DRP ON AUDITOR INDEPENDENCE - FINAL

EFFECTS OF AUDITORS’ INDEPENDENCE ANALYSIS AND RECOMMENDATIONThe purpose of this research is twofold. First, it is devoted to explain auditors’ independence, which is the corner of auditing profession. Emphasis has been given to possible factors that are considered to impair auditors’ independence in the performance of their duties. Secondly, it specifically treated the effects of non audit services and fees on auditor independence

EFFECTS OF AUDITORS’ INDEPENDENCE ANALYSIS AND RECOMMENDATIONThe purpose of this research is twofold. First, it is devoted to explain auditors’ independence, which is the corner of auditing profession. Emphasis has been given to possible factors that are considered to impair auditors’ independence in the performance of their duties. Secondly, it specifically treated the effects of non audit services and fees on auditor independence

2009

Fekadu BelaynehStrayer University

June 2009

Effects of Auditors’ Independence 2

EFFECTS OF AUDITORS’ INDEPENDENCE

Effects of Auditors’ independence on Public Accounting Profession

A research paper prepared in partial fulfillment for the degree of

Masters of Science in Accounting

Fekadu Belayneh

Strayer University

June 5, 2009


Running Head: Effects of Auditor Independence


Abstract

The purpose of this research is two fold. First it is devoted to explain auditor independence,

which is the corner of auditing profession. Emphasis has been given to possible factors that are

considered to impair auditor independence in the performance of their duties.

Secondly, it specifically treated the effects of non audit services and fees on auditor

independence.

The coming into being of Sarbanes- Oxley act of 2002 has been critical to bring about check

and balance in audit engagement process.

The SEC requirement about disclosure of non-audit fees has to larger extent affected auditor

independence. As auditor independence is critical to gauge and subjective to evaluate, it is

probably helpful to focus on factors that causes impairment of independence and look for means

and ways to improve independence which is otherwise called corner stone of auditing profession.

Key words: Independence

Securities and Exchange Commission

Audit fees

Non-audit services

Public Company Accounting Oversight Board


Acknowledgment

First of all, I would like to express my heart-felt feelings for the almighty Lord who helped

me accomplish the research from beginning to end.

I am also indebted to all members of Strayer University LRC for providing me with the

necessary materials to conduct the research.

I would also like to thank my Professor, Bill Makkawi, who has been very crucial in

providing me with the necessary direction and invaluable comments during the course of the

research.

Last but not least, I would like to extend my special thanks to my wife, Kidest Tadesse and

my three beautiful kids (Nate, Beza and Ruth) for their patience and love that enabled me to

complete the research paper.


Table of contents

Title Page

Chapter one: Context of the Problem ……………………………………… 7

1.2 Statement of the Problem…………………………………… 10

1.3 Research Question…………………………………………… 11

1.4 Significance of the Study………………………………………. 12

1.5 Research design and Methodology…………………………… 14

1.6 Organization of the Study……………………………………… 15

Chapter Two: Literature Review……………………………………………… 16

Chapter Three: The rationale of Auditor Independence…………………...... 22

Chapter Four: Factors Affecting Auditor Independence…………………… 27

4.1 Provision of Non audit services……………………………..... 28

4.2 Client-size…………………………………………………… 36

4.3 Audit firm tenure……………………………………………….37

4.4 Alumni affiliation………………………………………………37

4.5 Disclosure of Non-audit fees………………………………….. 39

4.6 Training of Auditors…………………………………………. 41


Title Page

4.7 Audit Committee……………………………………………… 41

4.8 Culture of the Audit firm……………………………………… 42

4.9 Auditors’ ethical and moral characteristics…………………… 43

Chapter Five: Audit and Non-audit fees- Conflict of Interest……………….... 44

Chapter Six: Conclusion and Recommendation……………………………… 47

References…………………………………………………………….. 52


Chapter one

Context of the problem

The public accounting profession passed through several difficulties over the past few years.

Being a prominent discipline since long time, it provided the public with a professional service to

affirm its commitment to providing assurance about financial information.

The role of accounting in the current global economy has been of paramount importance.

More specifically, auditors find themselves in a situation where they are all required to abide by

set of rules and regulations- independence being the cornerstone of their day- to-day activity.

According to AICPA “ Independence is the state of mind that permits the performance of an

attest service without being affected by influences that compromise professional judgment,

thereby allowing an individual to act with integrity and exercise objectivity and professional

skepticism”. (“Independence”, 2004, para.4)

This requirement has been a challenge for many auditors for it is the basis by which their

relationship with clients is to be evaluated. From this it follows that auditors should exercise

independence in the performance of their duties and responsibilities.

In the recent past we have witnessed facts where the auditor’s lack of independence resulted

in the closure of the biggest firms. Cases in point are the Enron and WorldCom fiascoes that

focused the attention of the investing public.

The issue of independence is described as a “corner stone of auditing profession that helps to

ensure quality audits and contributes to financial statements.” (Lindberg and Beek2004, para.3)


As mentioned above, the cardinal principle of auditing which is independence has been

challenged by two major issues- Non audit services and auditor-client relationship. This is

related with the high audit fee that the audit firm expects from its client that brings about a

conflict of interest thereby affecting the independent performance of auditors in attesting the

financial statement of the client. In an attempt to relate Auditors’ independence with non audit

service SEC (2000b) expressed its concern in the following way:

“the rapid rise in the growth of non-audit services has increased

the economic incentives for the auditor to preserve a relationship

with the audit client, thereby increasing the risk the auditor will be

less inclined to be objective…”

AICPA has also been consistently focusing on the issue of independence and its impacts on

the overall operations of various firms. Accordingly, it explains the issue in the following way:

“Independence shall be considered impaired by an auditor when he makes management

decisions on variety of factors. Generally, CPAs are not independent if they are in a position to

influence, provide certain accounting services, or have financial interests in an entity. A CPA is

required to document any possible situations that might impair his or her independence on an

engagement, inform his or her CPA firm, and inform the potential client if any such situations

may exist.” (“Independence”2006, para.4)

For the most part, independence is explained by the conflict of interest arising as a result of

the nature of relationship that audit firms establish with their clients. This means that some of the

audit firms might provide the public with misleading financial statements because of their

ulterior motive.


