todetermine and control the scope of theiraudit tests[129].

Under Australian corporate law, the auditorof a company is required to report to theshareholders on every balance sheet andprofit and loss account (income statement)submitted to shareholders of the company.The auditor has the right to access at alltimes the accounting and other records of thecompany and the right to obtain from officersof the company such information and expla-nations as are required for the audit. Aus-tralian auditing standards (AUS) are compa-rable with those applicable in the USA[130].AUS #1 requires that auditors be indepen-dent, honest, and sincere. They shall main-tain an impartial attitude and be free of anyinterest that might be regarded as beingincompatible with their integrity and objec-tivity. Auditors are prohibited from: • being beneficiary owners of shares in an

audit client;• acting as trustees of a trust or as directors

of a corporate trustee company;• accepting, making, or guaranteeing loans

from or to an audit client;• accepting from audit clients goods or ser-

vices on terms more favorable than thosegenerally available to others;

• accepting or retaining a directorship of acompany that exerts significant influenceoveranother company that is an auditclient;

• acting in an executive decision-making rolewhen providing management consultingservices to an audit client;

• participating in the preparation of the bookof account of a public company beingaudited[131].

The Canadian perspectiveIndependence is the keystone of the auditprofession; without independence, the usersof financial statements would not be able torely on the auditor’s report[132].

In Canada, an auditor must be independent,must be licensed by the province in which hepractices, and must comply with the rules ofethics of the organization to which hebelongs. The auditor has a statute-protectedright of access to all books, records, informa-tion, and explanations that he requests[133].

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 22 ]



The Canadian Business Corporation Actrequires an auditor to be independent. How-ever, the Act permits an interested person toapply to the court for an order exempting theauditor from the requirement to be indepen-dent. The Act still requires the audit to beconducted with generally accepted auditingstandards and the financial statements to beprepared in accordance with generallyaccepted accounting principles[134].

The New Zealand perspectiveThe Internal Auditing Standards Board ofthe Institute of Institute of Internal Auditorshas been diligent in its efforts to ensureinternationalization of the IIAStandards[135].

Companies incorporated under the NewZealand Companies Act 1955 are required tohave their financial statements audited. Allforeign-owned subsidiary companies mustalso be audited by a New Zealand charteredaccountant. The Code of Ethics of the NewZealand Society of Accountants is similar inmany respects to those of the USA, Australia,Canada, and the UK[136]. The Office of theAuditor General’s Guidelines on Integrity,Objectivity, and Independence preclude statu-tory auditors who certify financialstatements of a company from serving asinternal auditors of the company.

The UK perspectiveArguments about what is needed to safe-guard the auditor independence are peren-nial. Whatever rules are introduced, thedebate on independence will no doubt be aslively as it has been this time around[137].

The British have emphasized auditor inde-pendence for almost two centuries. The provi-sion against auditors serving as officers oremployees of their auditees has been a land-mark of the British system. A concern for theauditor’s independence in the UK appeared inthe Companies Clauses Act 1845, section 102,which prohibited auditors from serving asofficers of the company:

Where no other qualification shall be pre-scribed by the special Act, every Auditorshall have at least one share in the undertak-ing; and he shall not hold any office in thecompany, nor be in any other manner inter-ested in its concern, except as ashareholder[138].

The requirement of shareholding, however,has not been retained in the UK as an auditorqualification as evidenced by the CompaniesAct 1862, which permitted but did not requireshareholding[138]. The Companies Act 1948,Section 161, provided that no person who is“an officer or servant of the company” isqualified for appointment as auditor of suchcompany.

The standards of independence in the UKare similar to those in the USA, although onemajor difference is that, in the UK, independent auditors are allowed to performcertain bookkeeping functions for privatecompanies. The Companies Act 1985 requirescompanies to issue audited financial state-ments. Auditors have the right of access tobooks, records, and other pertinent informa-tion as needed to carry out their statutoryduties. The first statement on ethical mattersrequires a member in public practice “to beand to be seen to be independent”[139]. TheUK amended the Companies Act 1985 toimplement the European Union’s EighthDirective. It lays down minimum approvalrequirements for company auditors, includ-ing their education and training. It obligesmember states to ensure that company auditsare performed with integrity and that thereare appropriate safeguards to protect auditorindependence[140].

For over 100 years, the accountancy profes-sion in the UK has built its reputation on thefoundation of objectivity, integrity, and com-petence which include all that is required forauditor independence. Darbyshire[141] con-tends that investigations into corporatecrashes that have occurred over the past twodecades show that, in the relatively few caseswhere the auditor’s role has been challenged,in virtually no case has lack of independencebeen demonstrated or even alleged. It hasbeen suggested that, after a number of years,auditors become too cosy with their clients.Although the evidence presented is limited, itshows that audit failure is three times aslikely to occur in the first two years after achange in auditor than in subsequent years.He believes that there is substantial evidencethat auditors should be separate from theirclient’s management, although the US andCanadian commissions have concluded thatthere is no reason to suppose that auditorindependence is affected by the provision ofnon-audit services.

A questionnaire survey has revealed awealth of detail as to how auditors and someof the main participants in the UK companyfinancial report process differ in their viewsregarding the nature of auditing and the workthat auditors do. The survey confirms theextent of the auditor’s responsibilities tothird parties, the nature of balance sheetvaluation, the strength of, and continuingthreats to, auditor independence. The resultsof the factor analysis of activity constructsprovide evidence of the prevalence of inde-pendence-related attributes in assessments ofthe contribution and quality of auditing[142].Owen Green[143] has called for a greaterauditor independence and an in-depth review

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 23 ]



of the auditing profession in the UK. Heargues that such a system would restore theauditor as watchdog and release nonexecu-tive directors to a more constructive role.

African countriesThe Africa perspective

As the eyes and ears of the audit committee,it is essential that internal auditors be trulyindependent[71].

Auditing has always been seen as an alienphenomenon in most parts of the ThirdWorld, especially in Africa. This is because ofAfrica’s history, culture, and collective way oflife . The Charter, as defined by the Instituteof Internal Auditors, does not really seem togive that unrestricted scope to Third Worldauditors. If auditing is a reflection of culture,applying the IIA standards of independenceand objectivity poses a serious dilemma toThird World auditors[103].

The Nigerian perspectiveIn the Third World countries, an objectiveauditor is not always accepted by manage-ment as loyal. The auditor is made to feelhelpless and totally dependent on manage-ment[100].

Ahmed Opetubo[144], in his Master’s thesison “Perceptions of Nigerian auditor indepen-dence”, showed that public accountants andusers of certified statements disagree aboutthe role that the auditor’s independence playsin the audit environment. This discrepancyreflects the cultural and political bias inNigerian society.

South American countriesThe Argentine perspective

Rules on independence are stated, usually ingeneral terms, but are appropriately devel-oped and defined by the technical institu-tions[145].

In Argentina, annual financial statements ofall companies must be audited by an indepen-dent public accountant. The auditor’s report,issued after an examination made in accor-dance with defined auditing standards, mustbe filed with regulatory authorities. Auditingstandards are similar to those of the USA andare embodied in Technical PronouncementNo. 7 of the Argentine Federation of Profes-sional Councils of Economic Sciences. Audit-ing standards include guidelines dealing with auditor independence, integrity, andobjectivity[145].

The Middle EastThe Israeli perspective

Professional competence is largely acquiredthrough the study of technical literature,but the information available that may

permit an auditor to be unequivocallyassured of independence is much moreuncertain[84].

The Israeli legislature, the Knesset, passedthe Internal Auditing Act 1992 on 16 March,1992. The new law makes the State of Israelone of the few to award such explicit statu-tory status and governmental recognition tothe internal audit function and the role of theinternal auditor. It requires public institu-tions to establish the internal auditing func-tion in their organization. The legislation hassafeguards for auditor independence.

The Israeli Securities and Exchange Com-mission Act 1968 and guidelines published on24 July, 1989, by the Israeli Institute of Certi-fied Public Accountants preclude statutoryauditors who certify financial statements of acompany from serving as internal auditors.

The Russian Federation perspectiveAs long as internal auditing staffs arehighly skilled, efficient and responsive tomanagement, organizations are best servedby keeping the internal audit function inter-nal[146].

Auditing in the Russian Federation is in itsinfancy. In December 1993, the PresidentialCommission on Auditing Activity started toissue licences to auditing firms to carry outauditing activities. The Commission plans toco-ordinate auditing practices and issuesguidelines dealing with auditor’s objectivity,integrity, and independence[147].

Part IV – Cases impairing auditorindependence

Although independence is a necessity forinternal auditors, the respondents in thisarea reflect some discomfort with the politi-cal aspect of the internal auditor’s positionand the ethical dilemmas that result[74].

Several situations may impair the auditor’sindependence, such as contingent feearrangements, gifts, auditor’s overfamiliaritywith personnel or operations, managementadvisory services (MAS), outsourcing, opin-ion shopping, reporting relationships, andothers. The line of what constitutes impair-ment to the auditor’s independence may bedebatable and subject to cultural, economic,environmental, legal, and political biases.Even in the USA, we witness that despite themany similarities between the SEC rules onindependence in Rule 2-01(b) of Regulation S-X and the AICPA Interpretation of Rule 101of the Rules of Conduct, there are substantivedifferences in the way the two regulatorybodies interpret conflict of interests, familyrelations, financial interests, former

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 24 ]



partners, outsourcing, MAS, and other mat-ters related to auditor independence. Thusdivergent views may arise from the AICPA’sadvocacy posture in the expanding role of theexternal audit work and in the SEC’s positionin protecting investors, creditors, and thepublic.

Conflict of interestIndependence means that an auditor shouldbe objective and unbiased. An auditor doesnot subordinate his judgement to pressuresfrom others and avoids relations that wouldappear to others to create a conflict of inter-est[148].

The SEC considers independence impaired inmost cases when a spouse, dependent personor someone else in the member’s householdhas a direct or material indirect financialinterest, or when non-dependent close rela-tives have material direct financial interests inor management relationship with an auditclient. The AICPA, however, makes allowancefor the “audit sensitivity” of a relative’semployment, letting independence be consid-ered intact if the position is not sensitive.Overall, the AICPA position appears to be veryflexible and permits assessment of the circum-stances in each case[64)] The SEC considersthe firm’s independence impaired if:• a former partner becomes a member of the

board of directors of the auditee within twoyears after his resignation or retirement;

• a former partner who was prominent in hisfirm becomes a director of a client of theaccounting firm within five years; and

• a former partner becomes an executive of aclient of the accounting firm without a totalseparation, including settlement of retire-ment benefits from the firms.

Although the AICPA rules are similar, theydo not contain the specific time limits[63].

The performance of duties that conflictwith the internal audit role constitutes apotential impairment to internal audit objec-tivity. The underlying philosophy of a policydealing with conflict of interest is to ensureall concerned employees avoid situationswhich might be interpreted as a conflictbetween their personal interests and those ofthe organization (PSB 84-7). The IIA Stan-dards for the Professional Practice of InternalAuditing suggest that internal auditorsshould report to the director of internalauditing any situation in which a conflict orbias is present or may be reasonably inferred.In such circumstances, the director shouldreassign the internal auditors (120.02.2). Arti-cle IV of the IIA Code of Professional Ethicsaddresses independence by prohibiting inter-nal auditors from entering into activities

which may be in conflict with the interest oftheir organization or which would prejudicetheir ability to carry out objectively theirduties and responsibilities. Violation of theIIA Code of Professional Ethics is subject toforfeiture of membership in the institute andthe certified internal auditor designation.

Fifty-four audit partners participated in astudy by completing hypothetical audit casesdesigned to allow varying ranges of accept-able accounting alternatives. This investiga-tion revealed that the degree to which firmsemphasized local office performance in deter-mining individual partner compensation wasa discriminating feature of compensationschemes. This represents an audit-clientconflict in audit judgements[149].

In the UK, the Guidance for Internal Audi-tors states that the internal auditor, notwith-standing his employment, should be free fromany conflict of interest arising either fromperformance or personal relationships orfrom pecuniary or other interests in an orga-nization or activity which is subject toaudit[150]. The 1991 Ethics, Interpretationsand Rulings of the Joint Ethics Committee ofthe Institutes of Chartered Accountants inEngland and Wales (ICAEW), Scotland (ICAS)and Northern Ireland (ICANI)[151] give exam-ples of cases in which independence may bedeemed to be impaired. For instance, inde-pendence would be considered to be impairedwith respect to a client for whom the memberor the client has guaranteed a loan for theother party. If the guarantee exists during theperiod of the professional engagement or atleast at the time of expressing an opinion,independence would be considered impaired.

Another case of impaired independencearises when an individual participating in anengagement, who is offered employment by,or seeks employment with, that client duringthe conduct of the engagement must considerwhether or not his or her ability to act withintegrity and objectivity has been impaired.When the engagement requiresindependence, the individual must removehimself or herself from the engagement untilthe employment offer is rejected or employ-ment is no longer sought, in order to preventany appearance that integrity and objectivityhave been impaired[152].

Contingent feesContingent fee agreements may tempt apractitioner to issue the wrong opinion[148].

Contingent fee is a fee established for theperformance of any service pursuant to anarrangement in which no fee will be chargedunless a specified finding or result isattained, or in which the amount of the fee is

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 25 ]



otherwise dependent upon the finding orresult of such service. Rule 302 of the AICPACode of Professional Conduct prohibits contingent fees in attest engagements whereusers of financial information may be relyingon the CPA’s work. Acceptance of contingentfee arrangements is considered an impair-ment of independence. There are, however,exceptions in tax matters as described in Rule302-1. As of January 1990, state laws andboard of accountancy rules in 48 states pro-hibit contingent fees. Some professional lia-bilities insurance policies exclude contin-gency-fee arrangements from their malprac-tice[153].

Report-contingent audit contracts mayappear inherently undesirable because theyseem to compromise auditor independence.An analysis conducted shows that a singleauditor with a single client may seek toemploy a contingent contract, even thoughauditors collectively would prefer to bancontingent fees. In addition, it is possible toidentify certain conditions under whichexpanding auditors’ contracting opportuni-ties may reduce competition[154].

Disclaimer of opinionThe independent public accountant must bewithout bias with respect to the client; oth-erwise, he would lack that impartialitynecessary for the dependability of his find-ings[155].

Another reason for a departure from thestandard report is when the auditor is notindependent. SAS No. 26 states:

When an accountant is not independent, anyprocedures he might perform would not bein accordance with generally acceptedauditing standards, and he would be pre-cluded from expressing an opinion on suchstatements. Accordingly, he should disclaiman opinion with respect to the financialstatements and should state specifically thathe is not independent[155].

