Examining how independent auditing can help create a healthy corporate environment Essay

Due to the rapid growing in planetary economic system, the universe has become a topographic point with no boundaries. With the addition of foreign investing, joint venture activities, the separation of ownership from the direction and the limited liability of members become the chief characteristics of the corporate organic structures today. Therefore, the administration of these organisations must be maintained. The rapid development in the size of companies and their complexness constructions had truly challenged the traditional position of a company seen as a self-regulatory organic structure which chiefly accountable to the market and its members. That is why the term and construct of corporate administration has become a hot treatment about in every state.

Corporate administration merely means the execution of the best corporate patterns to heighten stockholders value every bit good as protecting the involvement of the other stakeholders at the same clip. However, high-profile corporate dirts such as Satyam Computers have gained the attending from the populace of how direction attempts to lead on the populace by pull stringsing the figures and net incomes in the fiscal statements. Since so, public assurance towards the corporate administration constructions and the capablenesss of corporate board of managers in modulating themselves has been decreased to a really low degree. Then, who should be in charge in guaranting good corporate administration in the organisations?

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As the celebrated stating “ there will be no moving ridges without air currents ” , the present push is being widely circulated due to scrutinize failures in assorted elephantine companies. We all realize that the chief aim of an audit procedure is to do certain that the day-to-day operation of a company are being carried out in good religion by the top direction without utilizing the resources allocated to function their opportunism. An hearer is expected to supply his/her sentiment in good religion. However, late, audit has failed in supplying the right judgement and sentiments on the operations carried out by the direction. The chief ground for the failure of effectivity of audit is because of the absence of hearer independency. With merely one factor, it has already paved their manner for good corporate administration.

What is this hearer independency and what function does it play in guaranting good corporate administration? Elliott and Jacobson ( 1998 ) said that the immediate function of audit independency is to function the audit, and the aim of the audit is to better the dependability of information used for investing and recognition determinations. Ultimately, the intent of audit independency is to better the cost-effectiveness of the capital markets.

2.0 Concept and Transformation of Auditor Independence

Auditor independency really means that hearers should be executing their audit work with honestness and earnestness. An hearer should besides be just and should non allow bias to overrule his/her objectiveness. Moizier viewed auditor independency in an economic sense. Harmonizing to him, hearers are given outlook to execute audit plants that will diminish the opportunities of a company being sued to an acceptable degree to the hearer. ( Moizier, 1991, as cited in Mahdi Salehi, 2008 )

Independent auditing is really a critical characteristic of efficient capital markets. As we all know, in the auditing profession the chief aim of independent audits is to supply and present adept sentiment sing the equity of the fiscal statements. Independence is really the base of the public accounting profession. A high independency degree will guarantee a good quality accounting pattern.

Mahdi Salehi ( 2008 ) said that the construct of hearer independency had really existed since 150 old ages ago. Auditor independency really has a relationship to the concern environment for different period of clip. However, there was no clear passage or transmutation from a construct associating hearer independency to another. The initial construct of hearer independency really begins during the 19th century from the British. During that clip, the primary responsibility of an hearer and professional comptroller was to execute inadvertence to the absentee investings in bing settlements of British Empire. During this period, the British investors strongly prohibit the hearers from holding fiscal bets or working in concern that they are presently scrutinizing. Besides, so long as the hearers retained their trueness to the investors in British, they were already considered as carry oning professional accounting services.

The initial construct sing hearer independency transformed in between the late nineteenth and the early 20th century. This is due to the economic displacement of capital from the foreign beginnings to the capital that are derived from local beginnings. From so, the management-auditor relationship is normally viewed base on the objectiveness and independency of the hearers. The comparatively new construct of hearer independency needs hearers to non being advocators with their clients, and that direction must non be able to impact the range of audit every bit good as the audit fees. Without this passage, the hearer independency criterions will be merely something on the surface that will non supply adequate confidence that an hearer is independent from the client direction. Therefore, the best protection for the hearers to turn out that their pockets are empty is to observe deceitful coverage on fiscal statements ignoring the materiality degree on the fiscal statements with independent position!

Auditor independency is basically of import because the separation in ownership from the direction truly necessitate a professional whom they can believe for the dependability to safe guard their involvement. A professional ticker on direction is needed as they will be the 1 who will be fixing and showing the fiscal statements. There is an statement that hearer independency will heighten the credibleness of fiscal statements in two facets. First, independent hearers will heighten the possibility of fiscal statements prepared are in conformity with the recognized accounting rules ( GAAP ) . Second, investors will surely more likely to hold strong trust on fiscal statements that are audited by an independent hearer. Base on these statements we can state that hearer independency truly plays an of import function in heightening the value and credibleness of the fiscal statements. Therefore, anything that will impact an hearer independency will surely has uninvited effects to the capital markets.

In recent old ages, hearer ‘s independency has ever been a important issue in accounting position. Audit fees, non-audit services, qualified studies have been related with hearer ‘s independency. However, there are still many factors that will act upon the independency of an hearer. It is accepted as true that hearer independency and credibleness are an of import issue and will hold important impact on the development of scrutinizing patterns and criterions. The inquiry is, what will really impact an hearer ‘s independency and how could this issue be prevented? This will be discussed at the undermentioned subdivisions.

3.0 Real Life Issue in India – Satyam Computers

Satyam Computers was the 4th largest Information Technology house in India. However, its bequest and concern was struck and stranded when the so Chairman of Satyam Computers, confessed to the populace that the fiscal statements were being overstated for a figure of old ages. The proclamation of dirt had caused Satyam Computer to be removed from the Nifty 50 and Sensex. Besides, the clients of the company pulled off from them before they no longer set any religion in the company. In fact, the exaggeration was a significantly material sum of $ 1.04 billion!

How could this dirt even go on when the company fiscal statements were under the safe guards of one of the Big Four Accounting Firm in the universe – PricewaterhouseCoopers? Who should be in incrimination for this dirt? In this instance, it is the hearer ‘s independency that should be questioned upon.

Obviously, the intent of audit is to independently function and look after the involvements of stockholders. Therefore, they have the authorization to entree the information that they need in their audit. Their chief aim is to function the stockholders ‘ involvement, but it is the direction that hires and fires the hearers. So, the issue here is, can hearers be genuinely independent given that the direction has the authorization to use and fire them? Should they carry through their duty towards the stockholders or the direction?

The difference between India and the United States is that there is a limitation on the size of audit house and maximal figure of clients that a spouse can function in India. Therefore, the little sum of clients will take to a great trust of audit houses to the fees. In contrast, the largest single client ‘s history was simply half a per centum of audit house ‘s entire charge in the United States. This will surely take to greater possibility for audit houses in India to impact their independent point of position because of fright in losing their clients. Furthermore, there were 1,000 audit houses in India. Each of them merely has approximately one stock-exchange-listed client each. With this extent of entire dependance on one client for an audit house ‘s support, could we anticipate the hearers to be independency?

Other than that, the Torahs and ordinances in India were non rigorous plenty to make fright among the hearers to execute their audit work in self-respect. Like many other states, audit houses in India regulate themselves through the Institute of Chartered Accountants of India ( ICAI ) . However, they did non enforce the jurisprudence that rigorous disciplinary punishments to those who did non execute their occupations independently. In this instance for case, if the spouses of PricewaterhouseCoopers, Messrs Gopalakrishnan and Talluri are held to hold merely been negligent instead than guilty of condemnable behavior, there will merely be a cancellation of the licence of pattern and a discovery of Rs. 5 hundred thousand. No farther countenances and punishments could be made against the audit house – PricewaterhouseCoopers! With immense benefit and not-so-strict punishment, hearers will be supplying unqualified sentiments to their clients against their independent point of position without fearing that they will confront terrible legal countenances!

In this instance, it is clear that the factors that affect hearer independency are the dependance of the audit house to the client ‘s fees and the ordinances that are non rigorous plenty to enforce countenances to them. We personally feel that, a state should develop or come out with a regulation that will guarantee hearers will execute their occupation with self-respect. Furthermore, an active audit commission should be set up to execute oversight activities in guaranting external hearers perform their patterns in conformity to the legal demands and professional moralss. Hearers should no longer be given the authorization to modulate their auditing activities. These will farther discussed and elaborated at the undermentioned subdivision.

4.0 Factors That Affect an Auditor ‘s Independence ( Perspective from China )

In our research, we had chosen China as a state stand foring Asia as China is one of the developing states in Asia. Therefore, the factors below were really being referred from the surveies by experts sing the auditing services in China. ( Wan Hua L. et al. , 2010 )

1. Non-audit services

Presents, audit house has already expanded their services into non-audit service by offering direction advisory or fiscal audience such as internal control execution in order to prolong in the competitory environment. Although non-audit services are a value – added services to the audit client, these services will somehow impact the audit independency. An audit house is prohibited to execute auditing and consulting services at the same clip. This is because hearer who serves a consultancy function might possess fiscal interest in the company ‘s public presentation and hence, the audit independent is decidedly questionable.

An hearer will be given to hold greater inclination to compromise with clients when there are economic inducements provided throughout the non-audit services procedure, hence it will diminish audit independency. An audit house that provided non-audit services and audit services at the same clip really will hold a struggle of involvement of whether to function the best involvement of the stockholders as a safe guarder or to function the involvement of the direction as a adviser.

For a state like China, they are a state confronting rapid development. Therefore, they have been oriented towards a private ownership theoretical account. Despite the Swift development of the separate function of ownership and direction construct, Chinese CPA houses, still do non supply significant non-audit services. Therefore, we can state that there are fewer incentives for the audit houses in China to give up their independency as compared to those states where audit houses perform significant non-audit services for their clients. However, non-audit services are an of import factor that will impact hearer independency in other states.

2. Regulations

We all are well-aware that how rigorous ordinances work in guaranting people to act. “ Auditor houses in states with stronger inducements to protect the stockholders and high quality legal systems are more likely to describe negative intelligence sing qualified studies. ” ( Bushman and Piotroski, 2006, as cited in Wan Hua L. et al. , 2010 ) In contrast, in states with weaker protections and judicial system, hearer houses will less likely study bad intelligence or issue qualified studies. Other than that, the province engagements in the national economic system besides affect the independency of the hearer house. For states with higher province fond regard, the audit houses tend to rush up the acknowledgment of positive intelligence and detain the acknowledgment of negative intelligence in reported net incomes. Therefore, we can state that the force of politic towards a state could be above the power of the ordinances and therefore will impact an hearer ‘s independency.

In China, the legal countenances for non-compliance with the auditing criterions are terrible. Rule-breaking hearers could hold their pattern licences being pulled back and even face imprisonment. However, “ The degree of jurisprudence enforcement of China is below norm as compared to other states. ” ( Allen et al. , 2005, as cited in Wan Hua L. et al. , 2010 ) This is due to the ineffectively enforcement of the Torahs. Besides, there was a struggle of involvement between the monopolising power of one and merely governing political party and the pattern of jurisprudence. Therefore, there is a possibility that hearers will conspire with the authorities and impact their independency when the authorities functionaries and their affiliates are involved in the pattern. So, harmonizing to this, China is regarded or can be said as one of the worst in stockholders protection and possesses a weak judicial system. Therefore, we can state that audit houses in China will be given to travel against the regulations and ordinances as there are “ holes ” between the Torahs.

3. Repute

The repute or trade name name of an auditing house is really of import for investors to trust on. This is because investors make their determination chiefly based on audit sentiments. The repute of an auditing house is basically of import as the investors do non cognize how to judge the quality of the hearers. They frequently consider the repute as an index of quality.

In China, hearer repute depends largely on their guanxi relationships. ( guanxi means relationship in Mandarin ) This type of guanxi codification of behavior is a batch more prevailing than being recognized as a house that has good audit pattern. Therefore, an scrutinizing house in China that has a closer relationship with the authorities will be given to indirectly hold a “ better repute ” as compared to those which do non hold relationship with the authorities. This will in bends affect the independency of those houses that have so called “ better repute ” . They will be given to conspire with their clients or the authorities against their independent point of position merely because of this acknowledgment. Investors that relied on the sentiments might be misleaded if the hearers did non supply an independent position.

