Why Is It Important for External Auditors to Be Independent? Essay

This essay has asked me to look at the importance of external auditors and why it is vital for them to remain independent. I will try and look at the many ways of the advantages of independent auditing from different perspectives for example the company itself, the general public and the state. I think it is important to first define what an audit and an external auditor to be able to answer this question effectively. Firstly an audit is (1)“an accounting procedure under which the financial records of a company or individual are closely inspected to make sure that they are accurate. An independent or external audit is carried out by a neutral third party, such as a professional accounting firm which specializes in audits. Typically in both cases without fail the financial records of that company will be checked by the auditors this includes payroll, official published reports accounts payable etc. The auditors check for any discrepancies and if any are found then they have to get sorted immediately and possibly in the most extreme cases criminal action could be taken.

I feel that this topic is a very important one and especially at present because as we have just come out of a recession there are going to be many companies that will have been tempted to perform creative accounting and therefore manipulate their figures to their advantage to possibly drive investment by raising their share price or possibly even give confidence in their company that they’re not going to reach bankruptcy therefore it is the external auditors job to spot this and to make sure that there is no wrong doings present.

Auditor independence is essentially the process to which the auditor’s integrity is at stake and the objective approach of the auditing process. (2) “To be credible, an auditor’s opinion must be based on an objective and disinterested assessment of whether the financial statements are presented fairly in conformity with generally accepted accounting principles”. A independent review from an auditor of the companies accounts will have many benefits to the owner for example for example he/she will be satisfied of the workings of that particular department.

This will mean that the owner will have confidence of where they should place their funds or research and development if they know for sure that there department’s financial record are in order. This will then allow for the best method to allocate resources allowing for greater efficiency and overall the company to be profitable in the future. Also allowing for the report to be independent the report of the auditor will be true and fair in all respects.

An independent auditor will also help keep staff of that company in check because of the fear that in the near future the accounts are to be examined and action would be taken against them if any irregular actions have been caused to happen. Thus the independent audit prevents this from starting in the first place and helps keep the staff in a moral check. A report by an independent auditor can also help in the process of borrowing money. As the report will have been done by an independent auditor it then becomes very easy for example a bank to trust this and therefore becomes very easy for them to issue a loan without time or delay.

Also it may enable the firm to achieve a better rate than otherwise expected because they may be seen as a less risky investment. This can obviously help the firm in many ways because they will be paying less money out in interest payments therefore they will have a greater amount of profits in the balance sheet. This will keep shareholders happy as a strong balance sheet usually enables a strong share price and increased dividends payments. An example of creative accounting which can be used is what was used by a company called WorldCom. The paper USA today covered the story in a article by Matt Cranz. 3) “WorldCom used the gimmick to a level never before seen. The company showed a $1. 4 billion profit in 2001,rather than a loss, by using what’s essentially the oldest trick in the book. Rather than subtracting certain costs which analysts think were for maintaining telecom systems — from profit, it called them long-term investments. Doing this allowed WorldCom to inflate earnings because the costs of long-term investments are subtracted from earnings over time, rather than all at once up front. ” This is an example of an audit that found out a company participating in creative accounting.

It was a independent auditing firm that checked the results of WorldCom. It’s vital that the reports done are done independently because for example if the auditor participating in this investigation had shares in this company he would have almost certainly portrayed a different picture in the story because he would have almost certainly lost personal financial gain and acting in his own interests he/she would modified or altered their investigation. This can also be seen in the case if the investigator has a family relation or personal relation i. a director in the particular firm they are constructing the report because this may also hinder their investigation. The presence of external auditors can also be beneficial and important to the government in many ways. One advantage is In the presence of audited accounts the assessment of tax becomes very easy because the tax is imposed on the basis of audited accounts. Therefore this will mean that the government will not have to spend money on for example employing external people to do this job and the government will also be able to receive the money quickly without time or delay which is a major luxury at present times.

The government can therefore place their money on other areas like fiscal policy improving the economy. Again it is important for the auditors to be independent so that the government can trust these figures. Without the trust in these figures the government could eventually get the tax figures wrong for that particular company and could send the system into distribute and produce major economic setbacks. To conclude with I hope that you can see from this report some of the ways that it is vital for external auditors to be independent. this is vitally important as it fits in with the contractual reference to public accounting standards/codes and also the Mautz, R. K. ; Sharaf, H. A. (1961) ‘The Philosophy of Auditing. However there is also the question that has to be answered can an auditor be completely independent ever?

There is, in fact two types of independence Real independence and Perceived independence. “These two differ because (4) an auditor who is independent ‘in fact’ has the ability to make independent decisions even if there is a perceived lack of independence present, or if the auditor is placed in a compromising position by company directors. There are many problems in actually determining whether the auditor is actually independent for example it is impossible to impose a person’s mental attitude and integrity. An auditor earns a living from what he is paid by the company, he is composing the report on therefore this reliance on the fee may affect his independence. For example if he is too relied on his fee he may not work in the necessary interest of the share holders therefore compromising standards.

As we have discovered the independence of auditors is a vital tool for the credibility of the profession and to allow the smooth running of the financial world there are possible reforms that can be made to ensure an even better system. For example service limitations and audit companies should not be able to provide clients from similar advisory services. Another example could be the rotation of external auditors this would lead to greater independency because this would allow for less co-operation between the auditors and the managers as they will only be with them for a certain time frame.

Reference list

1) (Definition of Auditing. )http://www. wisegeek. com/what-is-an-audit. htm accessed 8 feb 2011 2) American Institute of Certified Public Accountants (AICPA) in a statement adopted in 1947: http://www. scribd. com/doc/43627818/Auditor-Independence accessed 09/02/2011 3) http://www. usatoday. com/educate/college/business/casestudies/20030128-accountingfraud1. pdf accessed 8 feb 2011 4) Lindberg, D. L. ; Beck, F. D. , 2004. Before and After Enron: CPAs’ Views on Auditor Independence. The CPA Journal Online.