In his disclaimer, the auditor: • should not mention any reasons for not

being independent because the readermight erroneously interpret them as unim-portant;

• should make no mention of any audit proce-dures applied because readers might erro-neously conclude that they were sufficient;and

• should label each page of the financial state-ment as being unaudited.

The disclaimer of opinion should read asfollows:

We are not independent with respect to XYZcompany, and the accompanying balancesheet as of December 31, 199X and therelated statements of income, retained

earnings, and cash flows for the year thenended were not audited by us and accord-ingly, we do not express an opinion on them.

In Japan, if the auditors disclaim an opinion,the fact and reasons thereof, including nonap-plication of important audit procedures, mustbe indicated[114].

Disclosure of sensitive informationAlthough the appearance of independencedoes not guarantee independence in fact,such appearance is essential in maintainingpublic confidence[63].

Rule 301 of the AICPA Code of ProfessionalConduct defines confidential information thatinformation which should not be disclosed tooutside parties unless demanded by a courtor an administrative body having subpoenapower. The Code specifically provides that theconfidential relationship must not infringeupon auditor independence and obligation tofully and fairly report on audited financialstatements. In the US v. Arthur & Young, theUS Supreme Court stated:

The independent public accountant per-forming the audit function owes ultimateallegiance to the corporation’s creditors andstockholders, as well as to the investingpublic... If the auditor were convinced thatthe scope of the audit had been limited bymanagement’s reluctance to disclose mat-ters relating to tax accruals, the auditorwould be unable to issue an unqualifiedopinion on the corporation’s financial state-ment.

Information is not considered confidential ifdisclosure of it is necessary to make financialstatement not misleading. Disclosure of sen-sitive information may impair objectivityand internal auditor independence. An exper-iment was conducted to determine the predic-tion-task judgement of 54 internal auditorsfrom the public and private sector. Theresults of this experiment suggest that inter-nal auditors believe that disclosure of sensi-tive information such as fraud is unlikely,especially when disclosure would result injob termination. Disclosure is influenced bythe channel the internal auditor uses to com-municate information and is not affected bythe position of the internal auditing depart-ment within the organization[156].

GiftsIndependence is a cornerstone of theaccounting profession, but it is difficult toprove and easy to challenge[2].

Gifts and discounts received by the auditorsconstitute the most frequent conflict of inter-est concerning auditor independence. TheIIA’s professional standards state that

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 26 ]



internal auditors should be objective in per-forming an audit. Accepting a fee or gift mayimply that the auditor’s objectivity has beenimpaired. The IIA Code of Professional Ethicsalso prohibits internal auditors from accept-ing a fee or gift from an employee, a client, acustomer, or a business associate of theiremployer without the knowledge of seniormanagement. No consideration should begiven to the audit status as justification forreceiving fees or gifts. In Japan, small giftexchanges should be viewed as a part of thecultural etiquette rather than as a compro-mising of audit integrity[115].

Incentive plans As long as the auditing department is a partof the enterprise and receives its life supportfrom the enterprise, it must relinquish someindependence[10].

The IIA’s Professional Standards BulletinPSB 83-26 discusses the impact ofbonus/incentive plans on the internal audi-tor’s independence. PSB 83-20 states thatbonus/incentive compensation programmes,which are an integral part of the organiza-tion’s compensation programme and admin-istered by the board or its salary administra-tion committee, would not impair audit objec-tivity. However, if such programmes are basedon operating results, it may impair auditobjectivity. PSB 87-8 points to the possibilitythat an audit manager may fail to report theresults of the audit work completely orrelease the results of the audit work withtiming favourable to the bonus/incentivecompensation[157]. The PSB warns that extracare needs to be taken in designing abonus/incentive plan for auditors due to theunique reporting responsibilities they havein the organization. Numerous businessesare, however, including auditors in incen-tive/results sharing types of programmes.These can have positive impacts in that theysharpen the identification of auditors withimproving operating results.

There is also a concern that the auditor’sexpected economic benefit from keeping aclient (the value of incumbency) may affectauditor independence towards that client.Magee and Tseng[158] demonstrated that,when all auditors agree as to whether areporting decision is consistent with gener-ally accepted accounting principles (GAAP),a positive value of incumbency should notlead to a compromise of independence whenauditors disagree about the proper treatmentof an item. These conclusions are based onthe assumption that an enforceable ban oncontingent contracts exists between auditorand client.

Trompeter[149] examined the impact ofaudit partner compensation schemes andgenerally accepted accounting principles(GAAP) on audit judgements involving auditor-client conflict. These factors areimportant because of their potential impacton auditor independence and objectivity.Fifty-four audit partners participated in astudy by completing hypothetical audit casesdesigned to allow varying ranges of accept-able accounting alternatives. This investiga-tion revealed that determining individualpartner compensation was a discriminatingfeature of compensation schemes and had apotential impact on auditor independence.

Management advisory services and co-contracting

CPAs shall be aware of others’ views of theirrole and shall not permit themselves to beput in a position that would endanger theirobjectivity and independence[159, No. 3].

Management advisory services (MAS) consistof advice and assistance to a client to improvecapabilities and resources and achieve statedobjectives. The accountant may conduct stud-ies and counsel management in such mattersas business organization, planning, controls,system’s operations, personnel andfinances[159, No. 1]. Management engage-ments require an investigation and analysisof the client’s operations to determine theenterprise’s objectives, the nature of the prob-lem, and feasible solutions. They also includethe evaluation of alternative solutions, for-mulation and recommended action, and sug-gestions for and assistance in the implemen-tation process. MAS could also require thereview of the financial statements for a client.All these professional services may pose athreat to the auditor’s independence. Audi-tors must, therefore, exercise due care topreserve their status of independence.

In 1966, the AICPA appointed an ad hoccommittee investigating the propriety ofCPAs rendering management services. TheCommittee report did not find instances inwhich independence had been impaired. Someresearches have, however, shown that manage-ment advisory services can actually enhancean audit firm’s independence[160,161]. In the1970s and early 1980s, the issue on non-auditservices was once again debated. Some criticsargued that independence is improved whena firm realizes significant non-audit fees froman audit client.

In 1972, the SEC issued ASR # 126 FinancialReporting[57], which states that auditors arenot considered independent and cannot fulfilthe role of outsider critic for clients for whomthey also perform bookkeeping and write-up

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 27 ]



services. The SEC defined independence asan objective analysis of a situation by a disin-terested third party and stated:

It is the Commission’s position that anaccounting firm cannot be deemed indepen-dent with regard to auditing financial state-ments of a client if it has participatedclosely, either manually or through its com-puter services, in the maintenance of thebasic accounting records and preparation ofthe financial statements, or if the firm per-forms other accounting services throughwhich it participates with management inoperational decisions.

The basic consideration is whether, to a thirdparty, the client appears to be totally depen-dent on the accountant’s skill and judgementin its financial operations or to be reliantonly to the extent of the customary type ofconsultation or advice. In 1977, the MetcalfSubcommittee claimed that non-audit ser-vices impair independence. In 1978, theCohen Commission on Auditors’ Responsibil-ities considered management advisory ser-vices for audit clients and concluded that“there is little question that the provision ofsome other services to audit clients poses anobvious potential threat to the auditor’s inde-pendence”.

In 1977, the AICPA issued Rule of Conduct102, MAS Engagement to Evaluate ServiceBureaus. CPAs, who are asked to evaluateservice bureaux for processing the client’saccounting records, should not accept theengagement if they have a financial interestin one of the service bureaux under consider-ation. The client’s financial interests canconstrain the firm’s ability to perform cer-tain MAS engagements[162].

In 1978, the SEC responded to the nonauditservices issues with Accounting ReleaseSeries (ARS) # 250, which required disclosurein Form 10-K of the nature of all non-auditservices and the percentage of audit fees. In1981, the SEC rescinded ARS # 250, and as aresult, public disclosure of non-audit servicesis no longer mandatory. Some research in the1980s suggests that both sophisticated finan-cial information users, such as financialanalysts, and educated but inexperiencedreaders, have relatively high confidence inauditor independence, even in cases involv-ing non-audit services[163].

In June of 1979, the SEC issued ASR # 264implying that engaging an auditor for man-agement advisory services might impairindependence. AICPA rules do not emphasizethis point. Jack Robertson[64] feels that theSEC view casts a cloud of suspicion over thepractice of negotiating with the client thenature and amount of financial statementadjustments proposed by the auditors.

In 1979, at the request of the AICPA’s Execu-tive Committee of the SEC Practice Section,the Public Oversight Board (POB) examinedthe question of management services andauditor independence. The POB report con-cluded that “mandatory limitations on scopeof services should be predicated only in thedetermination that certain services, or therole of the firm performing certain services,will impair a member’s independence inrendering an opinion on the fairness of aclient’s financial statements or present astrong likelihood of doing so”[164].

In 1986, the POB of the AICPAcommissioned Audits & Survey Inc. to con-duct a survey on the public perception ofmanagement advisory services on auditorindependence. The findings indicate that thefollowing MAS engagements could impairindependence:• Negotiating mergers, acquisitions and

divestitures;• Performing actuarial services that directly

affect amounts involved on the balancesheet;

• Implementing a strategic plan;• Valuing assets in business combination;• Executive search for senior management;• Renegotiations or redetermining price

under a procurement contract;• Developing a strategic plan; and• Developing an executive compensation

plan[165].

In January 1991, the Big Six accounting firmspublished a report titled The Public Account-ing Profession: Meeting the Needs of a Chang-ing World suggesting a new framework fordefining independence. It stated: “Businessrelationships between public accountantsand audit clients do not impair independenceso long as they result from the ordinarycourse of business and are not material toeither party”. The proposed framework,which was rejected by the Securities andExchange Commission, downplayed concernsabout the appearance of conflicts of interestwith audit clients.

In 1993, the AICPA, in order to assist CPAsin identifying what functions make up con-sulting services, issued the first Statement onStandards for Consulting Services (SSCS),Definition and Standards. The new statementdiscusses auditor independence and the per-forming of consulting services for attestclients. The SSCS states that the AICPA’sindependence standards relate exclusively toperformance of attestation services and thatconsulting for an attest client does not, in andof itself, impair independence[81].

In March 1994, the Securities and ExchangeCommission issued its Staff Report on Auditor

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 28 ]



Independence and discussed whether or notthe performance of management advisoryservices by auditors has an impact on auditorindependence. The SEC stated that “the lackof an apparent, dramatic increase in MASprovided to SEC audit clients suggests that afundamental change in the Commission’sregulation is not necessary at this time[59].

As the size and the complexity of the clientinformation systems needs have risen, CPAfirms have found it necessary to co-contractwith non-CPA firms as a means of efficientlyproviding services to clients. The SEC hastaken the position that co-contracting withaudit clients is unacceptable because itimpairs auditor independence. The Big SixCPA firms have proposed certain safeguardsin an effort to satisfy the SEC’s concerns butthe SEC has not yet developed workable stan-dards on co-contracting with auditclients[166].

In providing management advisory ser-vices including training programmes, super-vision, review of engagements and co-con-tracting, those in charge should emphasizethe significance of independence in mentalattitude[63]. The history of providing MAS toaudit clients has been a thorny issue in theauditing profession. In providing MASengagements, CPAs must be independent infact; independence in appearance is encour-aged[45]. CPAs must be careful that the com-bination of accounting, tax, and managementservices does not create conflict of interest orthe appearance of such.

In summary, research on managementadvisory services impacting on auditor inde-pendence shows contrasting views. Someclaim that MAS can actually enhance auditfirms’ independence. Others believe thatMAS threatens auditor independence. CPAswho provide them may:• become the client’s advocate; • develop a stake in their client’s success;• make decisions that they are later required

to audit; and • become too close to management[45].

In the USA there is no prohibition againstauditors performing management advisoryservices for their clients as long as they donot get involved in making managementdecisions. In Germany, auditors do a lot of taxand management-consulting work with theirclient companies whereas in The Netherlandsauditors do not perform any tax services,management services work, or any otherform of consulting activity for their auditclients. In the UK, independent auditors areallowed to perform certain bookkeeping func-tions for private companies.

In Australia, non-audit service has becomea very important if not the most importantsource of revenue for accounting firms. Aquestionnaire regarding attitudes towardaccounting independence was mailed to Aus-tralian CPAs. The respondents did not thinkthat accounting firms rendering non-auditservices to their clients were at a greater riskof losing their independence than accountingfirms not rendering such services[167].Wines[168] investigated the question ofwhether there is the potential for an appear-ance of auditor independence impairmentwhen higher levels of non-audit services areprovided to audit clients. This question wasinvestigated by analysing the audit reportsfor a sample of publicly listed companies overthe period 1980 to 1989. The findings suggestthat auditors are less likely to qualify a givencompany’s financial statements when higherlevels of non-audit services fees are derived.Barkess and Simnett[169] also conducted aresearch study to:• identify the extent and level of other ser-

vices provided by incumbent auditors inthe Australian business environment;

• examine pricing issues and audit fees; and • address the question of independence by:

– identifying whether the incidence ofaudit qualification is related to the levelof other services purchases; and

– investigating whether there is a relation-ship between audit tenure and the levelof services, size, and audit qualifications.

The study provides evidence that an increas-ing number of clients are purchasing otherservices from their auditors.

Operating responsibilitiesSince complete objectivity is essential to theaudit function, internal auditors should notdevelop and install procedures, preparerecords, or engage in any other activitywhich they normally would be expected toreview and appraise[44].

The Standards for the Professional Practice ofInternal Auditing (SPPIA) specifically pro-hibit internal auditors from assuming operat-ing responsibilities since it would impairobjectivity. But if on occasion managementdirects internal auditors to perform non-audit work, it shall be understood that theyare not functioning as internal auditors.Moreover, objectivity is presumed to beimpaired when internal auditors audit anyactivity for which they had authority orresponsibility. This impairment should beconsidered when reporting audit results(120.02.4).

The Standards also state that: “Designing,installing, and operating systems are not

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 29 ]



audit functions. Performing such activities ispresumed to impair audit objectivity”(120.03).A study was conducted to determine whetherinternal auditor involvement in systemsdesign affects decisions about subsequentaudit work. The participants in the studyconsisted of 51 internal auditors who workedfor 21 different organizations located in alarge US city. The results of the study indicatethat the internal auditors maintained theirobjectivity despite previous involvement inthe design of a particular system. These find-ings support the view that internal auditorsare true to the ideals of objectivity[166].

