Programming independence

Programming independence essentially protects the auditor's ability to select the most appropriate strategy when conducting an audit. Auditors must be free to approach a piece of work in whatever manner they consider best. As a client company grows and conducts new activities, the auditor's approach will likely have to adapt to account for these. In addition, the auditing profession is a dynamic one, with new techniques constantly being developed and upgraded which the auditor may decide to use. The strategy/proposed methods which the auditors intends to implement cannot be inhibited in any way.

Investigative independence

While programming independence protects auditors’ ability to select appropriate strategies, investigative independence protects the auditor's ability to implement the strategies in whatever manner they consider necessary. Basically, auditors must have unlimited access to all company information. Any queries regarding a company's business and accounting treatment must be answered by the company. The collection of audit evidence is an essential process, and cannot be restricted in any way by the client company.

Reporting independence

Reporting independence protects the auditors’ ability to choose to reveal to the public any information they believe should be disclosed. If company directors have been misleading shareholders by falsifying accounting information, they will strive to prevent the auditors from reporting this. It is in situations like this when auditor independence is most likely to be compromised.

Independence within different audit firms

Different firms have different independence guidelines, with some being more strict than others. The types of software used to detect independence breaches or compliance also differ, with each firm preferring to have their own software.

Internal audits

Independence of the internal auditor means independence from parties whose interests might be harmed by the results of an audit. Specific internal management issues are inadequate risk management, inadequate internal controls, and poor governance. The Charter of Audit and the reporting to an Audit Committee generally provides independence from management, the code of ethics of the company (and of the Internal Audit profession) helps give guidance on independence form suppliers, clients, third parties, etc.

External audits

Independence of the external auditor means independence from parties that have an interest in the results published in financial statements of an entity. The support from and relation to the Audit Committee of the client company, the contract and the contractual reference to public accounting standards/codes generally provides independence from management, the code of ethics of the Public Accountant profession) helps give guidance on independence form suppliers, clients, third parties...

Internal and external concerns are convoluted when nominally independent divisions of a firm provide auditing and consulting services.^[4] The Sarbanes-Oxley Act of 2002 is a legal reaction to such problems.

United States

Price competition is a major factor in auditor independence.^[8] Prior to the 1970s audit firms were not allowed to advertise their services and take part in bidding competitions for contracts. Competition between the accountancy firms greatly increased when these restrictions were abolished, putting pressure on the audit firms to reduce audit fees. Competitive bidding for contracts has also encouraged the reduction of auditor engagement hours.^[8] The pressure to reduce costs may compromise the quality of an audit. If a firm feels threatened by competition they may be tempted to further reduce costs to keep a client. This risks lowering the standard of the audit performed and therefore mislead shareholders.

The increased competition between the larger firms means that company image is very important.^[3] No audit firm wants to have to explain to the press the loss of a big client. This gives the directors of the large company a commanding position over its audit firm and they may look to take advantage of it. The audit team would feel pressured to satisfy the needs of the directors and in doing so would lose their independence.

Service limitations

Many^[who?] have advocated that in order for an auditor to remain strictly independent they should not be allowed to provide audit clients with any other advisory services. This idea was detailed in the EC's Eighth Directive and was designed to remove conflicts of interest arising from audit companies having a high percentage of total revenue staked in the contract of one client. To date this has not been made a requirement. Both auditors and their clients have argued that the knowledge acquired during the audit process can allow other services to be provided less expensively.

Peer assessment

Peer review of accounting firms is focused on helping maintain independence within a firm. A peer review is a recurring external assessment of a firm's quality control system, sometimes referred to as monitoring. This process helps members cultivate and increase audit quality to further advance the uniformity within the profession. For auditors of non issuers, peer review is required once every three years of the firms auditing practice and accounting department. During the peer review process for a nonissuer, members are required to be convinced that the employee's on the engagement have the ability to manage the assigned services. The firm being reviewed selects an approved CPA firm to conduct their peer review.