Although we are not focusing on the Enron debacle, it would be beneficial to raise the issues

of independence of the audit firm, Arthur Anderson, who provided unqualified audit report for

consecutive years while Enron’s financial statements were in complete mess. According to

David (2003), “Arthur Andersen's audits of Enron's financial statements during each years

resulted in unqualified reports. In other words, Andersen expressed its opinion that Enron's

financial statements fairly presented, in all material respects, Enron's financial position in

accordance with Generally Accepted Accounting Principles.” (p. 5)

One may ask as to what is the motive behind such misrepresentation of financial statements

while the reality is just the opposite. As stated above, independence of auditors could be

primarily affected by their relation with the clients. It is evident that clients have an upper hand

in their relation with audit firms. With respect to the relationship between Anderson (the audit

firm) and Enron, it appeared that the former excessively intervene in the internal operations of

the latter. This situation resulted in loss of confidence on the audit firm for the simple reason that

it compromised its independence and integrity.

The issue of independence has been the focal point especially after the collapse of Enron.

Several firms were forced to shut down their business as a result of Auditors report that did not

reveal the actual financial standing of the firms.

In order for auditors to live up to the public expectation, they should qualify for the minimum

standards of professionalism- their independence. Their integrity should well be restored. The

accounting educators are expected “to help restore the credibility of the critically important, if

long underappreciated, independent audit function”. (Knapp, 2006.p1).


Among some of the factors affecting auditor independence is the non- audit service that the

audit firm provides to the clients. There has been regulation on how to break down and disclose

those fees in an attempt to protect the principle of independence.

The focus of the auditor independence standard is to better serve the public interest and to

maintain a high degree of integrity, objectivity, and independence for audits of government

entities. The standard includes a principle-based approach to addressing this issue, supplemented

with certain safeguards. The independence standard for non-audit services is based on two

overarching principles:

1. Auditors should not perform management functions or make management decisions.

2. Auditors should not audit their own work or provide non-audit services in situations

where the amounts or services involved are significant or material to the subject matter of

the audit. (“Independence”, 2006)

When we raise the issue of independence, the effects of the provision of non- audit services

come into the picture. There is a wide spread perception that the provision of non-audit services

undermine auditor independence (Islam,Karim & Van Zijl, 2005).

Generally speaking, the purpose of this paper will be mainly analyzing those factors affecting

the independent performance of an auditor.

1.2 Statement of the Problem

Independence is one of the core elements of Auditing profession. Auditors are always

expected to be objective in their attitude and performance of duties during their engagement

with their clients. However, the independence functions of Auditors are affected by such factors


as audit fees, non-audit fees, size of the firm and so on. Lack of independence resulted in loss of

public confidence towards audit professionals.

1.3 Research Questions

It is evident that the general public attaches great importance to the functions performed by

Auditors. Auditors need to provide the general public with unbiased and objective audit findings.

The ultimate objective is to provide third parties or the public with their findings on the accuracy

of financial statements. Regarding this fact, (Hopwood, Leiner & Young, 2008) stated that the

Auditors’ objective is to determine whether the financial statements are free of material

misstatement, whether from error or fraud. From this it follows that such an objective could be

attained if independence of auditors is not impaired by factors described in this research paper.

Therefore the purpose of this research is to analyze and determine how the independent

functioning of Auditors serves as a core element in audit engagement process and what major

factors affect independence of Auditors? In order to effectively answer this question, the

following sub-question will be touched upon.

1. What does Auditor independence entail in general?

2. What specific factors are considered to have influence on independent functioning of

an Auditor?

3. Why audit and non-audit fees are the main causes of conflict of interest of Auditors?


1.4 Significance of the study

It has become critically important to look into the independence related problems associated

with audit firms in their engagement with their clients. Over the past few years, we have

witnessed the collapse of many companies due to problems linked with the lack of independence

in their audit firms.

As it is clearly stated in Generally Accepted Auditing Standards, auditors are expected to

be independent in mental attitude in all matters related to their assignment (AICPA, 2005).

Despite this accepted principle, many audit firms violate this core principle primarily because of

the large sum of audit and non-audit fees they receive from their clients.

In an attempt to cite a realistic example of the lack of independence associated with Arthur

Andersen, an accounting firm that audited Enron’s financial statements, David ( 2003) explains

the fact that conflict of interest simply overwhelmed prudential consideration and millions of

dollars were at stake- not only audit fees but also consulting revenues.

This implies the fact that the core element on which the auditing profession is built is

always in danger in so far as the client has an upper hand in providing the audit fee. It is also

important to clearly limit the type of activities that an audit firm is expected to perform for its

clients.

Many problems arose when audit firms excessively interfere in their clients’ internal

operation by compromising their independence. Because of this, when they issue their opinion, it

could be hard to be impartial.


To maintain overall revenues and firm profitability, accounting firms began to place more

emphasis on non-audit services. The relative reduction in audit fee revenue and relative increase

in reliance on revenues from non-audit services may have placed increased pressure on auditor

independence (The CPA Journal, 2005)

In light of the above issues mentioned, this research will try to address basic factors

contributing to the lack of independence of Auditors. It will also try to reveal some of the

conflicting interests of audit firms in the performance of their duties to their clients. As we

discussed in the background of this research, there are so many factors to be considered in

dealing with independence issues.

In dealing with independence “Financial relationships and interests as well as the safeguards

regarding non-audit financial services offered by audit firms are among the issues of continuing

concern…” (Auditor Independence, 2005, para.3)

Generally speaking, the investing public expects the audit firms and the CPAs to act

responsibly and without bias when they issue their audit opinion. For the last many years, audit

firms have been accountable to their clients rather than to the public. The public require each

audit firm to issue its qualified or unqualified audit opinion of companies by employing the basic

auditing standards of independence. Regardless of this fact, this process has been deeply

challenged over the past years. And that is why this research is significant in revealing those

factors apart from the audit fees that are affecting the independent functioning of Auditors

recommendations.


1.5 Research Design and Methodology

Basically, it is the researcher’s plan to make use of qualitative research methodology to

gather, analyze and interpret data concerning the independence of Auditors. Quantitative method

will also be used to a certain extent.

In an attempt to make the best use of a qualitative research, the actual research will employ

content analysis whereby it is possible to systematically examine the varying concepts Auditor

independence and some of the factors therein.

This procedure applies to the research due to the fact that it is suitable for analyzing issues

surrounding independent functioning of Auditors.

The specific data gathering method to be applied to the research consists of secondary data

(Journals, web-resources, conference papers, text books, etc) to be collected from libraries and

internet resources.

The research basically addresses all accounting professionals who are trying to improve the

standards of the discipline and who may be helpful in providing information on the subject.

It is believed that this research is directly relevant to the current study of Accounting the

researcher is engaged in.

Any research is not free from bias. Due to the qualitative nature of data gathering, the

researcher is concerned not to be biased in limiting himself with those data written on problems

associated with independence of Auditors disregarding some of the positive elements in it.


