The fundamental importance of auditor independence

5 Nov 2015

5 min read time

At a glance

By Josephine Haste

Let me take you back to your time at university. Do you remember when you would diligently attend your audit lectures and madly scribble notes on every word the lecturer said? No?

Recent observations from CPA Australia’s quality review program suggest that many of us skipped the lecture (and forgot to collect the notes!) on the fundamental importance of actual and perceived independence.

The quality review program continues to find members who have failed to comply with this most critical accounting principle. Perhaps even more concerning is that when a breach of independence is reported, many members don’t fully understand that it may be illegal not to satisfy the requirements of actual and perceived independence.

So what is independence and why is it at the cornerstone of every audit that is conducted? The purpose of an audit is to express an opinion that is objective, impartial in judgement and reliable for those who are using an audit opinion to make decisions about investment or for regulatory purposes.

For an audit report to be worth its salt, the auditor who prepared it must be seen to be free of any undue influence. In financial terms, this means that the auditor should not have any dependency on the client by either personal affiliation or financial reliance. An auditor who fulfills these criteria is regarded as independent.

Actual independence is quite straightforward for an accountant who is across the requirements. If, however, there is a significant financial connection, other than through the reasonable fees paid for the auditing services, or a connection via a personal relationship, actual independence may be impeded.

This could be a problem to the point where it is unlikely that any safeguards would ensure that the audit opinion is seen as objective, even if an independent auditor would have drawn the same conclusions from an examination of the entity.

"Perhaps it is the time for your practice to take an independence health check."

— Josephine Haste

Perceived independence is where shades of grey creep in to the normally black-and-white world of audit. Looking at the relationship between the auditor and the client, every individual may perceive an arrangement differently, and this is where professional judgement comes to the fore.

As a guiding principle, perceived independence is when a third party looking into the arrangement would consider the auditor independent from the client. When faced with a perceived independence issue, an appropriate consideration is materiality. APES 110 Code of Ethics for Professional Accountants suggests that “When assessing materiality, a member in public practice or a firm shall consider both the qualitative and quantitative aspects of the matter which might have, or be seen to have, an adverse effect on the objectivity of the member or the firm.”

What is key in this quote are the words “or be seen to have”, which suggest that the accountant should adopt a wider viewpoint when assessing perceived independence.
In Australia, there is an abundance of literature on auditor independence. To compile a risk assessment on the topic, the place to start is the principles enshrined in law. These are the legal requirements that impose the greatest risk to an accounting practice.

The independence requirements applying to auditors are legally enforceable and are located within the following legislation and standards:

Divisions 3, 4 and 5 of Part 2M.4 and section 307C of the Corporations Act 2001
APES 110 Code of Ethics for Professional Accountants, sections 290 and 291 – applicable to all members of professional accounting bodies
Auditing standard ASQC 1 Quality Control for Firms that Perform Audits and Reviews of Financial Reports and Other Financial Information, and Other Assurance Engagements
Auditing Standard ASA 220 Quality Control for an Audit of a Financial Report and Other Historical Financial Information

To help members better understand the independence requirements and fully digest this information, the Joint Accounting Bodies issued the fourth edition of the Independence Guide in February 2013. This provides practical, case-based scenarios to help practitioners assess issues of independence that they may encounter.

So let’s now take the mid-semester test on independence. For each example given below, state whether you think the accountant is independent or non-independent and, if the accountant is non-independent, whether that non-independence is actual or perceived.

The accountant has their domestic partner, who is also an accountant, sign off on their trust account audit.
A sole practitioner employs a staff member who holds a public practice certificate. The sole practitioner prepares the accounts and the staff member signs off on the audit of a superannuation fund.
A practitioner who is not a qualified Registered Company Auditor (RCA) employs an RCA to sign off on an audit engagement that requires an RCA sign-off. The RCA engaged has no public practice certificate or public liability insurance.
A firm with three partners has one partner responsible for the compilation of accounts and another partner responsible for signing off the audit.
A sole practitioner completes the audit for an entity who engages the practitioner’s wife for bookkeeping services.
A small firm accepts a large audit engagement where the fees associated with the audit will comprise 85 per cent of the total fee revenue for the firm.

You may consider these examples to be great works of fiction, but in fact they are taken from case findings from the quality review program.

All of these examples are real concerns for auditors. How did you score on the test? Perhaps it is time for your practice to take an independence health check. Here’s a prescription for some resources which may help you assess your own independence, both actual and perceived: