There are five key threats that may have an adverse effect on an auditor’s independence. It is important that every member of an audit team reviews the five threats to auditor independence before a company or organization outsources its audit needs. If an auditor is exposed to any of the threats in the course of carrying out audit functions, he or she is expected to create safeguards to reduce the threat to the barest minimum or resign from the audit engagement.
What Is Auditors’ Independence?
One major thing expected of an auditor is to be unbiased and professional in the work he or she audits. Having an auditor who lacks the independence to audit a report makes the report of all other accompanying auditors useless to those who depend on them.
For instance, if a potential investor in a company sees that an auditor has a personal relationship with the CEO of the company, that investor will find it hard to believe that the audited work is a true representation of the company’s financial standing, as he may think the CEO and auditor conspired to issue a favorable report.
Without a doubt, auditors who have no independence end up compromising the integrity of financial markets and the reliability of information for decision-making. It will be difficult for an investor to put capital into companies while being aware that the audited information was done by an auditor who lacks independence. In the same vein, banks will refuse to grant loans to the company for fear that the report provided by the auditor is biased.
6 Key Threats To Auditor Independence
While carrying out audit work, auditors must make sure that they are independent of the client’s management, as it is a very important criterion for objective auditing.
However, various situations create threats to auditor independence, and they are explained under different categories. In the course of explaining the threats, we will also be looking at some examples of threats to auditor independence and possible remedies.
- Self-Interest Threat: This is one of the potential threats to auditor independence that may affect the audited information of a company. It occurs when the interests of an auditor clash with those of a client or investor.
An auditor must make sure he considers the interests of other stakeholders, but an auditor may also be one of the stakeholders in a company and may choose to neglect their needs if his own interests are at stake.
For instance, when an auditor becomes aware of an irregularity in the financial statement of a company he has shares in, he might decide not to disclose the information with the belief that if he does, the company’s share prices will fall.
Another example is when an auditor decides to prepare a favorable audit report so that the company can secure a loan from a bank to pay off outstanding audit fees. Here, the auditor’s self-interest has gotten in the way of other stakeholders’ interests.
To avoid this threat, an auditor can decide to leave the team, and if all the auditors can’t resolve it, they may leave the engagement altogether.
- Self-Review Threat: This happens when an auditor is saddled with the responsibility of auditing his previous work or that of his colleagues, especially when he offers more than a service to a company.
Threats to auditor independence case study: If an auditor does the account preparation of a company and while auditing, he notices there are issues with the financial statements for which he is responsible but chooses not to disclose them to stakeholders, there is a self-review threat.
However, this threat can be avoided if different auditors are used for different assignments and an auditor does not have to review his own audit.
- Advocacy Threat: This can be regarded as one of the ethical threats to auditor independence because it has to do with an auditor compromising his stand for the benefit of the client or company he is auditing for. It occurs when an auditor has to promote or represent a client to a point where his objectivity is potentially compromised.
An example is when an auditor has to make sales for a client and also reviews the financial statements of the client, but because of his advocacy, he does not disclose the misstatements found in the report.
An auditing team can avoid this threat by segregating members of the team for each task. An auditor is expected to choose between representing the client or continuing with the work of an auditor.
- Intimidation Threat: This particular threat exists when a client is in a position of leverage against an auditing company and there is a management threat to auditor independence because the company does not want to lose a big client.
For example, if a client is aware that the income derived from him constitutes more than 35% of the audit company’s income but is not satisfied with the audit report of the company in a given year, the client may threaten to change auditors the following year, thereby intimidating the audit company to present a favorable audit.
To be safe from this threat, the auditor must leave the engagement, but this can be managed if the auditing company does not allow the client to get to the leverage position.
- Familiarity Threat: This is another example of a threat to auditor independence caused by a personal relationship with the client. When an auditor has served a company for a long time and has become familiar with the management of the company, the audit report may lack objectivity.
For instance, if an auditor who has been with a company for several years discovers there are some misstatements in the financial statements of the company, he may not disclose the information so as not to affect their relationship.
This threat is avoidable by rotating the audit teams at regular intervals.
Having explained the threats to auditor independence and safeguards, an auditor planning to take up a new engagement or continue with an existing one must make sure that he understands the threats and how they creep into his objectivity so as to prevent it. The ability to safeguard against these threats is professionalism.