1.6 Organization of the study

The first chapter of the research paper devotes itself to providing background information

related to the research topic of interest – Auditor independence within the context of the

statement of the problem mentioned therein. The main research question is also given with four

related sub-questions and an overview of the significance of the study. The second chapter

presents the review of literatures written in the areas of public accounting profession, challenges

of Auditor independence and factors affecting independence. An analysis of the role of

independence of Auditors in Audit firms’ financial statement has been briefly touched upon.

Chapter 3 provides basic understanding as to what is meant by auditor independence in general.

Chapter 4 deals with explaining major factors considered to have influenced independent

functioning of an Auditor. The role of audit and non-audit fees will be described in depth.

Chapter 5 presents the main reasons and significance of audit and non audit services and outline

some of the regulatory framework within which audit firms implement their services. The last

chapter concludes the paper by summarizing and providing recommendations.


Chapter Two

Literature Review

The concept of auditor independence has been special area of concern since the collapse of

the big accounting firms in the last decade. Knapp (2006) underscores that a series of high

profile scandals and the collapse of Enron and World com “focused the attention of the investing

public, business journalists, wall street and eventually the U.S. congress on our profession” (p.

xvii). The main problems of the scandals were associated with the lack of integrity by the then

famous accounting firms in the performance of their duties. Knapp (2006) continues to

emphasize that a renewed dedication on the part of the accounting firms will have “a far reaching

implications for the independent audit function in coming years” (p. xvii).

The issue of independence has been exhaustively argued to have been looked at in two

different perspective- independence “in fact” and independence “in appearance”.

The CPA journal (2004) states that an auditor who is independent in fact has the ability to make

independent audit decisions regardless of whether there is a perceived lack of independence.

Regarding the public outlook on auditor being independent “ in fact”, the journal continue to

state that even though the auditor is independent “in fact”, the public believe that there are some

factors that lead the public to believe that the auditor does not appear independent.

It went on emphasizing the fact that “since auditor independence in fact is a mental state,

investors and other users of financial statements can not accurately assess actual auditor

objectivity; thus even when an auditor acts independently in fact and issues an unbiased audit


opinion, investor confidence is eroded if investors and other users of the financial statement

information do not perceive that the auditor was independent in appearance”.

On the same subject of independence, it has been noted that auditors should comply with

generally accepted auditing standards that require that auditors perform the engagement with due

care and an objective state of mind. (“Auditor’s responsibilities,”2000, para.8). The article also

stresses on how auditors remain independent by taking into account the context in which they

practice, the risk to independence and the safeguards available to them. (p. 7).

It is true that the investing public attach much more importance with the way the auditors are

operating. In view of this expectation, it is firmly stated that “the fact and appearance of

independence is the independent auditor’s most fundamental distinguishing professional

characteristics given their primary role to serve as unbiased competent witnesses of management

prepared financial statements. They must thus avoid situations that may lead to outsiders to

doubt their independence” (Auditor Independence, 2001, para.1).

This refers to the fact that providing auditing services to clients should be performed

independently to meet the public demand. Nevertheless, this expectation has not been realized

and still remains to be a problem.

In an attempt to give emphasis to the problems associated with independence it has been

stated that “Independence derives the accounting profession which survives on the public’s faith

in the integrity and objectivity of its opinion. However, the increasing size and number of CPA

firms’ non-audit engagement has raised concerns of potential conflicts of interest that could

compromise independent audit services” (Auditor Independence, 2001, para.2).


Though it seems hard to evaluate, auditors are required to adhere to the principles of

independence to perform their duties without being prejudiced by such factors as the size of the

audit fees they receive from their clients and non-audit service fees. It is argued whether auditors

independence is a function of non audit fee ration (ratio of non-audit to total fees from a client)

or client importance (the ratio of fees from a given client to total revenue (Ghosh, Kallapur and

Moon, 2006).

Regarding clients financial power over the auditor, it is noted that “many clients who perceive

that audit service do not add value also aggressively negotiate for lower audit fees”(Auditor

Independence, 2001, para.4). In such a situation, auditor independence will be in jeopardy.

McGrath (2001) also pointed out possible threats to independent performance as self interest, self

review, advocacy, familiarity (or trust) and intimidation. Apart from financial interest, these

factors are also considered to affect independence.

AICPA, in its practice alert 99-1, elaborates the above mentioned risks in the following way:

Self interest risk- a threat that arises from an auditor acting in his or her own

interest

Self review risk- a threat that arises from an auditor reviewing his or her own work

by others in the auditor’s firm

Advocacy risk- a threat that arises from an auditor acting as an advocate for or

against an auditee’s or opinion rather than as an unbiased attester


Familiarity or trust risk- a threat that arises from an auditor being influenced by a

close relationship with an auditee.

Intimidation risk- a threat that arises from an auditor being in appropriately pressured

by an auditee or by another interested party.

Capitalizing on the factors to be considered on independence, the Canadian Institute of

Chartered Accountants (CICA) on its on-line publication stated the following:

“The significance of a threat depends on factors such as its force,

the stature of the persons involved, the nature of the matter causing

the threat and the strength of the auditor’s integrity….. A threat can

be considered significant if, considering all of its quantitative and qualitative

aspects, it increases the level of independence risk to an unacceptably high

level.”

Apart from the general view that auditor’s independence can be impaired due to factors

described previously, many attribute this issue to specific monetary benefits derived from the

audit engagement process, be it the regular audit fee or the peripheral services such as non-audit

fees.


Flaming (2001) also indicated the provision of non-audit services reduces investors’

judgments of auditor independence, audit quality and the attractiveness of the firm as an

investment.

Over the last decade, many companies were forced to collapse as a result of independence

related issues. Miller (2001) points out that “Anderson appears to have failed miserably in its

responsibility as Enron’s auditor” (p.5). In order to alleviate the problems an audit firm may have

with regard to independence, the Securities and Exchange Commission (SEC) promulgated

several guidelines. (Palm rose and Saul, 2001) mentions the new rules that “prohibits accounting

firms from providing certain non-audit “consulting” services to their audit clients”.

Emphasizing on the issue of independence (Beck and Lindberg, 2004) stated that the Enron

bankruptcy had great impact on the public attitude towards what is expected of auditors. The

service rendered by any incumbent audit firm to a client is highly restricted by Sarbanes-Oxley

act of 2002. This act was necessitated to minimize any possible interference of the audit firm into

internal operation of any potential client.

There is a general consensus in the fact that auditors may act favorably towards their client

from whom they receive a large sum of non-audit fees. The Sarbanes-Oxley act of 2002 restricts

a registered public accounting firm from providing non-audit service to its clients. Some of such

services are outlined below (Sarbanes-Oxley, 2002).

Bookkeeping or other records related to the financial statements of the audit client

Financial information system design and implementation

Appraisal and valuation services


Internal audit outsourcing services

Management functions and human resources.

In general, it is very important to recognize the type of audit service that would affect

independence of auditors.


Chapter Three

The rational of Auditor Independence

As has been explained in the previous chapter, auditor independence is the corner stone of

auditing profession. Auditors need to show their integrity to the general public and be abiding by

set of rules and regulations.

The Securities and Exchange Commission has stipulated major requirements of auditor’s

independence in its final rule of 2001 and adopted certain amendments. Auditor independence

has been explained in the executive summary of this amendment as follows:

“Independent auditors have an important public trust.

Investors must be able to rely on issuers' financial statements.

It is the auditor's opinion that furnishes investors with critical assurance

that the financial statements have been subjected to a rigorous

examination by an objective, impartial, and skilled professional, and that

investors, therefore, can rely on them. If investors do not believe

that an auditor is independent of a company, they will derive little confidence

from the auditor's opinion and will be far less likely to invest in that public company”

It is also argued that the investor’s attitude towards the day to day performance of an auditor

impacts to a great extent how the auditor can accomplish the task objectively. With respect to the

investor attitude ( SEC 2000 ) states the fact that an auditor may not be operating independently


if a reasonable investor with knowledge of all relevant facts and circumstances concludes that

the auditor is not capable of exercising objective and impartial judgment ( p.3)

One should always analyze the importance of independence to perform tasks without any bias

and hidden benefit. According to SEC’s independence standard, independence generally is

understood to refer to a mental state of objectivity and lack of bias. The amendments retain this

understanding of independence and provide a standard for ascertaining whether the auditor has

the requisite state of mind.

The role of the audit committee is of paramount importance in reinforcing the independence

of auditors. Therefore, audit committee should be able to bridge the gap that may exist between

the board of directors and external auditors. It is indicated that “by probing the relationship

between management and the auditor, the audit committee helps to promote the independence of

the auditor and ensures higher quality financial reporting”(CISA Publication, 2000, p.9).

AICPA Standards Document establishes the need for independence in its Code of conduct in

a very clear way. According to Section 100 of the code, Independence, Integrity, and Objectivity

of an auditor are inseparable elements of the audit process. The code of ethics:

a. Sets independence standards that CPAs must adhere to in regards to the type of

work performed.

b. Applies to CPAs in all situations involving an attest client.

c. Attest: Services requiring independence and assurances from the CPA such as

audits, reviews, and agreed-upon procedures.


Moreover, Government Accountability Office (GAO) emphasizes on independence

whereby it:

d. Sets independence standards for federal entities and those organizations receiving

federal funds. Various laws require compliance with the comptroller general’s

auditing standards in connection with audits of federal entities and funds.

Furthermore, many states, local governments, and other entities, both

domestically and internationally, have voluntarily adopted these standards.

e. Underscores the fact that GAO rules are generally more restrictive than those of

the AICPA pertaining to independence of auditors.

Even though different institution sets their own standards on auditor independence, there

seems to be a general consensus on the basic requirement of the subject. Many argue that

auditors must fulfill obligation even in a situation where it might adversely affect their

employers. From this we could appreciate how this principle is important in the auditing sphere.

When we discuss the “what” of independence, it is primarily necessary to understand the

threats associated to it. Mcgrath(2001) clearly mentioned the following three steps that the

Independence Standard Board put forward as a conceptual framework for auditor independence .

The three steps are:

i. Identifying threats to auditor independence and analyze their significance

ii. Evaluate the effectiveness of potential safeguards including restrictions

iii. Determine an acceptable level of independence risk.


In order to address the issue of auditor independence, one needs to recognize the threats to the

independence. Auditors operate in an open system where their profession is being challenged

critically. However, the investing public always expects a reliable financial reporting in which

the objectivity of auditors is reflected.

Regarding the relationship between conflict of interest and independence, Brenkert( 2004)

made it clear that “ auditor independence involves conflict of interest”. It went on explaining

conflict of interest arise when the auditor owes a duty the performance of which could well be

influenced by his/her interest.

This argument is related with the notion that self interest could be the main deriving force for

auditors to compromise their independence. As we will see in the next chapter, the primary

reason of conflict of interest causes the independence issue to be questionable.

The question of independence has vastly been addressed by AICPA from the very beginning.

Accordingly, AICPA (2005) mentions that the maintenance of objectivity and independence

requires a continuing assessment of client relationship and public responsibly. It is also described

that a member who provides auditing and other attestation services should be independent in fact

and appearance.

The Public Company Accounting Oversight Board (PCAOB) also supports the fact that

auditors should maintain independence standards as promulgated in AICPA code of conduct.

The PCAOB which was established under the 2002 Act of Sarbanes- Oxley is believed to

provide assurance to investors by looking into auditors’ engagement with their clients.

According to PCAOB web site, the mission of the organization is stated as follows:


“The PCAOB is a private sector, non-profit corporation, created by

the Sarbanes-Oxley Act of 2002, to oversee the auditors of public

companies in order to protect the interests of investors and further

the public interest in the preparation of informative, fair and independent

audit report.”

It is also stated in the PCAOB web site that a registered firm is not independent of an audit

client if the firm provides tax services during the audit and professional engagement period.

The CPA Journal (2004) emphasized that most audit failure arise as a result of the failure by

the auditor to understand the wider business dimension rather than lack of independence.

However, this assertion seems to ignore the recent issues that caused such big firms as Enron and

WorldCom to collapse once and for all.


Chapter Four

Factors affecting auditor independence

As explained in the background of the paper, auditor independence can be seen in terms of

two pronged approach: independence “in fact “and independence “in appearance’’. The former is

a state of mind of the auditor which in most cases is considered to be a semblance of

independence in appearance to influence investors’ judgment.

It is evident the goal of independence boils down to “support user reliance on financial

reporting process and to enhance capital market efficiency’’. To arrive at unbiased audit decision

independence is not only requirement but also a mandatory element of audit engagement process.

Nonetheless, the desire to bring about a change in independent performance of auditors has

never existed without problem. This is because of multitude of factors affecting auditor

independence and considered to be a threat to independent performance of audit duties.

The inherent problem that has existed and continues to exist is what is described in the

AICPA rules of professional conduct as “conflict of interest”. The code in section 102-2

mentioned the fact that “a conflict of interest may occur if a member performs a professional

service for a client or employer and the member or his or her firm has a relationship with another

person, entity, product, or service that could, in the member's professional judgment, be viewed

by the client, employer, or other appropriate parties as impairing the member's objectivity”.


