Ethical Issues, Actions, and Limitations of an Auditor’s Independence

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A financial auditor’s independence is a freedom that can lead to several advantages and disadvantages. Ethical principles, such as an auditor’s credibility, trust, and reputation heavily affect the confidence of a company and general public. An auditor’s independence is susceptible to several destructive factors due to the responsibility and nature of the job. The size of an accounting firm and the fear of losing clientele are strong factors that lure financial auditors to deviate from their ethical responsibilities. Several courses of actions have been implemented to reduce the influences that lead auditors to compromise their reputation and credibility. Factors, such as time and cost also influence an auditor’s ability to provide accurate findings. Intangible abilities, such as human judgment and decision making are heavily relied upon to accomplish and provide accurate results. This paper will focus on the ethical accounting issue of independence financial auditor’s encounter on a regular basis. Understanding the ethical issue and its consequences will provide more insight to several courses of actions and limitations relevant to this profession.

The Ethical Issue of Independence

One of the most crucial ethical concepts of a financial auditor is independence. It is quite simple and tempting for financial auditors to take advantage of the freedom such independence entails. The improper use of independence can hinder the confidence of business people, such as investors; thus, risking the reliability of security markets (Hoffman, 1996, p. 101). Additionally, the U.S. Supreme Court has stated that the responsibility of a financial auditor surpasses that of a business relationship to the general public, which also participates in purchasing goods and services (Hoffman, 1996, p. 101). Such statements have been clearly and specifically documented to provide a general definition of independence and its professional and ethical implications. Investors confide and trust financial auditors with a crucial aspect of business. While independence and trust are intangible qualities, an auditor is expected to provide integrity and credibility in their work. This includes denying any type of subornment, sharing confidential information, and/or manipulating results or findings.

A financial auditor’s ethical independence can be threatened through several factors. For instance, during emergency situations, the occasion of deciding or influencing the planning of a client’s accounting records or financial statements places the auditor in a position requiring a high level of exigency and credibility (Crawford & Loyd, 2008). Furthermore, another threat to a financial auditor’s ethical independence is prevalent through serving as an expert witness (Crawford & Loyd, 2008). The responsibilities and authority such position entails demands proper ethical independence, as the lives of other people are at risk while others are being influenced by the testimony and information provided. Such information should be as accurate as possible and presented with the independence the position of a financial auditor demands. Most importantly, independence can be threatened when asked to provide possible or estimated conclusions and results of financial statements and the like.

The oversight of a company’s financial statements has fallen on financial auditors in the field of accounting. The importance of an auditor’s simple stamp on financial statements is a symbol of validity, respect, and accuracy. Such stamp is taken with a considerable degree of importance by investors (Duska, 2007). Contrarily to the threats and negative aspects of independence, financial auditors are usually expected to have independence to avoid any conflict of interests, which may influence an auditor’s ethical responsibility to the client (Duska, 2007). This independent preference can be associated with the previous threat of subornation. The additional influence of monetary compensation is a temptation that can hinder the objective performance of the financial auditor. The more independence the auditor possesses, the less likely the auditor is to receive subornment. For these reasons, independence can be perceived as a double edged sword with a fragile and vulnerable ethical state, risk, and challenge.

Some of the factors affecting the ethics of auditor independence are the size of the audit firm and the fear of losing clientele. Financial auditors in larger firms are less likely to receive an individual fee from the client, as the auditor’s compensation is more likely to derive from the accounting firm (Malachowski, 2001). This standard of compensation is less likely to cause a threat to the auditor’s independence. Additionally, to avoid losing clients, financial auditors are often at risk of compromising with clients, which contradicts the standard procedures of the accounting firm (Malachowski, 2001. The probability of the accounting firm discovering this deviant act is less likely to occur due to the level of independence an auditor possesses, except when paper traces revealing such compromises have been completed. These factors tend to lower the credibility and trust of the financial auditor, as previously emphasized by Crawford and Loyd. As a consequence, auditors might maintain or even increase their clientele; however, their ethical reputation is more likely to be negatively affected.

Courses of Actions

To diminish the ethical issue of independence, financial auditors review other auditor’s financial statement. Upon reviewing the financial statements, the second and supervising auditor is able to decide whether or not to assume full responsibility for the financial statements (Dauber & Qureshi, 2008). Consequently, the second financial auditor is to complete a report specifying the reasons for the refusal to assume responsibility for the financial statements. This system is similar to that of checks and balances and it is an effective course of action to discover unnecessary modifications or compromises made by the former financial auditor. Additionally, this course of action is more likely to sway the former financial auditor away from taking any unethical actions while ensuring the second financial auditor does not assume responsibility for incorrect or negatively influenced financial statements.

Another important course of action implemented by the Government Accountability Office (GAO) is restricting financial auditors to perform only one type of service. Often times, financial auditors are capable of providing several services, other than financial auditing. According to the study presented in the book “Governing the Corporation: Regulation and Corporate Governance in an Age of Scandal and Global Markets,” O’ Brien stated that financial auditors are not to perform more than one type of service, even if the other services are not related to auditing (2005). In such situations, the financial auditor or client must select which service to provide or receive. Furthermore, financial auditors are prohibited from making management decisions, such as participating in payroll functions and bookkeeping services. The new standards presented have been revised in the “Governance Auditing Standards” issued in 1972, which is commonly known as the ‘Yellow Book’ (O’Brien, 2005). These new regulations are more likely to limit issues relating to auditor independence and are more likely to produce effective results. Additionally, the temptation to manipulate or provide misguiding results is less likely to occur.

Decision-Making Constraints

Some of the constraints financial auditors experience are time and cost. These factors affect an auditor’s ethical issue of independence due to the restrictions that interfere with providing adequate and complete results. To overcome these constraints, auditors have improved their procedures, increased their fraud awareness, and have reestablished proper independence (Bergevin & MacQueen, 2010). Due to the stringent statutes and continued threats of increased involvement from the government, market individuals have increased their awareness of the constraints in the responsibilities of a financial auditor.

The effectiveness of an accounting system is extremely reliant on human judgment and decision making abilities. These abilities are interconnected to cost-benefit concerns and can be greatly hindered due to a basic human error (Walton & Aerts, 2006). Decisions and suggestions based on the evaluation of a company’s internal audit control system rely on the auditor’s human judgment. Although the auditor’s judgment and quality evaluation is based on prior experience and decision making processes, new situations and scenarios often occur. Such frequent and unique scenarios are heavily reliant on the auditor’s discretion. Additionally, the auditor’s ethical responsibility, sound-judgment, and credibility are all factors relevant to the decision making process and human judgment. These factors occupy an active role in promoting a positive reputation within a company. Particularly, an auditor’s ethical characteristics are vital in developing a positive culture, especially when establishing and/or resolving interpersonal relationships (Walton & Aerts, 2006). Eventually, the factors are applicable in functions of a financial auditor’s independence with clients and within a firm.

Conclusion

This paper focused on a financial auditor’s ethical issue of independence. Credibility, trust, and reputation were a few of the ethical principles discussed in the current research. Additionally, the vulnerability of an auditor’s independence and the use of proper human judgment and decision making skills were included in this analysis. Previous research studies have been incorporated and analyzed to support the current study. Factors of an accounting firm, including its size and an auditor’s fear of losing clientele were stated as part of the current study.

Finally, courses of actions were included as a solution to the ethical issue of independence.

References

Bergevin, P. M., & MacQueen, M. M. (2010). Auditing and taxation. Accounting for Managers (p. 79). New York: iUniverse, Inc..

Crawford, M. A., & Loyd, S. D. (2008). The IFAC code of ethics 6 01. Cpa's Multistate Guide to Ethics and Professional Conduct 2008 (pp. 6.16 - 6.17). Chicago: Cch Inc.

Dauber, N. A., & Qureshi, A. A. (2008). Part of audit performed by other independent auditors. Wiley The Complete Guide to Auditing Standards, and Other Professional Standards for Accountants 2008 (p. 285). Hoboken: John Wiley & Sons, Inc..

Duska, R. F. (2007). The ethical responsibilities of accountants. Contemporary reflections on business ethics (p. 235). Dordrecht, the Netherlands: Springer.

Hoffman, W. M. (1996). Was maintaining the executive payroll at PTL an example of auditor independence. The ethics of accounting and finance trust, responsibility, and control (p. 101). Westport, Conn.: Quorum Books.

Malachowski, A. R. (2001). Auditor independence: A real issue. Business ethics: critical perspectives on business and management (pp. 181, 183). London: Routledge.

Brien, J. O. (2005). Restoring trust after recent accountability failure. Governing the corporation: regulation and corporate governance in an age of scandal and global markets (p. 40). Chichester, West Sussex: John Wiley & Sons.

Walton, P. J., & Aerts, W. (2006). Accounting and accountants. Global financial accounting and reporting: principles and analysis (pp. 42-43). London: Thomson.