The importance of audit independence can be categorized into four reasons: Firstly, audit independence can hold the public confidence and avoid interest conflicts; Secondly, audit independence can help auditors to provide high quality financial report and avoid scandals like ‘Enron bomb’; Thirdly, the development of no-audit services make it more difficult but more important to maintain audit independence; Lastly, audit independence can improve the quality of audit and it can assist managers to make strategy formulations.
Stakeholders make economic decisions by taking advantage of financial reports. Whether those reports are related and reliable are questions. Audit can help to solve this problem. However, auditor fails to fulfill the duty if they cannot remain independence in the conducting process. On one hand, report users will doubt this kind of dependence if they thought auditor and consigner belong to the same party. On the other hand, when auditor cannot keep an unbiased mindset, the auditing opinion probably gets wrong. For example, auditor fails to find out the information is cooked and issues unqualified opinion. This result is easy to mislead related report users for decision making. They may bear loss because of depending on this audit opinion. As the situation varies from Stakeholder to Stakeholder, the following analysis in the importance to remain independence in body and mind is based on different Stakeholders.
Importance of Audit Independence for Shareholders
Shareholders are the direct beneficiary of companies and they will get more bonuses if the companies operate successfully. Consequently, shareholders have high demand for audit independence. Actually, when the company is in poor operation, controlling shareholders are not willing to public the truth, and then hurt the interest of minority shareholders. Controlling shareholders don’t have the incentive to employ high independence auditors, and this phenomenon is called Entrenchment Effect.
As the shareholders right separates from the management right, owners do not involve into the daily management to the company. They employ staff to operate their company and enjoy the profits. Usually, shareholders care much about the profitability, efficiency, going concern, and solvency and so on. Those indexes reflect how well manager operates the company. Also, shareholders can assess managers’ performance according to the information. Generally speaking, they obtain the information from the reports prepared by managers. However, the report may involve fraudulence because it is manager who makes those reports. It has the possibility that managers cook the report so as to cover up their mistakes, bad performance and other situation where they fail to fulfill their responsibility. At this time, auditor’s work helps answer the question that how much report users can depend on the report information. But if auditor is unable to keep independence, it probably arouses the doubt to audit opinion from report users. Obviously, audit loses the value under this condition. Without unbiased and objective audit opinion, report users are unable to acquire useful information to know the company’s condition and assess managers’ performance. Once shareholders lose control to the company, this business mechanism will definitely go disorder as managers probably make their own benefits by taking advantage of shareholders’ resource and power and regardless of the limitation from regulation and law. In the end, the company probably goes to liquidation or bankruptcy.
Importance of Audit Independence for Creditors
Nowadays, debtor-creditor relationship is very common and necessary. Debtors want to loan in order to expend production or develop new market, and creditors want to obtain interest using their spare money. And what the creditors concern most is the debtor’s ability to pay for the debt. The debtor’s financial reports can offer some information such as some ratios which can reveal the debt paying ability. And if the company has a bad financial result, creditors can consider calling in a loan ahead of the expiry day to insure their money is safe. However, those reports are made by the debtor. Therefore, creditors may raise the doubt whether there exists the possibility that debtor offer false information to diddle money or conceal the fact that they have no ability to pay that money back. At this time, auditor’s work can eliminate or alleviate this doubt. However, audit can’t work out if auditor were unable to remain independence when conducting the audit. Creditors are likely to make a wrong decision due to the failed audit opinion. When creditor lends money to unqualified debtor, it probably bears a lot of bad accounts and toxic asset as consequence. Consequently, audit independence which can help to provide true financial reports is very crucial to creditors.
Importance of Audit Independence to Government
As a company operates within one country, it uses the infrastructure construction and investment environment offered by the government. It should take on tax responsibility. The financial statement provided by companies is the evidence for government to decide whether levy or not and how many to levy. For example, business tax is based on the gross income of the company which can be found on the income statement. And the income tax is based on the profit also from income statement. If company cooks the financial reports in order to save tax cost, the government will be suffered directly. Therefore, government will conduct audit in case of tax evasion.
Moreover, lacking of audit independence would influence government indirectly. If auditors provided fake financial reports, the pubic will be suffered. They will have less confidence on the trueness of the operation of the company, and the stakeholders will feel betrayed. If their interests are impaired, conflicts would emerge, and it is bad for the stability of the society. That is why the government passed the 2002 Sarbanes-Oxley Act after the “Enron Bomb“.
Importance of Audit Independence for Operators
Many people may misunderstand that auditor is enemy to operator referring to manager in this essay and the existence of audit is a stone in the way. This idea is partial and shallow. The role of audit plays is to increase the dependence to the information and check whether the whole business activities are in accordance with the regulation. To some degree, it serves to obtain superior management. Sometimes, auditors will come up with solutions to the existing management problems. For example, the internal control has leak which may incur situation where damages the whole benefits of company. Going details, the design of regulation may give a chance for embezzlement. Or auditor finds out some staff goes against regulation. Cases like that should call managers’ attention for better management. If auditor cannot keep independence when conducting audit, it will pose the threat to the company such as damage the company benefits. For example, the auditor is a brother to the cashier. When this auditor conducts audit to cash, he can’t remain independence or his independence has been affected. He may conceal the fact if the cashier had some guilt and issues unqualified opinion. Because of this opinion, managers can’t notice this threat. It may have a bad effect on their working performance and company development.
Importance of Audit Independence for Other Stakeholders
The existence of a company has to bear many responsibilities. Therefore, the stakeholders can never be limited to the above mention. When a company becomes a listed company namely a public limited company, it has to fulfill more duties to the society and accept more supervision from the public. It raises fund by stock shares. Its public investors sell or buy the shares in the stock exchange, and their decision usually relies in the financial reports. However, those reports perhaps cannot reflect the financial position and income condition. Audit opinion is very important in their decision making process. If auditor could not remain independence, the audit opinion will mislead the users. Investors will lose money if they invested a loss company. For example, the collapse of Enron results from the accounting firm Andersen failed to remain independence. In the end, the share price cannot reflect the value of the company. Stock market will go wrong and the economy will fall apart.