This conflict of interest arises, among other things, due to the following factors.

4.1 Provision of non-audit services

As the name entails, non-audit services (NAS) constitute all those services rendered by the

auditor except the regular audit jobs acquired as a result of the audit engagement.

According to Sarbanes- Oxley act of 2002, nine major non-audit services have been specified.

The act indicated the fact that if the following nine non-audit services are provided by an

accounting firm, it is highly likely that auditor independence is impaired. The prohibited services

are mentioned as follows:

Bookkeeping or other services related to the accounting records or financial statements of

the audit client

The rules will prohibit an accountant from auditing the bookkeeping work performed by

his or her accounting firm.

Financial information systems design and implementation

These rules will prohibit the accounting firm from providing any service related to the

audit client's information system, unless it is reasonable to conclude that the results of

these services will not be subject to audit procedures during an audit of the audit client's

financial statements. These rules will not preclude an accounting firm from working on

hardware or software systems that are unrelated to the audit client's financial statements

or accounting records as long as those services are pre-approved by the audit committee.


Appraisal or valuation services, fairness opinions, or contribution-in-kind reports

Appraisal and valuation services include any process of valuing assets both tangible and

intangible, or liabilities. Fairness opinions and contribution-in-kind reports are opinions

and reports in which the firm provides its opinion on the adequacy of consideration in a

transaction. These rules will prohibit the accountant from providing such services unless

it is reasonable to conclude that the results of these services will not be subject to audit

procedures during an audit of the audit client's financial statements.

Actuarial services

These rules will prohibit an accountant from providing to an audit client any actuarially

oriented advisory service involving the determination of amounts recorded in the

financial statements and related accounts for the audit client unless it is reasonable to

conclude that the results of these services will not be subject to audit procedures during

an audit of the audit client's financial statements. The accountant, however, may assist a

client in understanding the methods, models, assumptions and inputs used in computing

an amount.

Internal audit outsourcing services

These rules will prohibit the accountant from providing any internal audit service that has

been outsourced by the audit client that relates to the audit client's internal accounting

controls, financial systems or financial statements unless it is reasonable to conclude that

the results of these services will not be subject to audit procedures during an audit of the

audit client's financial statements.

During the conduct of the audit or when providing attest services related to internal

controls, the auditor evaluates the company's internal controls and, as a result, may make


recommendations to the audit client for improvements to the controls. Doing so is a part

of the accountant's responsibilities under GAAS or applicable attestation standards and,

therefore, is not a prohibited service.

Management functions or human resources

Consistent with our proposal, the final rules will prohibit the accountant from acting,

temporarily or permanently, as a director, officer or employee of an audit client, or

performing any decision-making, supervisory, or ongoing monitoring function for the

audit client.

These rules also will provide that an accountant's independence is impaired with respect

to an audit client when the accountant seeks out prospective candidates for managerial,

executive or director positions; acts as negotiator on the audit client's behalf; or

undertakes reference checks of prospective candidates. Under the rule, an accountant's

independence also will be impaired when the accountant engages in psychological testing

or other formal testing or evaluation programs, or recommends or advises the audit client

to hire a specific candidate for a specific job.

Broker or dealer, investment adviser, or investment banking services

Acting as a broker-dealer (registered or unregistered), promoter or underwriter on behalf

of an audit client and similar activities will make the accountant an advocate for the audit

client and will impair the accountant's independence.

Legal services

An accountant will be prohibited from providing to an audit client any service that, under

circumstances in which the service is provided, could be provided only by someone

licensed, admitted, or otherwise qualified to practice law in the jurisdiction in which the


service is provided.

Expert services unrelated to the audit

These rules will prohibit an accountant from providing expert opinions or other expert

services to an audit client, or a legal representative of an audit client, for the purpose of

advocating that audit client's interests in litigation or in a regulatory or administrative

proceeding or investigation. An accountant's independence will not be impaired,

however, by an accountant providing factual accounts or testimony or explaining the

positions taken or conclusions reached during the performance of any service by the

accountant.

The Act which was designed to establish a mechanism by which the inherent problems

associated with independence of auditors is believed to serve the investing public.

SEC had also designed a system by which independent audit firms categorize and

disclose any fee received by providing non-audit service. Knapp (2006) stated that “the

continuing controversy over the magnitude and nature of non-audit fees paid by large

companies to their independent auditors caused SEC to revise its audit fee disclosure”

Accordingly, SEC has established a mechanism that requires its registrants to classify

professional fees paid to their auditors into the following four categories:

Audit fees

Audit related fees

Tax fees

All other fees (Knapp, 2006 p.368).


The rational behind this regulation serves one and only one purpose- verifications of

auditor independence.

Some proponents of this regulation described that auditors should provide any service to their

audit client (Peterson, 2008). They insist on mentioning that providing NAS does not affect

independence but rather helps the auditing firm understand its client and undertake the audit

efficiently. He continued to advocate that “audit firms should be free to provide their clients with

any services within their skills…

However, the researcher has come to realize the fact that most audit failure that occurred over

the last decade was the results of lack of independence by providing what is known as non-audit

service to audit clients. Because of the financial interest, many audit firms refrain from

disclosing the real financial situation of their client thereby providing unqualified audit report to

the investing public.

This problem necessitated the enactment of the new rule of independence by Securities and

Exchange Commission. ( Palm rose and Saul, 2001) stressed that the adoption by the Securities

and Exchange Commission of the rule helps to avoid the basic conflict of interest that existed in

providing both auditing and consulting services to a client (p.18).

In general, the basic conflict lies in providing consulting services to a client who will be

audited by the same firm that provided consulting business.

There is also a wide spread concern that provision of non-audit service severely affect

independence. Wooten (2003) indicated that providing other services to audit clients may

influence pricing. He also continued to emphasize that when a firm provides both auditing and


consulting services, some type of fee savings is given to the client. The firm can lose its

independence if it becomes economically bonded to the client through the receipt of large fees,

unrelated to the audit (The CPA Journal, 2003).

One also may appreciate the significance of non-audit service in terms of financial

contribution in relationship the regular audit service from the following table.