PSB 81-1, Independence – Bank Reconcilia-tions, cautions that the director of internalauditing should avoid preparing bank recon-ciliations as an operating responsibility. Ifmanagement requires the internal auditingdepartment to perform bank reconciliations,the director of internal auditing shouldinform management and the company’s pub-lic accountant that this activity is not aninternal audit activity; and therefore, audit-related conclusions should not be drawn. PSB81-3, Independence – Operating Responsibili-ties, suggests that the assignment of person-nel to audit the activities for which they pre-viously had authority or responsibilityshould be delayed until their successors havehad the time and opportunity to influence thesystem of control for the activity. Even thoughobjectivity could be preserved by carefullyscheduling steps in the audit programme,PSB 81-3 suggests that the director of internalauditing must consider whether those mem-bers of the organization who read the reportwill accept the results if the auditor previ-ously had operating responsibility or author-ity within the audit area.

When a CPA firm is asked to help an auditclient to implement an information and con-trol system, the firm must be careful to avoiddirect supervision of operations or undueinvolvement in management function. UnderRule of Conduct 101, the CPA firm’s indepen-dence would not be impaired if: • management made all of the decisions

related to both hiring and system imple-mentation; and

• supervisory activities were restricted toinitial instruction and training[171].

In the UK, the Ethics, Interpretations andRulings of the joint Institutes of CharteredAccountants state that an independent audi-tor should not participate in the preparationof the accounting records of public companyaudit clients except in exceptional circum-stances[135].

OutsourcingBecause external auditors must be indepen-dent, in fact and in appearance, of the com-pany being audited, external auditorsattempting to attend to both responsibilitiesof the external auditor and the responsibili-ties performed by the internal auditor func-tion must exercise great care[110].

The independence issue arises when thesame firm that provides an independentopinion of an organization’s financial state-ment also performs an internal auditingengagement upon which management basesits opinion[172].

Reasons for outsourcingThe recent phenomenon of outsourcing is

viewed by the Institute of Internal Auditors,the Securities and Exchange Commissionand internal auditors as a potential threat toauditor independence. Courtemanche[173]believes that the major reason for outsourc-ing the internal audit function is that CPAfirms can provide better services with betterqualified staff, lower overall costs, continuityof internal audit operations, and better plan-ning. To prevent outsourcing, he believes thatinternal auditors must provide added valueto their organizations since outside firmsclaim that they have: • more qualified staff; • better planning; • greater emphasis on internal control; • discount pricing and lower overall costs;

and • continuity of operations.

Peter Block[174], in his book Stewardship,maintains that “consistency and control havebeen the way we rationalize the need forpolicing and auditing” and admonishes that“when given a choice, and it is coming, theline organization will not continue to buypolicing, inspection, and care-taking ser-vices. Instead, they will ask: “What valuehave you added to the process of deliveringour product or service to our customers?”Block’s idea is that staff functions, includinginternal auditing, need to begin buildingcompetency in the organization they serve.He stated: “Instead or maintaining consis-tency and control, their contribution is thatof building capability. Auditing’s deeper pur-pose is to support stewardship responsibili-ties at every level”[175].

Gary Stern[176] suggests 15 ways of addingvalue to the company; these include auditors:• becoming catalysts of change; • sharing technology; and • concentrating on business risks.

Lampe[177], James[178], and others share thesame view that audit departments that fail to

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 30 ]



bring added value to the company may runthe risk of being outsourced. The outsourcingof the internal audit functions proves, accord-ing to Tongren[179], that internal auditorsare not independent of those who controltheir resources. Internal auditors cannotperform objective audits of the overall inter-nal control system when they are an integralpart of it. He questions the basic doctrine ofinternal audit as of an independent appraisalfunction that aims to assist members of theorganization in the effective discharge oftheir responsibilities and suggests to replacethe concept of “independent” internal audi-tor with the synergy of the work group, thejudgemental appraisal of an “outsider” inter-nal auditor with team self-realization.Richard Anderson[129] believes that if audi-tors are not successful in enhancing servicesand perceived value to clients and sharehold-ers, “future examples of entrenched,inwardly focused, and defunct organizationsmay include us”.

Downsizing, rightsizing, re-engineering,and outsourcing are not limited to the inter-nal auditing departments. The trend suggeststhat companies are moving away from a hier-archical organization structure to a horizon-tal or flat organization structure to increasecommunication among various departmentsand gain a better control of their organiza-tion. But the outsourcing of the internal auditfunction may pose more problems than com-panies had bargained for.

Management may unconsciously outsourceinternal auditing departments, not because ofits lack of added value to the organization, butrather for other suspicious motives such as:• meeting stockholders’ expected higher

returns; and • eliminating those basic controls which may

impair management fraud.

Outsourcing is often undertaken by compa-nies without understanding the full spectrumof the advantages and disadvantages in elimi-nating the internal auditing function. TheTreadway Commission and a recent study onaudit committees sponsored by the Instituteof Internal Auditors suggest that auditorsmust be proactive in advising both manage-ment and audit committees on internal audit-ing matters. A well-informed audit committeecan be a strong ally in preventing outsourc-ing[68].

A survey of 72 Big Six audit partnersreveals that outsourcing is a real threat toauditor independence. The partners whohave been involved in outsourcing reportedthat 86 per cent of their engagements werewith current clients[178]. Outsourcing elimi-nates the common checks and balances that

exist between internal and external auditorssince the Big Six firms would have a monop-oly on an organization’s operational auditprocesses[180]. This limitation would existwhen the same firm was performing bothfunctions.

The SEC position on outsourcingThe 1984 SEC’s interpretative decision onRule 2-01(b) of Regulation S-X views outsourc-ing an impairment to auditor independence:

It also appears that the “Internal Audit TypeDuties”... would impair the appearance ofthe Firm’s independence. The internalauditor relationship seems to be one whichwould be close in nature to that of anemployee. An auditor may assist a client inthe establishment of a system of internalcontrol which will be administered by theclient’s personnel. An internal audit func-tion generally would be part of the system ofinternal controls administered by employ-ees of the client.

On 4 November, 1994, during the AICPA’sNineteenth Annual Conference on Banking,Walter D. Schuetze, the past chief accountantof the US Securities and Exchange Commis-sion, questioned the independence of out-sourcing practices whereby external auditorsperform both the external and internal auditfunctions. He stated:

I understand that there are many differentalternatives available to a company thatwishes to outsource its internal audit func-tion. One alternative being considered bysome is for a company to completely replaceits internal audit function with an“expanded” external audit function. As aresult, the external auditor would performboth the external audit functions and thefunctions previously performed by the inter-nal audit department. That is, the externalauditor would be responsible for: • performing audit procedures and issuing

an opinion on whether the financialstatements were prepared in conformitywith GAAP,

• issuing another opinion on manage-ment’s assertions regarding the effective-ness of the company’s internal controls,and

• designing and executing audit proce-dures that traditionally were performedby the internal auditors.

Because external auditors must be indepen-dent, both in fact and in appearance, of thecompany being audited, external auditorsattempting to attend to both the responsibili-ties of the external auditors and the responsi-bilities traditionally performed by the inter-nal audit function must exercise greatcare[181].

At the 1995 AICPA’s National Conference onBanking, Michael H. Sutton, SEC chief

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 31 ]



accountant, expressed his frustration overthe lack of clear, ethical guidance in the areaof auditor independence[182]. The SEC offi-cial called for clarification as to whether ornot an independent auditor who accepts out-sourced internal audit functions from a clienthas assumed management or employeeresponsibilities:

I’m getting impatient with the AICPA; I’mgetting impatient with the process of clarify-ing the standards. I want to emphasize thatit is not the staff ’s goal to preclude auditorsfrom providing internal audit outsourcing.Rather, if auditors provide those services tothe audit clients, we believe that the impactof those arrangements on auditors’ indepen-dence should be carefully considered ineach situation[183].

At the 14 December, 1995 meeting of the Com-mittee of Sponsoring Organizations (COSO)of the Treadway Commission, Sutton dis-cussed the situation in which the externalauditor has both the attest function and theinternal auditing engagement. He expressedthe SEC’s concern regarding the externalauditor’s independence in providingextended audit services. He emphasized thefollowing points:• There should be a responsible and compe-

tent manager for internal auditing withinthe company with a clear separation ofmanagement and external auditor func-tions.

• The guidelines covering “extended auditservices” should clearly delineate ongoing“monitoring” activities so as to identifythose that could impair the independence ofexternal auditors.

• In attestation situations such as FDICIA,the external auditors should obtain assur-ances from management that it did not relyheavily on the external auditor to form thebasis for management’s assertion on theeffectiveness of internal controls.

• There should be a clear separation of man-agements’ and auditors’ responsibilitiesand that their individual roles should beclarified (Bishop’s letter to Finkston,Appendix 1).

Spectacular business failures have beenattributed to the absence of a sound internalcontrol system. The SEC enforced the ForeignCorrupt Practices Act and required that allcompanies devise an internal control systemto prevent unethical and illegal actions per-petrated by management. Simply, outsourc-ing means weakening the apparatus of theinternal control system for which the SEChad worked assiduously for many years. Italso runs counter to the Treadway Commis-sion’s recommendation that active

participation of the internal audit function inall facets of the company is vital to preventthe issuance of fraudulent financial state-ments.

The AICPA position on outsourcingIn 1993, the AICPA, aware of the potentialimpact of outsourcing on the external auditor’s independence, issued Ethics Ruling97, Performance of Certain Extended AuditServices[31], which states that the externalauditor: • cannot perform management functions or

make management decisions; • cannot be part of the client’s approval

process; and • cannot be part of the internal control sys-

tem without impairing their independence.

In its response to the proposed interpretationof the AICPA Ethics Ruling 97, the AICPA’sPublic Oversight Board (POB) declared itssupport “of the performance of extendedaudit services by the external auditor as longas the auditor does not assume management’soperational or decision-making responsibili-ties”. However, the SEC staff advised auditorsthat it would question independence, consis-tent with Ethics Ruling 97, when externalauditors perform procedures that are man-agement functions. Practitioners are, there-fore, advised to give careful consideration tothe implications that attend such outsourcingarrangements and the resulting effect on theaccountant’s independence[182].

Jerry Sullivan, executive director of thePublic Oversight Board, observed that thePOB’s position is based on the premiss thatthe monitoring of the internal control systemover and above that required by the generallyaccepted audit standards, when performed bythe external auditor, is not part of the inter-nal control structure as defined by the COSOReport. In his letter to the AICPA’s director ofprofessional ethics, Sullivan stated:

COSO recognizes and states that partiesexternal to the organization, such as regula-tors, the independent auditor, customers,and others transacting business with theenterprise, are not part of the entity’s inter-nal control system but do assist manage-ment in fulfilling its responsibility to moni-tor internal control. Thus, monitoring activ-ities conducted by the independent auditorto replace the internal audit function arenot internal to the organization and are notpart of the monitoring component of theinternal control structure[184].

Sullivan’s interpretation refers to the follow-ing passage of the COSO Report:

Everyone in the organization has someresponsibility for internal control. Manage-ment, however, is responsible for an entity’sinternal control system. The chief executive

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 32 ]



officer is ultimately responsible and shouldassume “ownership” of the control system.Financial and accounting officers are cen-tral in the way management exercises con-trol, though all management play importantroles and are accountable for controllingtheir unit’s activities. Similarly, internalauditors contribute to the ongoing effective-ness of the internal control system, but theydo not have primary responsibility for estab-lishing and maintaining it. The board ofdirectors and its audit committee provideimportant oversight to the internal controlsystem. A number of external parties, suchas external auditors, often contribute to theachievement of the entity’s objectives andprovide information useful in effectinginternal control. However, they are notresponsible for the effectiveness of, nor arethey a part of, the entity’s internal controlsystem.

But the COSO reports indicates that:• Internal control is effected by people within

the entity.• Internal auditing is part of the entity’s

internal control system – a Managementresponsibility.

• External auditors are not part of the inter-nal control system.

At the session on “Outsourcing the auditfunction” sponsored by the IIA, some panel-lists expressed their concerns about CPAfirms performing the internal audit functionfor their clients. Richard Anderson, nationaldirector of internal audit services for Ernst &Young, expressed concern for independenceand urged that care be taken in such situa-tions. He stated:

Such an engagement has to be very carefullystructured to protect our independence andthe independence of the company. We havevery specific policies how those types ofengagements have to be structured[185].

On 5 April, 1995, key representatives of theAICPA’s Public Oversight Committee (POB),visited IIA headquarters seeking input on theissue of auditor independence. POB executivedirector Jerry D. Sullivan and representativeDonald J. Kirk discussed with IIA representa-tives the independence of external auditorswho perform both the internal and externalauditing functions for the same organization.The IIA presented the argument that anexternal auditor’s independence is impairedwhen performing both financial and internalauditing for an organization[35].

In June 1995, A.A. Sommer Jr, chairman ofthe POB, wrote a letter to the AICPA EthicsDivision stating that the POB is supportive ofthe performance of the extended audit ser-vices by the external auditor “as long as theauditor does not assume management’s

operational or decision-making responsibili-ties”. He further stated: “We have heard infor-mally from representatives of the Institute ofInternal Auditors and certain regulators acontrary view, i.e., that such extended moni-toring is part of the internal control structureas defined in the COSO Report, and therefore,the performance of the service by the external auditors might impair independenceunder certain circumstance”. He urged thatthe Ethics Ruling 97 dealing with this issue bere-examined[186].

In September 1995, the Public OversightBoard (POB) report entitled Directors, Man-agement, and Auditors – Allies in ProtectingShareholders Interests stated that under theresponsibilities of the independent auditor:

The board of directors, as the representativeof the shareholders, should be the client, notcorporate management. Corporate boardsand audit committees should make thisclear to the auditors[187].

At the 19 January, 1996 meeting of the AICPAProfessional Ethics Executive Committeeheld in Fort Lauderdale, Florida, there wasrecognition that independence could becomean issue when the attest function auditor andinternal auditor are the same. The Commit-tee commented that services can be dividedinto components: management of the internalauditing function; and performance ofextended audit procedure. The view of theCommittee is that performance of procedurescan be performed by the external auditorwithout impairment of independence. TheIIA recognized that “extended audit services”can effectively supplement an organization’sinternal auditing function, although “The IIAbelieves that total management of the inter-nal auditing function must consist of organi-zation employees”[188].

On 28 February, 1996, the ProfessionalEthics Executive Committee issued an Expo-sure Draft of proposed interpretation 101-13“Extended Audit Services” and related rul-ings under Rule 101, Independence, whichwas mailed for a six-day comment period to10,000 AICPA members. William J. Inlanfeldt,president of the Institute of ManagementAccountants (IMA), in response to the Expo-sure Draft, wrote:

Generally, the IMA Ethics Committee doesnot support the AICPA’s proposed interpre-tations and rulings as outlined in the Expo-sure Draft, and the committee urges theAICPA not to proceed based upon the pro-posed provisions. The principal reason forthe committee’s position is that the perfor-mance of the extended audit services suchas internal auditing by the same form whichconducts the external audit would, at aminimum, impair the appearance of inde-pendence under any circumstances.

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 33 ]



Inlanfeldt felt that: the exposure draft’s attempt to define cir-cumstances that would maintain indepen-dence for the external auditor to performsuch services will create a serious publicperception problem if the rulings and inter-pretations are implemented. It would appearto us that the solution to this problem isstraightforward. Any public accountingfirm can perform the internal audit func-tion for any client for which it does notperform the attest function[189].

By advocating outsourcing, directly or indi-rectly, the AICPA has aroused the IMA’s andthe IIA’ s suspicion, and justifiably so, that theconcept of independence of CPAs does notreflect the ethical posture on independenceespoused by its predecessor – the AmericanInstitute of Accountants – which stated that:“Independence in the last analysis bespeaksan honest disinterest on the part of the audi-tor”. Some internal auditors may interpretthat the AICPA is reneging on its originalposture on auditor independence.

The IIA position on outsourcingThe IIA position, in its white paper entitledPerspective on Outsourcing Internal Auditing:a Professional Briefing for Chief Audit Execu-tives[146], is that a competent internal auditdepartment that is properly organized withtrained staff can perform the internal auditfunction more efficiently and effectively thana contracted service since “internal auditorsare better acquainted with the organization,policies, procedures, operating practices, andpersonnel”. The IIA recommends that inter-nal auditors:• evaluate their mission and strategies on an

ongoing basis, and they should ensure thatmanagement is aware of the unique andcritical contributions of the internal audit-ing department;

• prepare and implement a vision statementwhich is based on and linked to the overallorganizational vision and is implementedthrough a strategic plan. An internal audit-ing department with vision is: – proactive, – innovative, – focused, – integrated, and – motivated.

Other key indicators for strong auditingdepartments include:• a clear image of who are the most impor-

tant internal auditing customers;• an enhanced planning process;• an enhanced methodology that provides

selective risk coverage and increased man-agement involvement in the audit process;

• a definition of the role and services that theinternal auditing function must provide;

• strong communication skills;• enhanced organizational and staff develop-

ment[190].

The IIA has discouraged outsourcing andprovided useful advice to help members todevelop a positive professional strategy withregard to outsourcing. The IIA’s position onoutsourcing is based on the following ratio-nale: • When the internal auditor and the external

auditor are one and the same, it will jeopar-dize the external auditor’s independence.

• An organization cannot delegate its totalresponsibility for monitoring the effective-ness and efficiency of its internal controlstructure to an external party, especially toits external auditors.

One-time extended services or activities can,however, be performed under the supervisionof the internal auditing director, such as:• reviewing controls in new applications

development;• providing auditors to support audit tests in

remote areas;• providing language skills on international

audits;• analysing controls of re-engineered

processes; and• investigating frauds.

The IIA’s posture on outsourcing is a graveconcern for the auditing profession. The IIAbelieves that outsourcing:• violates the IIA’s Standards for the Profes-

sional Practice of Internal Auditing (SPPIA)which states: “The internal auditingdepartment is an integral part of the orga-nization and functions under the policiesestablished by senior management and theboard”;

• does not comply with the Committee ofSponsoring Organizations’ (COSO) Guide-lines on internal control which state that:– internal control be effected by people

within the entity;– internal auditing is part of the entity’s

control system – a management respon-sibility;

– external auditors are not part of theinternal control system.

The pamphlet has had a great impact in dis-suading some corporations from outsourcinginternal audit departments[191]. The stature,the maturity, and the professionalism of theauditing profession, as evidenced in the last20 years, supports the IIA position on out-sourcing.

On 26 September, 1995, William G. BishopIII, president of the Institute of Internal

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 34 ]



Auditors, in his letter addressed to MichaelH. Sutton, the SEC’s chief accountant, reiter-ated the IIA’s long-standing position on out-sourcing which considers outsourcing ofmaterial segments of internal auditing workto an external auditor to be inappropriateand a threat to independence. Bishop makes aforcible argument on the incompatibility ofthe so-called “extended services” on the partof the external auditors (Appendix 2).

On 5 December, 1995, IIA president Bishop,in a press release titled Accountants MayImpair Independence by Accepting InternalAudits, termed the move by public accoun-tants into total “outsourcing” internal audit-ing functions a threat to the objectivity andindependence of the auditing process[192].Bishop believes that the control environmentof the organization is adversely impacted bythe disruption of the roles of internal andexternal auditing.

On 15 January, 1996, IIA president Bishopsent a letter to Herbert Finkston, director ofthe AICPA Professional Ethics Division, inwhich he wrote that the development andinterpretations on the independence of theexternal auditors when performing the inter-nal auditing function for a client, should giveconsideration to the IIA Standards and otherpronouncements which provide a basic struc-ture to frame the three factors impacting theindependence of the external auditor:1 the scope of internal auditing;2 the structuring of internal auditing as part

of management; and3 the demand for total independence of the

external auditor.

Bishop made the following three recommen-dations:• that the Ethics Executive Committee specif-

ically define “extended audit services” so asto identify those services that would impairthe independence of the external auditor;

• that language be included that wouldrequire a dedicated, competent professionalappropriately resourced to be able to carryout the full authority and responsibilityrequired to comply with the IIA Standards;

• that the Code of Professional Ethics guide-lines should focus on the need for totalindependence of the external auditor.Guidelines should encompass the breadthof internal auditor and managementresponsibilities, including planning,staffing, organizing, controlling, reporting,follow-up, etc. Further, the guidelinesshould include requirements to documentfully the scope and conditions of theengagement, including an understanding ofthe extent of management’s reliance upon

the external auditor for an assessment ofthe system of internal control (Appendix 1).

Bishop believes that the “extended auditservices” provided by the external auditorare not clearly defined, and it is unclearwhether these services encompass the fullrange of internal auditing activities.

On 31 January, 1996, IIA president Bishopmet with representatives of the Big Sixaccounting firms to discuss the outsourcingof the internal auditing function. The IIAarticulated its view on outsourcing into eightstatements:1 Internal auditing must be performed in

accordance with the IIA’s Standards.2 The internal auditing function is best

performed by a fully resourced and profes-sionally competent staff that is integratedto the management of an organization.

3 Independence is an issue when total inter-nal audit function is performed by theorganization’s external auditor.

4 Some situations warrant outsourcing toachieve organizational goals and objec-tives more economically.

5 Outsourcing could be a remedy to substan-dard internal auditing activities.

6 Outsourcing can be preferable to havingno internal auditing.

7 The IIA’s role in guiding internal auditorsto improve the quality of the internalauditing services.

8 The IIA posture to co-operate with publicaccounting firms in all aspects of the pro-fession[193].

On 26 April, 1996, the Institute of InternalAuditors made its official response to theAICPA Professional Ethics Division regard-ing the Exposure Draft, Omnibus Proposal ofProfessional Ethics Division Interpretationsand Rulings, dated 28 February, 1996. In itsresponse, the IIA recommended that theExposure Draft:• include greater definition of the manage-

ment responsibilities that the externalauditor cannot assume without impair-ment of independence;

• more clearly define the types of extendedaudit services (internal auditing) which, ifperformed, would impair the external audi-tor’s independence;

• delineate ongoing “monitoring” activitiesand identify those that impair the externalauditor’s independence.

The IIA also made the following suggestions:• With respect to the responsibilities of the

client for managing the internal auditingfunction, the IIA recommends that the finalinterpretations and rulings include a refer-ence to the IIA’s Standards, and/or incorpo-rate explicit statements individually

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 35 ]



describing those “director of internalaudit” responsibilities prescribed in theIIA’s Standards.

• The Exposure Draft should amplify themanagement functions of the internalauditing department that must remainwithin the company to protect the indepen-dence of the external auditor from impair-ment and should require the company toretain a qualified director of internal auditcapable of performing those managementfunctions.

• Management should not rely to a materialdegree on the work of the external auditorwhen performing their assessment of thesystem of internal control. In executingtheir responsibilities to the client’s share-holders, the external auditor should testmanagement’s representations withoutbeing involved in supplying informationused to formulate the assessment.

• The Exposure Draft should delineate thetypes of extended audit services and specifythose that impair independence. The rulingshould preclude performance ofoperational audits during which the mem-ber evaluates business activities andprocesses to the point of formulating rec-ommendations for procedures which aremanagement’s responsibility[189].

The IIA believes that the adoption of theExposure Draft, in its present form, wouldresult in independence standards in the USbeing less stringent than in other countries.

Cases of outsourcingThe following cases show that outsourcing ofthe internal auditing function can be detri-mental to companies:• An outside auditor, who was doing the

Landmark Bancorp’s internal audit work,failed to detect a $2.1 million fraud. Thebank officer was stealing from unusedcredit lines of six customers and using anoutside address to receive the customers’billing statement. Landmark discontinuedthe outsourcing and hired its own internalauditors[194].

• In 1993, most of the internal audit depart-ment of Morrison Knudsen Corporation inBoise, Idaho, was laid off and Deloitte &Touche was charged with performing Mor-rison’s external and internal audit. A Mor-rison’s spokesman defended Deloitte’s“double duty” arguing that there was noconflict of interest because the accountingfirm has a “Chinese wall” and so, inessence, it does two audits. In early 1995, theboard ousted William Agee as chief execu-tive officer because the construction com-pany reported huge losses[194,195].

Some corporations have adopted the singleintegrated approach. In 1993, Chicago’s Conti-nental Bank outsourced the bulk of its inter-nal auditing function by expanding its rela-tionship with Price Waterhouse, its externalauditor since 1985. Under this unusualarrangement, internal and external auditingwork have been integrated[196]. The Conti-nental Bank researched the possibility ofoutsourcing the internal function completelybut rejected it. Instead the Continental Bankadopted a single integrated audit programmewhich combines the previously separateinternal and external audit programs into asingle whole under the joint management ofContinental’s Audit Department and PriceWaterhouse[125].

Some companies and banking institutionshave rejected outsourcing:• In New York, the audit committee of a large

multinational bank rejected the idea ofoutsourcing the internal audit functionafter a presentation on the topic by thegeneral auditor. The presentation, whichrelied heavily on the material from the IIA’spamphlet on outsourcing, pointed out theadvantages of a professional internal func-tion and outlined the SEC’s position onoutsourcing[197].

• On 9 February, 1995, the Norwegian Bank-ing, Insurance, and Securities Commissionsent a circular to the boards of directors ofall commercial and savings banks, andinsurance companies stating that internalaudit work cannot be performed by thefinancial institution’s externalauditors[198].

• The US Government’s FDIC ImprovementAct 1991, the Office of the Comptroller of theCurrency, the Federal Reserve Board, andthe Office of Thrift Supervision’s Draft,Interagency Policy Statement on Audit Out-sourcing, have raised the external auditor’sindependence issues and questioned thepractice of outsourcing[198].

Some companies may prefer outsourcing theauditing function. The cost savings providedby outsourcing may be worth the risk. In1993, McDermott International, the bigmarine-construction company based in NewOrleans, gave Ernst & Young, its externalauditor, the internal auditing job. The movewas made to save several million dollarsannually[194].

Reactions to outsourcingThe specific functions attributed to the inter-nal auditors and external auditors are viewedby professional and governmental bodies asseparate and independent in the checks andbalances of the internal control systems. Thenecessity of the internal audit function in the

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 36 ]



corporate and governmental settings hasbeen recognized worldwide. The ResearchCommittee of the Institute of CharteredAccountants of Scotland (ICAS) in a discus-sion document entitled “Auditing into thetwenty-first century” emphasizes such aneed:

To provide a board of directors with reassur-ance that its management informationsystems and internal control systems aresufficiently reliable and relevant, we believeeach company should establish and main-tain a strong internal audit function underthe direction of a Chief Internal Auditor. Asthe internal auditors will be carrying outtheir work on a continuous basis theyshould have a sound understanding of therange of activities in which a company isinvolved. The Chief Internal Auditor shouldbe in a strong position to provide a board ofdirectors with reassurances regarding thereliability and relevance of the systemsbeing operated within that company.

The ICAS Research Committee also recog-nized that the need for constant monitoring ofthe system of internal control is a role for theinternal auditors rather than the externalauditors. McInnes and Stevenson[118] believethat “the present work of the external audi-tors does not provide boards of directors withthe reassurance on internal controls”.

Prior to the POB’s statement on outsourc-ing, the IIA presented its view that, becauseof the auditor’s dual role in the controlprocess, the performance of internal auditsby the external auditor may jeopardize theauditor independence and thereby contributeto the organizational risk. Carman Young,the auditor for the Bank of Canada and IIApast chairman, voiced the IIA’s concern whenthe same external auditor responsible forattesting to the fairness of an organizational’sfinancial statement performs the internalaudit[186].

According to the Institute of Internal Audi-tors’ survey on outsourcing, several coun-tries and organizations preclude statutoryauditors who certify financial statements of acompany from serving as the internal audi-tors:• The European Confederation of Institutes

of Internal Auditing stated in their 1995Position Paper that the “knowledge andunderstanding of internal auditing can bestbe achieved by entrusting internal auditingto personnel employed within the enter-prise”.

• The Federation of European AccountingExperts, in their The Role, Position andLiability of the Statutory Auditor in theEuropean Union (January 1996), stated thattwo countries, France and Italy, prohibit the

simultaneous provision of all non-auditservices by the statutory auditor.

• The Italian agency which oversees the pub-lic companies quoted in the stock exchangehas released regulations which forbid com-panies from hiring management consultingfirms which are directly or indirectly asso-ciated with the firms who certify theirfinancial statements.

• The Indian Companies Act 1956 precludesstatutory auditors, who certify financialstatements, from serving as internal audi-tors of the company[189].

Opinion shopping and lowballingThe value of the accountants’ attestation isdue to their neutrality and judicial impar-tiality[63].

The SEC has defined opinion shopping as thepractice of seeking an auditor willing to sup-port a proposed accounting treatmentdesigned to help a company to achieve itsreporting objectives even though doing somight frustrate reliable reporting. Auditorindependence, the credibility, role, and statusof the accounting profession, and the reliabil-ity of financial statements can be substan-tially affected by opinion shopping[199].

In 1977, the Commission on Auditors’Responsibilities, known as the Cohen Commission, cited possible “excessive com-petition” for opinion shopping. Such a prac-tice affects the quality of services[200]. Toenhance auditor independence and deteropinion shopping, the SEC requires thatregistrant companies provide an explanationas to why the auditor was fired. ASR # 165explicitly states that whenever the companiesdismiss the auditor they must give the follow-ing information in filing Form 8-K onwhether:

there were any disagreements with theformer accountant on any matter ofaccounting principles or practice, financialstatement disclosure or auditing scope orpractice, which disagreements if notresolved to the satisfaction of the formeraccountants would have caused him to makereference in connection with his report onthe subject matter of the disagreement[201].

Form 8-K requires the following disclosures: • Were former accountants dismissed or did

they resign? • Did the board of directors or audit commit-

tee discuss disagreements with formeraccountants? and

• Did registrant company limit discussionbetween new and former accountants?[202].

A study found that after the change of auditor,the company’s reported earnings and audi-tors’ opinions were more favourable[203]. In

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 37 ]



the UK, the need to take into account thepublic’s perception of auditors and theirindependence led the Joint Ethics Committeeof the Institutes of Chartered Accountants inEngland and Wales (ICAEW), Scotland (ICAS)and Northern Ireland (ICANI) to limit thecircumstances in which audit firms may givesecond opinions, and to ban specialist valua-tions. It was felt that the danger in providinga second opinion is that the firm might not beaware of particular circumstances[204].

Regulatory bodies have also expressedconcern about the common practice of pric-ing initial audit significantly below cost (low-balling). They fear that lowballing couldweaken auditor independence and reduceaudit quality[205]. The SEC also criticized thepractice of lower initial fees, suggesting thatit could affect the auditor independence in amanner analogous to uncollected fees[206].

Quality controlThe evaluators must be independent of theorganization and without a real or apparentconflict of interest[10].

Competence alone is not sufficient; auditorsmust also be free of client influence in per-forming the audit and in reporting the find-ings. To emphasize independence from theirclients, members of professional associationsembraced self-regulation to emphasize theirindependence toward their clients. Theywanted to assure the public, investors, andcreditors that their services were not only ofhigh quality but were also done with impar-tiality. As a consequence, the AICPA, the IIA,the SEC, the GAO and other professionalbodies developed policies to ensure qualitycontrol among them by subjecting themselvesto self-regulation and independent reviewsand appraisal of performance.

In 1976, the US General Accounting Office(GAO) issued Audit Standards SupplementNo. 9, Self-Evaluation Guide for GovernmentalAudit Organizations[207]. In 1977, the Comp-troller General of the USA issued a Comptrol-ler’s Handbook for National Bank Examinerscontaining instructions for the review of abank’s internal audit function[208]. In 1977,the AICPA issued its Statement of QualityControl Statement No. 1, System of QualityControl for CPA Firms which mandates CPAfirms to have a system of quality control. Thefirst element of quality control is indepen-dence and pertains to the performance ofattest services only. It states:

All professionals should be independent ofclients when performing attest services. Aninvestigation is made to determine thefirm’s independence before accepting a newaudit client[209].

In 1978, the AICPA established a QualityReview Division for CPA firms and issued aPeer Review Manual to emphasize CPA firms’independence and integrity in theirwork[210]. Policies and procedures should beestablished to provide the firm with reason-able assurance that firms at allorganizational levels maintain independenceto the extent required by the: • rules of conduct; • regulations; • interpretations; • rulings of the AICPA, state CPA society,

state board of accountancy; and, if applica-ble,

• accounting series releases of the Securitiesand Exchange Commission[124].

In 1984, the Institute of Internal Auditorsfollowed other professional organizations asa means of objectively reviewing internalauditing functions and issued a QualityAssurance Manual for Internal Auditing[211].Later, the IIA amended the SPPIA and issuedSIAS No. 4, Quality Assurance[212].

In 1987, the suit over the fraud of E.S.L.Government Securities Inc. not only receivedthe profession’s attention as a threat to theentire profession’s reputation, but alsoencouraged improved emphasis on qualitycontrol, auditor’s independence, the maintenance of an ethical environmentwithin CPA firms and clearer communica-tion. Integrity is foremost in tandem withtechnical effectiveness[45].

Rotation of auditorsThe lack of auditor rotation could conceiv-ably compromise independence in someorganizations[213].

The SEC prohibits anyone who performswrite-up services for a company from alsoserving as an auditor for that company. Toprevent close relationships between the clientand the auditor that might impair the appear-ance of independence, accounting firms thatbelong to the SEC Practice of the AICPA arerequired to rotate every five years the partnerin charge of a client.

In March 1992, the SEC Practice Section ofthe AICPA issued a report entitled Statementof Position Regarding Mandatory Rotation ofAudit Firms of Publicly Held Companies mak-ing a case in opposition to mandatory rota-tion[214].

To enhance auditor independence, direc-tors of internal audit departments rotatetheir audit staff especially in small firms. In asurvey of internal audit directors of smallgroups (staff sizes two to eight), it was feltthat monitoring independence and handlingpeer review can present thorny problems for

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 38 ]



small audit staff. Directors must be sensitiveto situations that might impairindependence, and they should intervenepersonally as needed. Directors feel that sim-ply being aware of the potential problem andkeeping close watch mitigates the indepen-dence issue[213].

The IIA’s PSB 82-5, Independence – Objectiv-ity, cautions that auditing the same areaseveral times might result in personal rela-tions with the auditee that could impairobjectivity. Internal auditors may not con-tinue to use professional scepticism inreviewing areas with which they are familiar.Accordingly, it is a prudent policy to rotateauditors periodically from assignment toassignment. PSB 82-5 also recommends thatan internal audit department’s professionaldevelopment program for staff should includeproper job rotation that will allow profes-sional growth and will assure that audits areperformed objectively.

In 1992, the Chartered Accountants’ JointEthics Committee in the UK proposed therotation of audit partners, not only because itwould help avoid situations that could leadoutsiders to question the auditor’s objectivity,but also because it would give the client thebenefit of a fresh and objective scrutiny of thefinancial statements[204].

ConclusionWe must be fully aware of the truth thatcomplete independence can never beachieved. This is true because there arealways conditions that to some extent limitindependence[1].

Auditor independence is considered the hall-mark of the auditing and accounting profes-sion. Independence is viewed as the mostessential element of the audited financialstatements in safeguarding the interests ofseveral parties – management, investors,creditors, and the government. Professionalassociations such as the American Instituteof Certified Public Accountants, the Instituteof Internal Auditors, the Canadian Instituteof Chartered Accountants (CICA), the Cad-bury Committee in the UK, and many othershave recognized the importance of auditorindependence as both a professional andethical matter and codified it in their profes-sional codes of ethics. The US Securities andExchange Commission, the US GeneralAccounting Office, foreign governments, andstock markets have played an important rolein requiring that financial statements beaudited by independent accountants.

The SEC, since its inception, has played anactive role in enhancing auditor

independence, issued several accountingseries releases, and provided several exam-ples of situations that could impair auditorindependence. Unfortunately, many countriesdo not have a governmental body like the USSecurities and Exchange Commission toenforce auditor independence in auditedfinancial statements.

The survey of the countries examinedshows that they have taken steps to enhanceauditor independence by: • establishing codes of ethics; • promulgating professional auditing stan-

dards; and • detailing situations that may constitute

impairment of auditor independence.

The UK recognized the relevance of auditorindependence as early as 1845. Most countrieshave followed the UK footsteps in requiringthat financial statements be audited by inde-pendent auditors. Most countries view audi-tor independence not just as a legal tenet butalso an ethical matter to reckon with. Mostcodes of ethics prohibit conflicts of interestby not: • allowing the auditor to serve as director or

employee of the company audited;• acting as a corporate trustee of the com-

pany audited;• accepting, making, or guaranteeing loans

from or to an audit client;• having a direct or indirect material interest

in the company audited;• assuming operating responsibilities;• having family relationship with the audit

client;and • being in situations in which auditor inde-

pendence is presumed to be impaired.

In several countries, the implementation ofauditor independence and the compliancewith professional audit standards are carriedout by their governments and, in many occa-sions, sanctioned by professional associa-tions. Independent auditors may be censuredand even expelled from their respective pro-fessional associations if they are found inviolation of their codes of ethics.

The survey also shows that cross-culturaldifferences may limit the effectiveness ofauditor independence even within a rela-tively homogeneous profession such as audit-ing. First, they create a lack of consensuswithin a profession as to what constitutesauditor independence; and, second, theycause a diversity of interpretations. Thestatement that auditors should be indepen-dent “in fact and appearance” will be a puzzlein a collective culture in which relationshipsand group memberships are the cornerstonesof society[92]. Jensen and Yiu[106] indicatedthat the Western concept of auditor

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 39 ]



independence runs counter to the culturalvalues of the Asian communal society. EvenConfucius’s admonishments discourage audi-tor independence since “The man who islearned and discerning risks his life, for heexposes others’ faults” – (Lau Tse’s Admon-ishment to Confucius). China, Japan,Malaysia, and Singapore may adopt interna-tional auditing Standards for their multina-tional corporations, still their cultural valuesare inconsistent with the independent rela-tionships of the Asian society, their belief inthe centrality of the group, and its resultingdesire for privacy[113].

Since the admission of the UK into whatwas then the European Common Market,later became the EEC and is now the Euro-pean Union, and the enactment of the EighthDirective on Company Law on auditors’ quali-fications, the European countries are famil-iarizing themselves with the American con-cept of auditor independence. Some criticsbelieve, however, that cultural differencesamong European countries make the conceptof auditor independence into a sort of windowdressing. This may be the reason that led theInternational Audit Committee of the Inter-national Federation of Accounting (IFAC) tolet the local governments deal with matters ofauditor independence and other related mat-ters.

Auditing in Africa, in Russia, and in someMiddle Eastern countries is still in itsinfancy. It is premature to predict how auditindependence will evolve. Audit indepen-dence in the Anglo-Saxon countries (Aus-tralia, Canada, UK, USA, and New Zealand)has reached a high level of sophisticationowing to the influence of powerful accountingand auditing bodies.

The Institute of Internal Auditors hasplayed a major role in fostering the internalauditor independence and placed it at the topof its agenda. To dispel the notion that inter-nal auditors, as part of management, may beviewed as less independent than their coun-terpart – the external auditors, the SPPIArequired that internal auditors report to thehighest echelon of the management hierarchyand that an audit committee be made of exter-nal directors. The Institute of Internal Audi-tors, as an international auditing association,will face some dilemmas in the area of audi-tor independence on whether the SPPIAought to be modified to meet the culturalvalues of its diverse international member-ship, or let the local institutes develop theirown standards in consonance to their cul-tural values.

The US Securities and Exchange Commis-sion has recognized the unique role of inter-nal auditors and has required that

corporations devise an internal control sys-tem and establish an internal audit functionto monitor the internal control system incompliance with the Foreign Corrupt Prac-tices Act. Internal auditor independence is awell-accepted notion worldwide that even theAICPA has recently created a new internalauditing post of the director of internal auditand quality control. According to AICPApresident, Barry Melancon, the creation ofthe post indicates that “internal auditing issomething that goes beyond the financials, itincludes your organization’s processes andability to meet its goals”[181].

Certified public accountants (CPAs) are notlimiting themselves to the traditional attestfunction of financial statements but haveexpanded their services by providing compa-nies with management advisory services(MAS) and absorbing the functions of theinternal auditors. This has caused a seriousconcern on the part of the Institute of Inter-nal Auditors and the Securities and ExchangeCommission.

Historically the AICPA and the SEC havebeen at the crossroads on matters of auditorindependence, conflict of interest, inflationaccounting, the Foreign Corrupt PracticesAct and now outsourcing. Unfortunately,attempts to align the differences between theSEC’s views and the AICPA’s rules in theareas of auditor independence have beenunsuccessful. The latest surveys and researchstudies conducted in Australia show aninverse correlation between the expansion ofservices provided by the CPA firms and thenumber of qualifications issued. The largerthe services provided the fewer the auditqualifications. This confirms the SEC’s longstanding position that extended services tocompanies being audited may impair auditindependence.

The Institute of Internal Auditors has artic-ulated its views about the new wave of out-sourcing that is endangering the internalauditing profession and casting a doubt onCPA firms that are assuming the dual role ofexternal and internal auditors. The reason-ing that the internal audit function and theattestation function of financial statementsare done by two different and separatedepartments within the same CPA firm doesnot seem a convincing argument that auditorindependence will be preserved. In the past,the SEC brought examples in which the CPAfirm played the dual role by helping the com-pany in preparing the financial statementand, at the same time, auditing them. Thereare no assurances that this will not happenagain thus creating a new wave of scandals.

The legislation on auditor independence isvery clear in demanding from external

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 40 ]



auditors complete independence from thecompany audited. In the United States v.Arthur Young & Co., the Supreme Court ofthe USA upheld that the independent publicaccountant owes “ultimate allegiance” to thecorporation’s creditors and stockholders, aswell as to the investing public. The publicwatchdog function demands that the accoun-tant maintain total independence from theclient at all times and requires completefidelity to the public trust. This is also theview upheld by the Securities and ExchangeCommission. This reinforces the concern ofthe Institute of Internal Auditors regardingthe new wave of internal audit services pro-vided by external auditors which creates animbalance in the internal control process.Since the CPA firms are assuming the dualrole of the internal auditor and the externalauditor, there is no need, therefore, for theexternal auditor to investigate the internalauditor independence in accordance to SAS #65, Considering the Internal Audit Function. Itis dubious when a section of the CPA firmthat is charged with the attestation of thefinancial statements has to assess the inde-pendence of another section of the same firmcharged with the internal auditing function.

Some critics have argued, and forcibly so,that when checks and balances betweenexternal auditors and internal auditors arebroken, who is going to safeguard the organi-zation against the issuance of potential fraudulent financial statements? But theAICPA is still arguing that CPA firms mayprovide internal auditing services and areoperating within the COSO framework.

Outsourcing the internal auditdepartments translates into billion dollars ofadded revenues for the expanding CPA firmsthat are fast incorporating internal auditingin their practice. There is a potential risk thatthe slowing down of the internal auditingfunction performed traditionally by the inter-nal auditors may further increase the likeli-hood of management fraud, the proliferationof fraudulent financial statements which mayresult in the collapse of corporations in thelong run. Historically, the US government hasbeen slow in preventing business failures andhas intervened only after congressional com-mittees have been formed to investigate theircauses and recommended courses of actionsto remedy the disastrous situations.

The IIA wants outsourcing stopped entirelyand warned the SEC that the “extended auditservices” or “double duty” trend can lead tomajor problems. These extended servicesprovided by external auditors are inconsis-tent with the checks and balances built intothe internal control system, are in violationof the Foreign Corrupt Practices Act which

requires the establishment of an internalcontrol system to be monitored internally,and threaten the very existence of the Insti-tute of Internal Auditors, an internationalassociation that provides counseling world-wide on internal controls. The IIA viewsinternal auditing as a key management func-tion that conflicts with the public accoun-tant’s responsibilities to be independent ofmanagement (Appendix 1).