Peer review is required once every three years for auditors of less than 100 publicly traded companies every year. The SEC portion is peer reviewed by the PCAOB and the non public portion is peer reviewed by an approved CPA firm, both every three years. For accelerated filers, firms who audit over 100 issuers every year, are required to have a peer review annually, performed by the PCAOB.

Audit committees

The recommendation for companies to form an audit committee was first made in the Cadbury Report (1992). A group of three to five non-executive directors from within the company are chosen to provide what is supposed to be a truly objective view on all aspects of the audit: from evaluation of internal control systems to recommendations on audit fee. Since the Cadbury Report, this practice has been implemented yet many still remain unconvinced of the neutrality of non-executive directors.

Rotating external auditors

Proponents argue either mandatory rotation of audit firm or mandatory rotation of engagement partners could improve auditor independence. It is argued that an incumbent auditor has less incentive to collude with their client if the firm's contract expires in the foreseeable future or that auditors are less likely to forge conflicting relationships with client personnel.^[9] Further, because current auditors will know they are soon to be replaced, they will be inclined to produce audit reports which demonstrate high standards and are an exemplar of true independence, and avoid having any shortcomings exposed by the new audit team.

However, empirical evidence is mixed. Most research suggests financial reporting quality is lower when auditor tenure is low.^[10] One possible explanation is that it is difficult and costly to obtain the client-specific knowledge required to produce a high quality audit. These costs need to be weighed against the threat of impaired independence, mentioned above. Proposals for a maximum client servicing period of five years have since been dismissed after lobbying by accounting firms and their clients, again stressing that it is vitally important that auditors familiarise themselves with client operations in order to conduct a successful audit.

Recent research suggests the relation between partner tenure and audit quality might be more effective for small audit firms, but that five years might be too short a period. There is evidence that the relation between audit partner tenure and audit quality is hyperbolic, with perceived audit quality reduced at the time of rotation but then improving for several years, only to deteriorate again when the audit partner has been incumbent for a fairly long time. This is based on an Australian study, where mandatory audit partner rotation was introduced in 2004 by the CLERP 9 legislation.^[11]

The International Federation of Accountants recommends partner rotation but not rotation of firms. The IFAC states in its International Standard on Quality Control (ISQC1 of 15/12/09) that "The IESBA Code (International Ethics Standards Board for Accountants) recognizes that the familiarity threat is particularly relevant in the context of financial statement audits of listed entities. For these audits, the IESBA Code requires the rotation of the key audit partner after a pre-defined period, normally no more than seven years, and provides related standards and guidance. National requirements may establish shorter rotation periods"^[12]

In the area of Government Auditing, in its ISSAI 1000 standard (art.66) the INTOSAI also recommends partner rotation: "ISQC 1 requires engagement partner rotation for listed entities after a predefined period. In the public sector, this requirement may be applied to significant public interest entities. However, legislation establishing the appointments and terms of office of the Auditor General may make rotation impractical. Supreme Audit Institutions may establish policies and procedures to promote compliance with the spirit of this requirement".^[13]

In the United States, audit partner rotation is recommended in Title II Section 203 Sarbanes Oxley 116 Stat 773 (Audit Partner Rotation) (Audit Partner Rotation) of the Sarbanes–Oxley Act.

The European Commission has issued on 16/5/02 a recommendation: "Statutory Auditors’ Independence in the EU, A Set of Fundamental Principles". The recommendation only requires partner rotation on listed clients after seven years. It differs in some respects from most national/international requirements, namely:• it allows a return after two years • it applies to ‘public interest clients’, not just listed clients • in a group context, extends to key audit partners other than the audit engagement partner. No countries within the EU, with the exception of Italy, currently have a system of mandatory audit firm rotation.

In the United Kingdom, the Auditing Practices Board (FRC) has issued a revised Ethical Standard 3: Long Association with the Audit Engagement (applies on 15 December 2009). It can be summarised as follows: Audit engagement partner - maximum rotation period remains at five years, with a minimum of five years not involved in the audit afterwards. However, flexibility of up to an additional two years is permitted.^[14]