Analysis of fee income of the Big Five firms in the US: 1990 and 1999

Service

Category

% of total fee income

Service 1990% of total fee income 1999

All clients SEC auditClient

All clients SEC auditClient

Accounting &

Audit

53 71 34 48

Tax 27 17 22 20

Consulting 20 12 44 32

Total 100 100 100 100

Source: Beattie, V. and Fernley, S. (2003)

Reported in Auditor Independence and NAS by Islam, Karim and Van Zijl (p.4)

The above table reflects how much of the auditing firm income derived from provision of

different services as accounting, tax and consulting. From this it follows that the prohibited

nine activities mentioned in this chapter would not only help to achieve independence but also


reduces the income derived out of non-audit service as the firm is required to report any income

derived from SEC registrants.

From the table, it is also evident to refer to the fact that the sum of non-audit fees, such as tax

and consulting services may impair the firm’s independence to report reliable financial

statements to the users. SOX (2002) stipulated that “a registered public accounting firm may

engage in any non-audit service, including tax services, only if the activity is approved in

advance by the audit committee of the issuer”.

There is no denying the fact that many audit firms have been counting on revenues derived

from audit related services thereby compromising their being objective in the opinion they

establish to the general public. According to Citron (2001) there has been a sharp increase in

audit firms’ total fee revenues and in the proportion of those fees earned from consulting and

related services. The combined UK fees of KPMG, Ernst & Young and Deloitte & Touche, the

three Big Five firms providing full data over this period, totaled £1.27 billion in 1994/95,

representing a 40% increase over their 1989/90 level. By 2001/2002 their fees had grown by a

further 130% to £2.92 billion. While audit and tax accounted for 75% of these firms’ fees in

1989/90, the share of these activities fell to 64% by 1994/95 and further to 58% by 2001/2002.

Thus consulting, corporate finance, corporate recovery and other activities contributed

42% of total fees in 2001/2002 (p.11).

The increasing dependence on audit related fees by providing peripheral services made the

accounting firms to rely on that revenue to a greater extent. However, post Sarbanes-Oxley

period brought about a relatively declining trend in revenue derived out of non-audit service

activities. We can also appreciate how the Act served the investing public by helping audit firms


achieve certain level of independence. This is to say that the measure taken to diferatiate audit

duties from non-audit duties would help the auditing firm exercise an objective judgment during

the course of its engagement with its client. Cheffers (2008) substantiated the declining trend of

non-audit revenues this in the following way:

As shown in the graph, while audit fees rise as percentage of total fees, non-audit fees

Continued to fall down.

Audit Fees & Non-Audit Fees as a % of Total Fees

100%80% A 70%60%50%40%30%20%

10%Non %

0%

2002

2002 2002 2003 2004 2005 2006

Source: Mark Cheffers ( Non-Audit fees- A five yearTrend- March 2008)


According to Cheffers (2008) we clearly understand that “from 2002 to 2006, non-audit

fees have consistently dropped as a percentage of the total fees paid by accelerated filers. During

calendar year 2002, non-audit fees represented 50.44% of the total fees paid to independent

auditors by the3, 667 accelerated filers. In 2003, the percentage dropped to 40.17% and

continued to drop the following years. In 2004, non-audit fees equaled 27.21% of total fees and

in 2005 they equaled 21.67%.Another drop occurred in 2006, with non audit fees representing

only 19.65% of total audit fees paid”. (Audit Analytics, 2008, p.1).

4.2 Client size

Among the common factors that affect perceived auditor independence is the size of the

client that the firm depends to generate revenue from. In other words, it is logical to assume that

the number of customers affect how much income an auditing firm derives.

The auditor expects a large payment of audit fee upon completion of the audit to the client.

Practically, we can assume that the auditor is dependent on the client in regards to audit fee. The

regular audit fee that the client pays could be the only source to the auditor or supplemental to

the auditor. In a situation where an auditor has very few clients, it is recognized that the

independence of the auditor is severely affected. This is because of the fact that the auditor does

not want to loose its client; rather compromise its independence. It is exemplified as “if an

auditor has 100 clients all of equal size, it may not matter much if the auditor loses one of the

clients. However, if the auditor only has 2 clients of equal size, it is obvious that the

consequences of losing a client will be serious to the auditor, in this case it would be hard to


argue that the auditor is not biased in favor of the client” ( Auditor independence- An Impossible

dream, p.2).

4.3 Audit firm tenure

The auditor-client relationship over a period of time establishes an environment whereby the

audit firm is fully aware of the goals and operation of the client. The longer the period of

relationship, the more will be the possibilities not to switch to other audit firms. This will also

bring about a potential benefit to both the audit firm and its client.

Regarding the relationship, Ye (2006) explained that the continuity of interaction makes the

audit firm more knowledgeable as to the needs of the client that enables the former to customize

some of its services. It is also stated that the lengthy audit firm tenure is critical to audit process.

Wooten (2003) associated audit tenure not only with independence but also with audit qualities

where he indicated that many audit failures are likely to happen as a result of short and long audit

tenure. (The CPA Journal, 2003). By the same token, it is also argued that long tenure would

provide the firm with the opportunity to understand its client and make possible adjustment

during the course of the engagement. However, the conventional wisdom is the fact that long

tenure severely affects the objectivity of auditors. Wooten continued to put this fact in the

following way:

“Long tenure with the client has been associated with low

audit quality. Long associations have the potential to breed

complacency, less rigorous audit procedures and too much

dependence on management representations. The auditor can


become too comfortable with the client and not adjust audit procedures

to reflect the changing business and associated risks.”

It is argued that the absence of rotation may give rise to making both client and audit firm

dependent on each other which in turn deprive the audit firm of the core element of

independence expected of it. In contrast, its correlation with audit failure is just the opposite.

There is an inverse relationship between auditor tenure and audit reporting failures. (American

Accounting Association, 2002).

It appears that there is a general consensus regarding the effects of audit tenure on

independent functioning of auditors. A CPA journal that was published in January 2005

indicated that the average auditor tenure for Fortune 1000 companies is 22 years. “Also, 10% of

the companies in the study were found to have had the same auditor for 50 years, with the

average tenure of this group being 75 years” ( The CPA journal, January 2005).

At this point it is essential to recognize one of the breakthroughs brought about by the

Sarbanes-Oxley act of 2002 to reduce the impact of long tenure ship where it required periodic

rotation of audit engagement partners.

4.4 Alumni affiliation

The good will that is created as a result of the clients director being former alumni of the audit

firm should also be considered in dealing with how independently the audit firm performs its

functions. It is also natural to predict that the alumni prefer to get non audit services from its

former employer. In this respect Ye (2006) continue to emphasize that when the alumni directors


make decision on NAS suppliers, they may naturally consider their previous firm for they have a

better knowledge of the range of services offered by their former firms.