The main body of literature and researchconcerning auditor independence showscontrasting views. It has centred mainly onalleged threats to perceived and actual inde-pendence. Schleifer and Shockley[27] investi-gated the differences in the way in whichauditors and financial statement users reactto policies designed to enhance auditor inde-pendence. They used multidimensional scal-ing techniques to measure the similaritiesand dissimilarities of four separate groups: 1 Big Eight CPA firms;2 non-Big Eight CPA firms;3 bank loan officers; and 4 certified financial analysts.

The results indicate that the four groupsdiffered significantly in the extent of theirsupport for the 14 policies discussed in theCohen Commission Report as a means toenhance auditor independence. The onlyperception gap on auditor independence thatcould potentially affect the accounting andauditing profession is the one regarding theauditor’s restrictions in providing servicessuch as MAS and outsourcing.

Internationally, there is no consensus onother auditing services provided by the exter-nal auditors. This has led the InternationalAuditing Standard Committee of the Interna-tional Federation of Accountants (IFAC) todefer this matter to the local governments.

Despite the controversy about CPAs provid-ing other accounting and auditing services, itmust, however, be acknowledged that auditorindependence is unparalleled in the USA.This is mostly due to the relentless efforts ofthe US Securities and Exchange Commission,the Institute of Certified Public Accountants,and the Institute of Internal Auditors.

References1 Brink, V.Z. and Witt, H., Modern Internal

Auditing, John Wiley & Sons, New York, NY,1982.

2 Mednick, R., “Independence: let’s get back tobasics”, Journal of Accountancy, Vol. 169,January 1990, pp. 86-93.

3 Watts Sells, E., “Corporate managementcompared with government control”, TheJournal of Accountancy, January 1908, p. 236.

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 41 ]



4 Editorial, “Should an auditor act as direc-tor?”, The Journal of Accountancy, March1928, p. 205.

5 Mautz, R.K. and Sharaf, H.A., The Philosophyof Auditing, American Accounting Associa-tion, Sarasota, FL, 1964.

6 Carey, J.L. and Doherty, W.O., Ethical Stan-dards of the Accounting Profession, AICPA,New York, NY, 1966.

7 Barrett, M.J, “Some behavioral attributes ofprofessional audit independence”, PhD Dis-sertation, University of Colorado, Boulder,CO, 1969.

8 Shockley, R.A., “A behavioral investigation ofsupplier differentiation on the market ofaudit services”, Journal of AccountingResearch, Vol. 21, Autumn 1983, pp. 545-64.

9 Knapp, M.C., “Audit conflict: an empiricalstudy of the perceived ability of auditors toresist management pressure”, The Account-ing Review, Vol. 60, April 1985, pp. 202-11.

10 Sawyer, L.B., Internal Auditing, The Instituteof Internal Auditors, Altamonte Springs, FL,1988.

11 Pasewark, W.R. and Wilkerson, J.E., “Intro-ducing... the power quintuplets: client powerand auditor independence”, Woman CPA,Vol. 51, July 1989, pp. 13-17.

12 Bartlett, R.W., “A heretical challenge to theincantation of audit independence”, Account-ing Horizons, Vol. 5, March 1991, pp. 11-16.

13 Editorial, “Words, words, words”, Forbes, 1October, 1970, p. 54.

14 Editorial, “Security National seeks to end aloan made to its auditor”, Wall StreetJournal, 10 April, 1974, p. 24.

15 American Institute of Certified PublicAccountants (AICPA), Statement on AuditingProcedures No. 23, AICPA, New York, NY,1948.

16 American Institute of Accountants (AIA),Yearbook of the American Institute of Accoun-tants, AIA, New York, NY, 1931.

17 AIA, 1934 Yearbook of the American Instituteof Accountants, AIA, New York, NY, 1934.



20 AIA, Tentative Statement of Auditing Stan-dards. Their Generally Accepted Significanceand Scope, AIA, New York, NY, 1947.

21 AICPA, Audits by Certified Public Accoun-tants. Their Nature and Significance, AICPA,New York, NY, 1950.

22 AICPA, “Results of the AICPA ReferendumBallots of January 1962”, The CPA, March1962, p. 3.

23 AICPA, Restatement of the Code of Profes-sional Ethics, AICPA, New York, NY, 1972.

24 AICPA, Statement of Auditing Standards #1,AICPA, New York, NY, September 1972.

25 Collins, A. and Schultz, N., “A critical exami-nation of the AICPA code of professionalconduct”, Journal of Business Ethics, Vol. 14,January 1995, pp. 31-41.

26 Lehman, M.W. and Thompson, J.H., “In ouropinion... a new audit report attempts toclose the expectations gap”, Woman CPA, Vol.52, Spring 1990, pp. 17-19.

27 Schleifer, L. and Shockley, R.A., “Policies topromote auditor independence: more evi-dence in the perceived gap”, Journal ofApplied Business Research, Vol. 7, Spring1990-1991, pp. 10-17.

28 AICPA, In the Public Interest: Issues Con-fronting the Accounting Profession, AICPA,New York, NY, 1993.

29 AICPA, Meeting the Financial ReportingNeeds of the Future: A Commitment from thePublic Accounting Profession, AICPA, NewYork, NY, 1993.

30 Graham, B., “The cost of policing fraud”,CFO: the Magazine for Senior FinancialExecutives, Vol. 9, August 1993, p. 13.

31 AICPA, Ethics Ruling 97 – Performance ofCertain Extended Audit Services, AICPA, NewYork, NY, 1993.

32 Schuetze, W.P., “A mountain or a molehill?”,Accounting Horizons, Vol. 8, March 1994, pp.69-75.

33 AICPA, Annual Report of the Public OversightBoard, AICPA, New York, NY, 1995.

34 AICPA, Strengthening the Professionalism ofthe Independent Auditor, AICPA, New York,NY, 1994.

35 The Institute of Internal Auditors (IIA),“POB confers with the IIA on auditor inde-pendence”, IIA Today, May/June 1995, p. 8.

36 Carmichael, D.R. and Craig, J.L., “Strength-ening the professionalism of the auditor: aninterview with Donald Kirk”, CPA Journal,Vol. 65, February 1995, pp. 18-22.

37 IIA, Statement of Responsibilities of the Inter-nal Auditor, The Institute of Internal Audi-tors, Altamonte Springs, FL, 1947.

38 Meyers, E.B., “Operational auditing”, TheInternal Auditor, March 1955, pp. 17-21.

39 Gupta, P.P., “Spiraling upward”, InternalAuditor, 1991, pp. 135-40.

40 Sawyer, L.B., The Manager and the ModernInternal Auditor, American ManagementAssociation, New York, NY, 1979.

41 IIA, Statement of Responsibilities of the Inter-nal Auditor, The Institute of Internal Audi-tors, Altamonte Springs, FL, 1957.

42 Chambers, A., “The changing role of internalauditors”, Accountancy, December 1978, pp.56-57.

43 IIA, Standards for the Professional Practice ofInternal Auditing, The Institute of InternalAuditors, Altamonte Springs, FL, 1978; 2nded., 1988.

44 Cadmus, B., Operational Auditing Handbook,The Institute of Internal Auditors, Orlando,FL, 1964.

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

http://emerald-prod.literatumonline.com/action/showLinks?crossref=10.2307%2F2490790


http://emerald-prod.literatumonline.com/action/showLinks?crossref=10.1007%2FBF00873733

[ 42 ]



45 Wallace, W.A., Auditing, South-WesternCollege, Cincinnati, OH, 1995.

46 “PSB:85-6 Independence – Independence ofInternal Auditors vs External Auditors”,Internal Auditor, Vol. 42, August 1985, p. 16.

47 Unites States v. Arthur Young & Co., 465 US805 (1984).

48 FTC (Federal Trade Commission), Rules andRegulations under the Securities Act of 1993, 6July, 1933.

49 Casler, D.J., “The evolution of CPA ethics”,Occasional Paper No. 12, Graduate School ofBusiness Administration, Michigan StateUniversity, 1964.

50 Securities and Exchange Commission (SEC),Accounting Series Release # 2, 6 May, 1937.

51 Securities and Exchange Commission (SEC),In the Matter of Interstate Hosier, Inc., 4 SEC706, 717 (1939).

52 Securities and Exchange Commission (SEC),Accounting Series Release #22,14 March, 1941.

53 Securities and Exchange Commission (SEC),Accounting Series Release #37, 7 November,1942.

54 Securities and Exchange Commission (SEC),Accounting Series Release #47, 25 January,1944.

55 Securities and Exchange Commission (SEC),Accounting Series Release #81, 11 December,1958

56 Journal of Accountancy, “SEC rules CPA whois client’s attorney is not independent”,Journal of Accountancy, May 1962,p. 14.

57 Securities and Exchange Commission (SEC),Accounting Series Release #97, 21 May, 1963.

58 Securities and Exchange Commission (SEC),Accounting Series Release #126, 5 July, 1972.

59 Securities and Exchange Commission (SEC),Staff Report on Auditor Independence, SEC,Washington, DC, March 1994.

60 Hardman, D.J. ,Toward a conceptual frame-work for government auditing”, Accounting& Finance, Vol. 31, May 1991, pp. 22-37.

61 General Accounting Office (GAO), Standardsfor Audit of Governmental Organizations,Programs, Activities, & Functions, US Gov-ernment Printing Office, Washington, DC,1981.

62 Nix, H.M. and Nix, D.E., “Auditor selection,monitoring and follow-up in the governmen-tal sector”, Internal Auditing, Vol. 8, Spring1993, pp. 44-52.

63 Cook, J.W. and Winkle, G.M., Auditing,Houghton Mifflin, Boston, MA, 1988.

64 Robertson, J.C., Auditing, Irwin, Homewood,IL, 1993.

65. Light, P.C., Monitoring Govelrnment – Inspectors General and the Search forAccountability, Washington, DC, 1993.

66 IJGA, “Audit profile: central auditing organi-zation in Egypt”, International Journal ofGovernment Auditing (IJGA), July 1995, p. 16.

67. IJGA, “Estonia”, International Journal ofGovernment Auditing, July 1995.

68 Vanasco, R.R., The Audit Committee: an Inter-national Perspective, The Institute of InternalAuditors, Altamonte Springs, FL, 1995.

69 Marsh, H.L. and Powell, T.E., “The auditcommittee charter: Rx for fraud prevention”,Journal of Accountancy, Vol. 167, February1989, pp. 55-7.

70 Knapp, M.C., “Factors that audit committeemembers use as surrogate for audit quality”,Auditing: A Journal of Practice & Theory, Vol.10, Spring 1991, pp. 35-52.

71 McHugh, J. and Raghunandan, K., “Hiringand firing the chief internal auditor”, Inter-nal Auditor,Vol. 51, August 1994, pp. 34-9.

72 Price Waterhouse, Improving Audit Commit-tee Performance: What Works Best, The Insti-tute of Internal Auditors Research Founda-tion, Altamonte Springs, FL, 1993.

73 AICPA, Advisory Panel on Auditor Indepen-dence, AICPA, New York, NY, 1994.

74 Chadwick, W.E., “In my opinion”, InternalAuditor, December 1995.

75 Burnaby, P.A., Powell, N. and Strickland, S.,“Contrasts: international auditing in the USand Japan”, The Internal Auditor, Vol. 49,February 1992, pp. 38-45.

76 Arthur Andersen & Co., Internal Auditingaround the World, Institut Français des Audi-teurs Consultant Internes, Paris, June 1995.

77 Heaston, P.H., Cooper, R.W. and Frank, G.L.,“The ethical environment of the internalauditor”, Internal Auditor, June 1993, p. 19.

78 Ratliff, R.L., Wallace, W.A., Loebbecke, J.K.and McFarland, W.G., Internal Auditing:Principles and Techniques, The Institute ofInternal Auditors, Altamonte Springs, FL,1988.

79 Whittington, G., Grout,P. and Jewitt, I., “Istotal auditor independence a good thing?”,Accountancy, Vol. 115, February 1995, p. 75.

80 Hosseini, A. and Rezaee, Z., “Partners”,Internal Auditor, December 1995, p. 38.

81 Read, W.J., “Consulting services and CPAfirms”, CPA Journal, Vol. 63, February 1993,pp. 55-7.

82 Harrell, A., Taylor, M. and Chewning, E., “Anexamination of management’s ability to biasthe professional objectivity of internal audi-tors”, Accounting, Organizations & Society,Vol. 14, 1989, pp. 259-69.

83 Price Waterhouse, Doing Business in Switzer-land, Price Waterhouse, Chicago, IL, 1992.

84 Spindel, F.S., “Independence and non-auditservices”, CPA Journal, Vol. 59, January1989, pp. 48-52.

85 Krishnamoorthy, G. and Spruill, W.G.,“Improving efficiency and cost-effectivenessin the materiel department”, HospitalMateriel Management Quarterly, Vol. 10,February 1989, p. 40.

86 Dame, D.R., “Auditing material transporta-tion costs”, Internal Auditing, 1995, p. 34.

87 Fern, R.H., “Independence: an incompletestandard”, The Internal Auditor, Vol. 42,October 1985, pp. 30-4.

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

http://emerald-prod.literatumonline.com/action/showLinks?crossref=10.1016%2F0361-3682%2889%2990027-5

http://emerald-prod.literatumonline.com/action/showLinks?crossref=10.1111%2Fj.1467-629X.1991.tb00251.x

http://emerald-prod.literatumonline.com/action/showLinks?crossref=10.1111%2Fj.1467-629X.1991.tb00251.x

[ 43 ]



88 Montondon, L. and Meixner, W.F., “Environ-mental characteristics: the effect on munici-pal auditor’s objectivity”, Internal Auditing,Vol. 7, Winter 1992, pp. 64-71.

89 Sharp, F. and Bull, I., “Information oversightfor efficiency and effectiveness in local gov-ernment”, Government Accountants Journal,Vol. 40, Winter 1992, pp. 59-65.

90 Schmidt, N.W., “Insurance company creditquality: crisis of credibility”, Pension World,Vol. 27, February 1991, pp. 16-22.

91 Cohen, J., Pant,L. and Sharp, D., “Culturaland socioeconomic constraints on interna-tional code of ethics: lessons from account-ing”, Journal of Business Ethics, Vol. 11, 1992,pp. 687-700.

92 Ho, D., “On the concept of face”, AmericanJournal of Sociology, Vol. 81, 1976, pp. 867-84.

93 Stamp, E. and Moonitz, M., “Internationalaccounting standards”, CPA Journal, June1982, pp. 48-53.

94 Gui, F.A., Ng, L.P. and Subramanian, N., “Anempirical analysis of Singaporianbankers/oerceptions of auditors’s indepen-dence”, Proceedings of the First Asian-PacificConference on International AccountingIssues. California State University, Fresno,CA, 1989.

95 Chetkowich, M., “The International Federa-tion of Accountants: its organization andgoals”, The International Journal of Account-ing, Vol. 15, 1979, pp. 13-20.

96 International Federation of Accountants(IFA), International Audit Guidelines, 2nd ed.,International Audit Committee, London,1988.

97 Roussey, R.S., “The changing world of inter-national accounting and auditing”, InternalAuditor, April 1994, p. 54.

98 Spoel, H.A.J., “Globalization through part-nership”, Internal Auditor, October 1990,p. 17.

99 AICPA, The Netherlands, AICPA, New York,NY, 1987.

100. Price Waterhouse, “Eighth Directive”, EECBulletin, Vol. 66, March 1984.

101 Price Waterhouse, Doing Business in theEuropean Community, Price Waterhouse,Chicago, IL, 1994.

102 Nordmann, H., “A look back with a view tothe future”, Accountancy, Vol. 107, January1991, pp. 68-9.

103 Johnson, M.D., “Professionalism in the ThirdWorld”, Internal Auditor, 1992, p. 51.

104 Vanasco, R.R., “International accountingstandards: myth or reality?”, in Klein, H.(Ed.), Proceedings of the WACRA Conference,WACRA, Needham, MA, 1990.

105 Chapman, C., “International accountingstandards timetable set”, Internal Auditor,December 1995, p. 8.

106 Jensen, H.L. and Yiu, K., “Audit indepen-dence and Confucian values”, Proceedings ofthe Seventh Asian-Pacific Conference in Inter-national Accounting Issues, California StateUniversity, Fresno, CA, 1995.

107 Lau, A. and Young, J.-L., “Auditing in China:historical perspective and current develop-ments”, Proceedings of the First Asian-PacificConference on International AccountingIssues, California State University, Fresno,CA, 1989.

108 Price Waterhouse, Doing Business in thePeople’s Republic of China, Price Water-house, Chicago, IL, 1992.

109 Reider, B., Maschmeyer, R. and Ji-Liang, Y.,“Auditing a changing institution: China’sstate enterprise”, Proceedings of the FifthAsian Pacific Conference on InternationalAccounting Issues, California State Univer-sity, Fresno, CA, 1993, pp. 238-41.

110 Schuetze, W.P., “SEC chief accountant ques-tions outsourcing practice”, InternalAuditor, December 1994, p. 9.

111 Moliterno, S.F., The Accounting Profession inHong Kong, AICPA, New York, NY, 1993.

112 Jensen, H.L., “Internal auditing in HongKong”, Internal Auditing, Summer 1995, p. 57.

113 McKinnon, J., “Cultural constraints on auditindependence in Japan”, The InternationalJournal of Accounting, Vol. 20, 1984, pp. 17-43.

114 Price Waterhouse, Doing Business in Japan,Price Waterhouse, Chicago, IL, 1993.

115 Albrecht, W.S., Marsh, H.L. and Bentzel, F.H.Jr, “Auditing on international subsidiary”,The Internal Auditor, Vol. 45, October 1988,pp. 22-6.

116 Blough, C.G., “Responsibility to third par-ties”, The Journal of Accountancy, May 1960,p. 58.

117 Price Waterhouse, Doing Business inMalaysia, Price Waterhouse, Chicago, IL,1994.

118 McInnes, B. and Stevenson, J., “Why isn’tinternal audit on the audit agenda?”, Man-agement Accounting, April 1995, pp. 12-13.

119 Tong, D., The Accounting Profession in Singa-pore, AICPA, New York, NY, 1993.

120 Ernst & Young, The Accounting Profession inDenmark, AICPA, New York, NY, 1994.

121 Swanson, G.A. and Marsh, H.L., InternalAuditor Theory – A System View, QuorumBooks, New York, NY, 1991.

122 Ernst & Whinney, The Accounting Professionin the Netherlands, AICPA, New York, NY,1987.

123 Price Waterhouse, Doing Business in France,Price Waterhouse, Chicago, IL, 1993.

124 Ricchiute, D.N., Auditing, South-Western,Cincinnati, OH, 1992.

125 Price Waterhouse, Doing Business in Spain,Price Waterhouse, Chicago, IL, 1990.

126 Forster, K.P. and Svensson, E., The Account-ing Profession in Sweden, AICPA, New York,NY, 1987.

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)




[ 44 ]



127 Chapman, C., “Swedish public authorities tofollow IIA standards”, Internal Auditor,December 1995, p. 8.

128 Whittington, R.O. and Pany, K., Principles ofAuditing, Irwin, Chicago, IL, 1995.

129 Anderson, R., “The truly integrated audit”,The Internal Auditor, December 1994, p. 65.

130 Price Waterhouse, Doing Business in Aus-tralia, Price Waterhouse, Chicago, IL, 1993.

131 Forster, K.P., The Accounting Profession inAustralia, AICPA, New York, NY, 1994.

132 Evans, T.G., Taylor, M.G. and Holzmann, O.J.,International Accounting & Reporting,South-Western, Cincinnati, OH, 1994.

133 AICPA, The Accounting Profession inCanada, AICPA, New York, NY, 1987.

134 Price Waterhouse, Doing Business in Canada,Price Waterhouse, Chicago, IL, 1994.

135 Taylor, W.L., “Opening doors”, Internal Audi-tor, October, 1995, p. 23.

136 Price Waterhouse, Doing Business in NewZealand, Price Waterhouse, Chicago, IL,1993.

137 “Auditors, outsiders and independence”,Accountancy, Vol. 104, September 1989, p. 1.

138 Berryman, G.R., “Auditor independence: itshistorical development and some proposalsfor research”, Contemporary Auditing Prob-lems, University of Kansas, Lawrence, KS,1974.

139 AICPA, The Accounting Profession in theUnited Kingdom, AICPA, New York, NY, 1987.

140 Anderson, J. and Keenan, D., “The CompaniesAct 1989: auditing aspects”, Accountancy, Vol. 105, March 1990, pp. 98-106.

141 Darbyshire, D., “Cutting auditors’ noses offto spite clients’ faces”, Accountancy, Vol. 110,December 1992, p. 101.

142 Humphrey, C., Mozier, P. and Turley, S., “Theaudit expectations gap in Britain: an empiri-cal investigation”, Accounting & BusinessResearch, Vol. 23, 1993, pp. 395-440.

143 Green, O., “Auditing review urged”, Accoun-tancy, Vol. 113, April 1994, p. 14.

144 Opetubo, A., “Perceptions of a Nigerianauditor on independence”, Master’s thesis,New School for Social Research, New York,NY, 1985.

145 Price Waterhouse, Doing Business inArgentina, Price Waterhouse, Chicago, IL,1992.

146 IIA, Perspective on Outsourcing InternalAuditing: a Professional Briefing for ChiefAudit Executives, The Institute of InternalAuditors, Altamonte Springs, FL, 1995.

147 Price Waterhouse, Doing Business in theRussian Federation, Price Waterhouse,Chicago, IL, 1991.

148 Bollom, W.J. “Ethics and self-regulation forCPAs in the USA”, Journal of BusinessEthics,Vol. 7, 1988, pp. 55-61.

149 Trompeter, G., “The effect of partner compen-sation schemes and generally acceptedaccounting principles on audit partnerjudgement”, Auditing: A Journal of Practice& Theory, Vol. 13, Fall 1994, pp. 54-68.

150 “Audit guideline: guidance for internal audi-tors”, Accountancy, Vol. 106, September 1990,pp. 141-4.

151 “Ethics, Interpretations and Rulings”, Jour-nal of Accountancy, Vol. 171, February 1991,pp. 110-14.

152 Arens, A.A. and Loebbecke, J.K., Auditing,Prentice-Hall, Englewood Cliffs, NJ, 1994.

153 Allen, P.W., “Changing standards for commis-sions and contingent fees”, CPA Journal,January 1990, pp. 12-18.

154 Dye, R.A., Balachandran, B.V. and Magee,R.B., “Contingent fees for audit firms”, Jour-nal of Accounting Research, Vol. 28, Autumn1990, pp. 239-66.

155 AICPA, Codification of Auditing Standards,AICPA, New York, NY, 1993.

156 Ponemon, L.A., “Internal auditor objectivityand disclosure of sensitive issues”, InternalAuditing, Vol. 7, Summer 1991, pp. 36-43.

157 “PSB 87-8: Independence – Conflict Arisingfrom Incentive Compensation”, The InternalAuditor, Vol. 44, October 1987, p. 22.

158 Magee, R.P. and Tseng, M.-C., “Audit pricingand independence”, Accounting Review, Vol. 65, April 1990, pp. 315-36.

159 AICPA, Statement on Standards for Manage-ment Advisory Services (MAS), Various num-bers.

160 Hartley, R.H. and Ross, T.L., “MAS and auditindependence: an image problem”, Journalof Accountancy, November 1972, pp. 42-52.

161 Schulte, A., “Compatibility of managementcounseling and auditing”, AccountingReview, July 1965, pp. 587-95.

162 “Rule of conduct 102: MAS engagement toevaluate service bureaus”, Journal ofAccountancy, January 1977, p. 98.

163 Reckers, P.M. and Stagliano, A.J., “Non-auditservices and perceived independence: somenew evidence”, Journal of Practice & Theory,Summer, 1981, pp. 23-47.

164 AICPA, Public Oversight Board Report: Scopeof Services by CPA Firms, AICPA: SEC Prac-tice Section, 1979.

165 AICPA, Public Perceptions of ManagementAdvisory Services Performed by CPA Firmsfor Audit Clients: A Research Report, AICPA,New York, NY, October 1986.

166 Lowe, J.D. and Pany, K., “Auditor indepen-dence: the performance of consulting engage-ment with audit clients”, Journal of AppliedBusiness Research, Vol. 10, Winter 1994, pp. 6-3.

167 Wong, T., Yau,O. and Johnson, R., “Theaccountants’ perceptions on auditor’s inde-pendence: an Australian experience”, Pro-ceedings of the Second Asian-Pacific Confer-ence on International Accounting Issues,California State University, Fresno, CA, 1990.

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)





http://emerald-prod.literatumonline.com/action/showLinks?crossref=10.1080%2F00014788.1993.9729907


[ 45 ]



168 Wines, G., “Auditor independence, auditqualifications and the provision of non-auditservices”, Accounting & Finance, Vol. 24, May1994, pp. 75-86.

169 Barkess, L. and Simnett, R., “The provisionof other services by auditors: independenceand pricing issues”, Accounting& BusinessResearch, Vol. 24, Spring 1994, pp. 99-108.

170 Church, B.K. and Schneider, A., “Maintain-ing objectivity despite conflict duties”, Inter-nal Auditing, Vol. 7, Fall 1991, pp. 11-17.

171 “Rule of Conduct 101: Independence duringMAS Systems Implementation”, Journal ofAccountancy, January 1977, p. 98.

172 Bishop, W.G. III, “Bishop shares IIA’s view onauditor independence with new SEC chiefaccountant”, IIA Today, December, 1995.

173 Courtemanche, G., “Outsourcing the auditfunction”, Internal Auditor, August 1991, pp.34-39.

174 Block, P., Stewardship, Berrett-Koehler, SanFrancisco, CA, 1993.

175 Gibbs, J., “Control and audit in an age ofempowerment”, Internal Auditor, December1995, p. 14.

176 Stern, G.M., “Ways internal auditing depart-ments are adding value”, Internal Auditor,April 1994, p. 30.

177 Lampe, H.C., “Using internal audit outsourc-ing to meet the challenges of the 1990s”,Internal Auditing, Summer 1993, pp. 3-12.

178 James, M.L., “Outsourcing from the publicaccountants’ perspective”, Internal Auditing,Summer 1994, pp. 55-8.

179 Tongren, J., “Reality check”, InternalAuditor, December 1994, p. 71.

180 Acciani, N., “Outlaw outsourcing”, InternalAuditor, February 1995, pp. 50-51.

181 IIA, “Schuetze raises questions regardingindependence”, IIA Today, February 1995,p. 5.

182 IIA, “SEC chief accountant expresses frustra-tion over lack of guidance in the area ofauditor independence”, IIA Today, January/February 1996, p. 4.

183 Rankin, K., “CPA chided on outsourcing”,Accounting Today, 11 December, 1995, p. 3.

184 IIA, “The independence question”, InternalAuditor, October 1995, p. 10.

185 IIA, “AAA panel discusses outsourcing”,Internal Auditor, October, 1995, p. 10.

186 IIA, “Changes at the AICPA”, Internal Audi-tor, December 1995, p. 8.

187 AICPA, Directors, Management, and Auditors– Allies in Protecting Shareholders Interests,AICPA, New York, NY, September 1995.

188 IIA, “IIA executives discuss independenceissue with AICPA professional ethics execu-tive committee”, IIA Today, March/April1996, p. 5.

189 IIA, “IMA Nixes AICPA exposure draft”, IIAToday, May/June 1996, p. 5.

190 IIA, “To remain ‘internal’ you must remain‘integral’, IIA pamphlet suggests how”, IIAToday, March/April 1996, p. 4.

191 IIA, “Outsourcing loses ground in bankingindustry”, Internal Auditor, April 1995, p. 8.

192 Bishop, W.G. III, “Accountants may impairindependence by accepting internal audits”,IIA News, 5 December 1995.

193 IIA, “IIA hosts meeting with Big Six”, IIAToday, March/April 1996, p. 2.

194 Berton, L., “Who is going to audit the audi-tors?”, The Wall Street Journal, 5 March,1996, p. B1.

195 Chapman, C., “Financial turmoil does notdissuade company from outsourcing”, Inter-nal Auditor, 1995, p. 9.

196 Verschoor, C.C., “Continental bankoutsources IA”, Internal Auditor, June 1993,p. 10.

197 Chapman, C., “Outsourcing loses ground onbanking industry”, Internal Auditor, 1995, p. 8.

198 IIA, Perspective on Outsourcing InternalAuditing: A Professional Briefing for ChiefExecutives, The Institute of Internal Audi-tors, Altamonte Springs, FL, 1995.

199 Hendrickson, H. and Espahbodi, R., “Secondopinion, opinion shopping and indepen-dence”, CPA Journal, Vol. 61, March 1991, pp. 26-9.

200 Cohen Commission on Auditors’ Responsibil-ities, Report of Tentative Conclusions, AICPA,New York, NY, 1977.

201 Securities and Exchange Commission (SEC),Accounting Series Release, #165, 12(b) of Form8-K, 1987.

202 Smith, D.B., “An investigation of securitiesand exchange commission regulation ofauditor change disclosure: the case ofaccounting series release No. 165”, Journal ofAccounting Research, Spring 1988, pp. 134-45.