According to the CPA journal of 2005, close auditor-management relation affects the audit

process affecting the audit process. It has also resulted in many auditors being hired by former

clients. Regarding Enron’s case, “it was revealed that many Enron employees had previously

worked for Arthur Andersen. Company personnel may be the auditors from the past, and current

auditors may be auditioning for future employment”.(The CPA Journal, 2005)

When we view same practice from the point of view of independence, it is also hard to

imagine the audit firm will not be biased on its client as a result of prior relation and the benefit

derived out of the sale of NAS to its client.

Having evaluated the adverse effects of the relationship, the Sarbanes-Oxley act of 2002

prohibited accounting firms from auditing companies that have hired a former auditor for a key

accounting position during the prior twelve months.

4.5 Disclosure of non audit fees

The requirement by SEC on all its registrants to disclose the non audit fees has affected

independence to a greater degree. If the proportion of non audit fees as a percentage of total fees

is high, then it may be possible to assume that the firm’s independence is in jeopardy.

Knapp (2006) points out that the SEC’s new audit fee disclosures re-ignited the contentious

debate whether auditors were truly independent of their major clients. To quell this controversy,

many corporate executives began insisting that the “other services” provided by accounting firms


were typically “audit related”…. Many companies encouraged by their auditors have tried to

allay such independence concerns by voluntarily disclosing how much of their fees for “other

services are “audit related”.

Several companies were urged to disclose the non audit fee as it is an indication of the

existence of independence or not. A case in point on the disclosure issue is described as follows:

General

During fiscal 2000, the company paid KPMG LLP fees in the aggregate amount of approximately $ 4,517,800. Of this amount, approximately $ 991,400 was fees for the fiscal 2000 audit and other audit services.

Financial Information Systems Design and Implementation

KMPG did not render any services related to financial information systems design and implementation during fiscal 2000.

All other Fees

KPMG rendered other services consisting primarily of tax consulting, due diligence assistance, environmental consulting, litigation support, and audit of the company’s employee benefit plans and other entities within the consolidated group for statutory filing purposes. Aggregate fees bills for all other services were $ 3,526,400

The Home Depot Fiscal 2000 Audit Fee Disclosure

Source: Knapp (Contemporary Auditing, 2006) P. 366


The merits of requiring public companies to disclose the fees associated with the auditing and

non auditing tasks has contributed to evaluate the pattern of audit expenses thereby urging audit

firms to comply with the independence rule.

4.6 Training of auditors

Human resources development plays a key role in implementing the independence rule. Apart

from their day-to-day endeavor to live up to the public expectation, auditors should consistently

acquire relevant information on the rule and procedure governing their profession. In this

respect, when laws are enacted auditors must be familiar with their implementation to be able to

perform.

Training pertains to enabling auditors to understand basic issues surrounding the audit

profession- independence being the primary issue. From this it follows that there is a direct

relationship between independence and proper awareness of rules governing auditor

independence.

4.7 Audit committees

The role of audit committees in the overall process of financial reporting has changed from

the traditional role of passive action to a proactive endeavor due to the challenges of the auditing

profession. Though a lot can be done by an audit committee, it should make sure that the proper

organizational culture is first in place in order to be able to positively influence management to

adhere to audit rules and procedures.


In order to discharge its responsibility, the committees should also be aware of the scope of

services provided by the audit firm.

A strong audit committee in an indispensable to the healthy functioning of the audit firms for

it strives to attain a check and balance in the organization.

Regarding the new role expected of any strong audit committee, Brodsky (2003) stressed that

audit committee should stand at the intersection of management, independent auditors, internal

auditors, and the board of directors. He continued to emphasize that “the role of the audit

committee has been to oversee, monitor, and advise company management and outside auditors

in conducting audits and preparing financial statements, subject to the ultimate authority of the

board of directors”.

Finally the author concludes by underscoring the fact that “audit committees therefore need to

ensure accountability on the part of management and internal and external auditors; make certain

all groups involved in the financial reporting and internal controls process understand their roles;

gain input from the internal auditors, external auditors, and outside experts when needed; and

safeguard the overall objectivity of the financial reporting and internal controls process”.

4.8 Culture of the audit firm

Independence is also a function of how the audit firm is originally structured. The belief to

promote responsible behavior is essential for audit firms to perform their duties independently.

Their track record in auditing other clients should well be evaluated in order to arrive at certain

judgment as to their objective opinion on financial statements.


4.9 Auditor’s ethical and moral characteristics

Ethical responsibilities of auditors are also a key element in an attempt to bring about

independent audit engagement with clients. It is evident that the lack of this core principle

resulted in many problems in the past.

It is stated under section 102 of the AICPA code of professional conduct that “in the

performance of any professional service, a member shall maintain objectivity and integrity, shall

be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or

her judgment to others”


Chapter Five

Audit and Non-audit fees - Conflict of interest

The primary relation that existed between an audit firm and its client during an audit

engagement process is that of providing an audit service to come up with an audit opinion based

on the realities reflected on financial statements of the latter.

As explained in the previous chapter, the magnitude of audit revenues is certainly affecting

audit firms. Many argue that audit firms will find it difficult to pick out their own mistake in

advising their clients while they perform the regular audit function. This will impair the degree

of independence and even create a conflict of interest on non-audit and audit functions.

Flaming (2002) is of the opinion that New SEC proxy disclosure requirement reveal an

average of non-audit service fee to audit fee ratio of over 200 percent (p.2). This figure is self

explanatory to arrive at certain judgment about the level of independence and audit firm may

have in performing the regular audit duties.

Results indicated that post SOX period has proved a declining non-audit revenues as some of

the activities are prohibited or needed prior approval of the audit committee. Iyengar and

Zampelli(2007) argue that “ Today, for most auditors, audit fees are but a small proportion of

their total income.” The authors tried to capitalize on the contribution of other services (non-

audit and audit related fees) apart from the regular means of income.

The conflict of interest that exists while undertaking both audit and non-audit services is well described in the SEC (2000a) rule proposal as follows:


“... as auditors become involved in a broad array of business

arrangements with their clients, they come to be seen by themselves,

their firms, their clients, and investors less as exacting, skeptical professionals

who must be satisfied before signing off on the financial statements,

and more like any other service vendor who must satisfy the client to make the

sale”.

SEC(2000b) went on underscoring that fact that “ the rapid rise in the growth of non audit

services has increased the economic incentives for the auditor to preserve a relationship with the

audit client, thereby increasing the risk that the auditor will be less inclined to be objective”.

Though it is extremely difficult to gauge auditor independence, it is not impossible to detect

some likely factors that cause impairment of independence. One such factor is analysis of the

client’s expenses in audit areas. In so doing, one can get a clue as to the existence of a healthy

relation between the audit firm and its client.

The other consideration is analysis of risk factors as described along the continuum in the

publication of CICA as shown below: RISK OF IMPAIRED INDPENDENCE

NO RISK REMOTE RISK SOME RISK PROBABLE

RISK

CERTIANITY

Auditor clearly

Independent

Impaired

independence

very unlikely

Independence

might be

impaired

Impaired

independence

very likely

Auditor clearly

not independent

Source: CICA Publication “Guidance for Audit committee” ( P. 9)


One needs to look into what causes this impaired independence. The view that the financial

dependency resulted in lack of objectivity is predominantly reflected in most audit related

researches. This is even stretched to influence the competition among audit firms to get a new

audit client by providing “Low Balling” to clients to step into the business. Providing below

market price to audit clients is also an indication of the hidden desire to undertake non-audit

services and compensate the revenue.

. When we analyze audit fee to affect independence, we basically measure the audit revenue

as percentage of the total revenue an auditor collects. Miller (2001) raises practical questions as

to why Andersen, a firm that audited Enron’s financial statements assisted Enron in its financial

shell games and replied, as “It appears that conflict of interest simply overwhelmed prudential

consideration Millions of dollars were at stake not only audit fees but also consulting fees (p.5).

In a nutshell, the researcher has come to realize that the conflict of inertest between audit and

non-audit fees exists as long as there is an audit engagement.


Chapter Six

Conclusion and Recommendation

As explained in the previous chapter, independence is a core element of auditing.

Nonetheless, this principle has been affected by the following factors:

Audit fees

Impartial mental attitude is a state of mind that lends itself to performing tasks without

external influence. The auditor expects a large payment of audit fee upon completion of the audit

to the client. Practically, we can assume that the auditor is dependent on the client in regards to

audit fee. The regular audit fee that the client pays could be the only source to the auditor or

supplemental to the auditor. In a situation where an auditor has very few clients, it is recognized

that the independence of the auditor is severely affected. This is because of the fact that the

auditor does not want to loose its client; rather compromise its independence. It is exemplified as

“if an auditor has 100 clients all of equal size, it may not matter much if the auditor loses one of

the clients. However, if the auditor only has 2 clients of equal size, it is obvious that the

consequences of losing a client will be serious to the auditor, in this case it would be hard to

argue that the auditor is not biased in favor of the client” ( Auditor independence- An Impossible

dream, p.2).

This suggests that if total fee received from a client is minimal, then the auditor may perform

his duties independently. When we analyze audit fee to affect independence, we basically

measure the audit revenue as percentage of the total revenue an auditor collects. Miller (2001)

raises practical questions as to why Andersen, a firm that audited Enron’s financial statements


assisted Enron in its financial shell games and replied as “It appears that conflict of interest

simply overwhelmed prudential consideration. Millions of dollars were at stake not only audit

fees but also consulting fees (p.5).

From this it follows that the audit fee impacts auditor independence. Jennings, Lander and

Reinstan (2001) clearly explained that the public interest is best served when auditors perform

reasonable tasks to genuinely reflect the real financial structure of the firm (p.4)

If auditor is not committed to achieving objectivity, then they are promoting their own

economic self interest. That is why the type and size of audit fee is directly related to auditor

independence.

Non-audit service fee

Non-audit services are considered to be all those services primarily of consulting services

rendered to the client.

The audit firms used to provide consulting services to its client until it was prohibited by

Sarbanes-Oxley act of 2002. The rational is that it is hard to be independent while providing

consulting services to a potential client.

Self-Interest

This is a factor affecting independence that arise out of an emotional, financial or personal

motive.


Self- Review

Self-review may adversely affect auditor independence as it requires an auditor to perform

auditing of his/her own work.

Familiarity

This is also a situation where the auditor may be influenced by a close friend.

Intimidation

If an auditor is threatened by a third party upon the performance of a auditing, then it is highly

likely that independence is in jeopardy.

This suggests that auditors might be affected by factors other than those having monetary

implications.

Finally the researcher has come to realize that though it is difficult to measure in concrete

terms, it is possible to determine the impairment of independence in perspective. This means that

there should be checks and balances in the process of audit engagement.

What we witnessed over the past decade was a complete lack of independence due to the

inherent weaknesses of the process of audit engagement. It is also possible to draw a lesson from

the collapse of too many big companies as a result of lack of independence of their audit firm.

The large sum of audit and non-audit fees has been the main concern for impairment of

independence.


The researcher has also arrived at a conclusion whereby the power imbalance between the

auditors and the client is a phenomenon that has existed and will continue to exist. However, the

new independence rule serves the public interest in its quest for getting unbiased audit opinion

from the audit firms.

The fact that an accounting firm is limited to providing specific tasks to the client by being

denied of consulting services would assure reasonable public confidence as it may help auditors

be independent.

The SEC requirement of disclosure of audit, non-audit and information technology fee of

audit firms helps to get information on the relative dependency of an audit firm. If the ratio of

non-audit fee to audit fee is too high, it is possible to conclude that the auditors’ independence

might have been impaired.

This suggests that the audit firm will be biased to arrive at an objective conclusion of the

clients’ financial statements.

The other aspect of power imbalance is when the audit firm has too few clients on whose

revenue the firm is dependent. In such a situation, it is hardly possible for the audit firm to arrive

at a qualified audit opinion. This also suggests that independence is impaired. However, it may

not hold true for big audit firms who have a large number of clients and alternative sources of

revenue.

In order to build public confidence in the accounting profession, a need arose to formulate

new rules of independence. The Sarbanes-Oxley act of 2002 was one step to assure the integrity

of auditors in the performance of their tasks. As an attempt was made in the previous chapters to


explain issues of independence, it is also the researcher’s belief to stress the fact that the

measures taken to improve standards of auditor independence have positively influenced

independence.

In conclusion, the researcher points out the following on the issue of independence:

1. Checks and balances could be achieved if auditors are in compliance with the new

independence rule.

2. As ethics and independence are highly interrelated, audit professionals must take ethical

standard training on regular basis.

3. The implementation of Sarbanes-Oxley act of 2002 must be re-assured by enforcing the

nine restricted services mentioned above.

4. There should be a need to follow-up how the independence rule is being implemented.


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http://www.aicpa.org/audcommctr/spotlight/Govt_21_Independence_and_Related_Topics.htm


Wyman, P. (2004). Is Auditor Independence really the solution? The CPA Journal, vol. LXXIV, Retrieved February 3, 2009, from New York State society of CPAs Website

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Documents

DRP ON AUDITOR INDEPENDENCE - FINAL