203 Mangold, N.R., The Effect of Auditor Changeson Earnings, Auditor’s Opinions, and StockPrices, Working Paper, California State Uni-versity, Hayward, CA, 1988.

204 Accountancy, “Ethics rules to be tightened”,Accountancy, Vol. 110, July 1992, p. 13.

205 Kanodia, C. and Mukheriji, A., “Audit pric-ing, lowballing and audit turnover: adynamic analysis”, Accounting Review, Vol.69, Oct 1994, pp. 593-615.

206 AICPA, The Commission on Auditors’ Respon-sibilities: Report, Conclusions, and Recom-mendations, AICPA, New York, NY, 1978.

207 General Accounting Office (GAO), AuditStandards Supplement No. 9, Self-EvaluationGuide for Governmental Audit Organizations,Comptroller General of the United States,Washington, DC, 1976.

208 Comptroller of the Currency, Comptroller’sHandbook for National Bank Examiners,Office of the Comptroller of the Currency,Washington, DC, 1977.

209 AICPA, Statement of Quality Control No.1 –System of Quality Control for CPA Firms,AICPA, New York, NY, 1977.

210 AICPA, Peer Review Manual, AICPA, NewYork, NY, 1978.

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)





[ 46 ]



211 IIA, Quality Assurance Manual for InternalAuditing – a Self-Assessment Handbook, TheInstitute of Internal Auditors, AltamonteSpring, FL, 1984.

212 IIA, “SIAS No. 4 – Quality Assurance”, TheInternal Auditor, December 1986.

213 Cuzzetto, C.E., “Lean, mean, auditingmachines”, The Internal Auditor, Vol. 51,December 1994, pp. 26-30.

214 AICPA, Statement of Position RegardingMandatory Rotation of Audit Firms of Pub-licly Held Companies, AICPA’s SEC PracticeSection, New York, NY, 1992.

Appendix 1: Bishop’s letter to Finkston

William G. Bishop III, CIAPresident

The Institute of Internal Auditors249 Maitland Avenua

Altamonte Springs, Florida 32701-4201(407) 830-7600 Ext. 288

FAX (407) 831-5171January 15, 1996

Herbert A. FinkstonDirector, Professional Ethics DivisionAICPA, Harborside Financial Center201 Plaza ThreeJersey City, NJ 07122-3881

Dear Mr. Finkston:

The Institute of Internal Auditors (IIA) appreci-ates the opportunity to present its view on theindependence and outsourcing of the internalauditing function. Basil Pflumm and I plan toattend the open session of the AICPA ProfessionalEthic Executive Committee meeting at 9:30 AM onJanuary 19, 1996, in Ft. Lauderdale.

The information in this letter provides The IIA’sgeneral comments regarding those situations inwhich an external auditor also performs internalauditing for an organization. After the PublicOversight Board provided its views in a June 14,1995 letter to you, The IIA considered it importantto make its views known to the Securities andExchange Commission (SEC). A copy of my letterto the Chief Accountant and an associated pressrelease also are enclosed for you and your com-mittee. I also understand that a replacement toEthics Ruling 97-101 will be exposed for a period of60 days; The IIA intends to comment on that expo-sure draft.

During the Committee of Sponsoring Organiza-tions (COSO) meeting on December 14, MikeSutton of the SEC, in discussing the situation inwhich the external auditor has both the attestengagement and the internal auditing assign-ment, expressed three major concerns on theimportant issue of independence and the out-sourcing of the internal auditing function:

1. There should be a responsible and competentmanager for internal auditing within the com-pany, with a clear separation of management andexternal auditor functions.

2. The guidelines covering “Extended AuditServices” should clearly delineate ongoing “moni-toring” activities so as to identify those that couldimpair the independence of external auditors.

3. In attestation situations such as FDICIA, theexternal auditors should obtain assurances frommanagement that it did not rely heavily on theexternal auditor to form the basis for manage-ment’s assertion on the effectiveness of internalcontrols.

The IIA has similar concerns as SEC officialshave expressed. The IIA is opposed to the totaloutsourcing of the internal auditing function to acompany’s public accountant because it impairsthe external auditor’s independence. Internalauditing is a key management function that con-flicts with the public accountant’s responsibilitiesto be independent of management.

Also, The IIA believes that total management ofthe internal auditing function must consist ofcompany employees. This would allow the com-pany to meet The IIA Standards for the Profes-sional Practice of Internal Auditing (Standards)and still outsource parts of the internal auditingwork. The IIA, however, objects to the appoint-ment of a “figurehead” member of management inan attempt to shield the public accountants from amanagement role.

Finally, The IIA acknowledges that the internalauditing function could be outsourced to thirdparty providers other than the company’s publicaccountants if The IIA Standards were followed.

We commend the Ethics Executive Committee forthe difficult work being performed to developinterpretations on the independence of the exter-nal auditor when performing the internal audit-ing function for a client. The IIA believes thatconsideration of pertinent IIA Standards andother pronouncements provides a basic structureto frame the three factors impacting the indepen-dence of the external auditor: (1) the scope ofinternal auditing; (2) the structuring of internalauditing as a part of management; and (3) thedemand for total independence of the externalauditor.

First, “Extended Audit Services” are not clearlydefined, and it is unclear whether these servicesencompass the full range of internal auditingactivities. The IIA Standard 300, Scope of Work,states that “The scope of internal auditing shouldencompass the examination and evaluation of theadequacy and effectiveness of the organization’ssystem of internal control and the quality ofperformance in carrying out assigned responsi-bilities.” This would include:

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 47 ]



1. (310) Reliability and Integrity of Information– “Internal auditors should review the reliabilityand integrity of financial and operating informa-tion and the means used to identify, measure,classify, and report such information.”

2. (320) Compliance with Policies, Plans, Proce-dures, Laws, and Regulations – “Internal auditorsshould review the systems established to ensurecompliance with those policies, plans, procedures,laws, and regulations which could have a signifi-cant impact on operations and reports, andshould determine whether the organization is incompliance.”

3. (330) Safeguarding of Assets – “Internal audi-tors should review the means of safeguardingassets and, as appropriate, verify the existence ofsuch assets.”

4. (340) Economical and Efficient Use ofResources – “Internal auditors should appraisethe economy and efficiency with which resourcesare employed.”

5. (350) Accomplishment of Established Objec-tives and Goals for Operations or Programs –“Internal Auditors should review operations orprograms to ascertain whether results are consis-tent with established objectives and goals andwhether the operations or programs are beingcarried out as planned.”

Second, The IIA Standard 500, Management of theInternal Auditing Department, establishes themanagement of the internal auditing function toinclude broad responsibilities requiring a compe-tent and professional director.

1. The formal charter of the internal auditingdepartment is to be approved by senior manage-ment and accepted by the board of directors. Thedirector of internal auditing is responsible forproperly managing the internal auditing depart-ment. This includes having a statement of pur-pose, authority, and responsibility of the depart-ment; planning to carry out those responsibilities;providing written policies and procedures to guidethe audit staff; selecting and developing the inter-nal auditing department staff; coordinating inter-nal and external auditing efforts; and establishingand maintaining a quality assurance program toevaluate the operations of the department.

2. The IIA position is that the independenceissue cannot be resolved simply by the organiza-tion retaining a general auditor with employeestatus to be responsible for directing or liaisoningwith the external auditor performing the out-sourced internal auditing function. Even if theresponsibilities for this position include prepara-tion of a charter of policy, oversight, approval ofaudit plans, review of results, and communicationwith the board and/or audit committee, thisgeneral auditor must be more than a “figure-head”. Specifically, the general auditor should bea dedicated, fully competent professional who has

complete authority and responsibility over theresources, techniques, and quality to assure thatinternal auditing is done in compliance with TheIIA’s Standards. As such, the general auditor musthave sufficient authority and resources to plan,direct, and control all internal auditing activities.

Finally, the Public Oversight Board (POB) Report“Directors, Management, and Auditors – Allies inProtecting Shareholders Interests”, September1995, states under the responsibilities of the inde-pendent auditor that “The board of directors, asthe representative of the shareholders, should bethe client, not corporate management. Corporateboards and audit committees should make thisclear to the auditors.” The POB Report also states:

1. “In United States v. Arthur Young & Co., theSupreme Court of the United States concludedthat the independent public account ‘owes ulti-mate allegiance to the corporation’s creditors andstockholders, as well as to the investing public.This, public watchdog’ function demands that theaccountant maintain total independence from theclient at all times and requires complete fidelity tothe public trust.”

2. “Too close a relationship can discourage theauditor from speaking up if the auditor questionsthe accounting principles selected, the clarity ofdisclosures, or the estimates and judgments madeby management.”

Thus, The IIA believes that any new interpreta-tion should alleviate the concerns articulated bythe POB.

In summary, The IIA recommends the following:

First, that the Ethics Executive Committeespecifically define “Extended Audit Services” soas to identify those services that would impair theindependence of the external auditor.

Second, that language be included that wouldrequire a dedicated, competent professionalappropriately resourced to be able to carry out thefull authority and responsibility required tocomply with The IIA Standards.

Third, that the Ethics guidelines should focuson the need for total independence of the externalauditor. Guidelines should encompass the breadthof internal auditor and management responsibili-ties, including planning, staffing, organizing,controlling, reporting, monitoring, follow up, etc.Further, the guidelines should include require-ments to document fully the scope and conditionsof the engagement, including an understanding ofthe extent of management’s reliance upon theexternal auditor for an assessment of the systemof internal control.

Again, we thank you for this opportunity to shareour views on this important issue. I look forwardto meeting you on January 19th, and, if we canassist you in formulating guidelines from an

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

[ 48 ]



internal auditing perspective, please call me atextention 288.

Regards,

William G. Bishop III, CIA

2 Attachments: 1. IIA Press Release, 12/5/952. IIA Letter to Michael H. Sutton, 9/26/95

cc: William L. TaylorAnthony J. Ridley, CIAArleen R. Thomas

Appendix 2: Bishop’s letter to Sutton

William G. Bishop III, CIAPresident

The Institute of Internal Auditors249 Maitland Avenua

Altamonte Springs, Florida 32701-4201(407) 830-7600 Ext. 288

FAX (407) 831-5171September 26, 1995Mr. Michael H. Sutton, CPAChief AccountantSecurities and Exchange CommissionWashington, DC 20549

Dear Mike:

The Institute of Internal Auditors (IIA) is aninternational organization comprised of morethan 52,000 internal auditing professionals in over100 countries. It is the only organization dedi-cated solely to the advancement of the individualinternal auditor and the internal auditing profes-sion. The IIA is the world’s leader in research andeducation for internal auditors and is the stan-dards-setting body for the internal auditing pro-fession.

The IIA has become increasingly aware ofarrangements through which an organization’sinternal auditing function is performed by itsexternal auditors on a contract or “extendedaudit services” basis, hereby defined as “out-sourcing”. Of particular importance is the situa-tion in which the entire internal auditing func-tion is performed by the same firm that does theexternal auditing. The source of this concernrelates to the public interest which is currentlyprotected by the independent external auditor.Shareholders and regulators of publicly heldcompanies rely upon management’s representa-tions of financial positions and results of operations and, to an increasing degree, uponassertions about the sufficiency of internal con-trols. This reliance is built upon the thesis that aprofessional external auditor completely indepen-dent of the organization’s management has com-pleted sufficient verification tests to attest tomanagement’s representations and assertions.

The primary concern of The IIA is that moderninternal auditing, as currently defined in profes-

sional literature and practiced in the majority ofU.S. publicly held companies, is generally incom-patible with the independence requirements ofthe eternal auditor. External auditors are pre-cluded by tradition, regulation, and rulings frombecoming part of the mangement functions of theorganization for which they perform publicaccounting. However, the internal auditing func-tion provides the major supporting assurancethat allows management to make a public asser-tion as to the effectiveness of its organization’sinternal control structure. If a public accountingfirm performs all the internal auditing activitiesan outsourced basis, it becomes, at the very least,an indirect advocate of management’s assertion.The independence issue arises when the samefirm that provides an independent opinion of anorganization’s financial statements also performsan engagement to express an independent opin-ion on the fairness of management’s assertion.This may result in reduced public confidence inthe integrity of the processes that provide vitalinformation to the various users.

Further, the control environment of the organi-zation is adversely impacted by the disruption ofthe roles of internal and external auditors.Boards of directors, management, regulators, andthe general public have come to rely on the checksand balances inherent in the relationshipbetween internal and external auditors. Internalauditors routinely comment to audit committeeson the sufficiency of the external auditor. Simi-larly, external auditors respond to audit commit-tee inquiries about internal auditor performance.When external auditors and internal auditors areone, this check and balance is eliminated and thecontrol environment is weakened.

Finally, the current controversy regarding thistopic is sufficient to warrant some considerationof public disclosure. Public statements by mem-bers of your staff and others have indicated thatmany share our concern about the independenceof auditors and the impact on control within theorganization. Their concern is of sufficient mag-nitude to warrant public disclosure in annualreports to shareholders whenever the traditionalrelationship between management and the exter-nal auditor has been disrupted.

On behalf of The IIA’s members, I submit thisletter and the attached discussion paper regard-ing The IIA’s perspective on the practice of out-sourcing. Thank you for the opportunity to shareour views on this important issue. If we can assistyou in any way, please advise. We would also bepleased to meet with you and members of the SECstaff to discuss these matters further.

Best Regards,

William G. Bishop III, CIA

cc: Roy T. Van Brunt

Attachment: The IIA Outsourcing Internal Audit-ing Discussion Paper, w/3 enclosures

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

This article has been cited by:

1. Zamzulaila Zakaria, Susela Devi Selvaraj, Zarina Zakaria. 2006. Internal auditors: their role in the institutions of highereducation in Malaysia. Managerial Auditing Journal 21:9, 892-904. [Abstract] [Full Text] [PDF]

2. Marshall A. Geiger, K. Raghunandan. 2002. Auditor Tenure and Audit Reporting Failures. AUDITING: A Journal of Practice& Theory 21:1, 67-78. [CrossRef]

Dow

nloa

ded

by I

QR

A U

NIV

ER

SIT

Y A

t 05:

08 2

0 Se

ptem

ber

2014

(PT

)

http://dx.doi.org/10.1108/02686900610704993

http://emerald-prod.literatumonline.com/doi/full/10.1108/02686900610704993

http://emerald-prod.literatumonline.com/doi/pdfplus/10.1108/02686900610704993

http://dx.doi.org/10.2308/aud.2002.21.1.67

Documents

Auditor Independence an international perspective.pdf