4. Competition

It is undeniable that competition is one of the factors that will impact hearer independency. In order to recover or prolong their clients, audit houses will sometimes utilize unethical methods, for case, by accepting clients ‘ sentiment and intercession to describe the modified sentiments.

Despite of the increasing figure of foreign audit houses that enters into China, the scrutinizing environment of China still remained as non so competitory. This is because the foreign auditing houses have to acquire proper mandate in order for them to scrutinize Chinese stock companies listed on the exchange. Other than that, foreign auditing houses are non allowed to carry on external audit for most of the unlisted and local-state-owned companies. These limitations in topographic point are to protect the China scrutinizing house as they might non hold the ability to vie with big transnational audit houses. Therefore, competition is non the ground why China hearers cut down their independency degree to prolong their clients.

5. Low-balling and price-cutting

Low-balling or price-cutting agencies that an hearer house will finally diminish the professional fees of their services to derive extra market portions. This can non be an alibi for the auditing houses in China as there is a decreased competition audit pattern in China. Other than that, the deficiency of Chinese CPAs ‘ houses ‘ trade name name as compared with the Big 4 besides prevent them from deriving an extra market portion with low-balling patterns. Therefore, low-balling is non a factor that will impact hearer ‘s independency in China.

6. Audited account houses size

Zulkarnain Muhamad Sori et Al. ( 2006 ) said that the size of audit house has been used as a alternate for audit quality, that is big audit houses have a repute to safeguard and hence will guarantee an independent quality audit service. So, audit houses size is besides one of the factors that will act upon an hearer ‘s independency. In general, bigger scrutinizing houses will certainly execute better in defying clients ‘ force per unit area than the smaller patterns. This will take to a better quality of service by the bigger audit houses. “ Bigger scrutinizing houses can defy clients ‘ force per unit area better than smaller auditing houses in China. ” ( Lia et al. , 2004, as cited in Wan Hua L. et Al. 2010 ) So, hearers in smaller audit houses might lose their independent point of position because they were unable to defy and get the better of the force per unit area of their clients.

To reason sing the scrutinizing environment in China, we can state that the ordinances of the state, the repute of the auditing houses, and the size of the audit houses will straight act upon and impact the independent point of position of an hearer. However, these factors defer depend on the scrutinizing environment of every states. In add-on to the factors above, there are still a few factors that will impact an hearer ‘s independency.

5.0 Extra Factors that will Affect Auditor ‘s Independence

1. Huge sum of audit fees

Harmonizing to the MIA By-Law, the sum of audit fees collected from the clients should non transcend 15 % of the house ‘s entire fees in each of every two back-to-back fiscal periods. Auditing houses should decline to execute the battle if that so. This is because the larger sum of audit fees being paid over the entire audit gross, it will be really likely that audit independency will be impaired. This can be shown when an audit house is functioning a large client, the hearers will hold the inclination to delight them by experiencing loath to show an qualified sentiment.

2. Self involvement of hearers

When an hearer has self involvement like fiscal bets towards an audited company, an hearer might experience loath to supply sound negative sentiment that would impact the fiscal public presentation of the company. In add-on, they might hold the inclination to maximise their ain personal involvement by irrupting the unauthorised information of the company audited by them. On the other manus, the independent point of position of an hearer might besides be affected if he/she has a household member in the company that being audited. In these sorts of state of affairs, the hearer would be more likely to show an unqualified sentiment instead than qualified sentiment.

3. Same audit client for a long continuance ( Audit Tenure )

When an hearer is engaged with the same audit client for a long period of clip, the state of affairs is called audit term of office. In this period of clip, hearer might hold already developed a personal relationship with the client. Hence, it will develop the bond of trueness relationships between the hearer and the client and will unconsciously impact the hearer independency. If hearers are excessively near with their clients, they will be given to diminish the thorough and precise stairss in carry oning their audit. Normally, the longer the continuance of the audit term of office, the higher will be the inclination of an hearer to publish an unqualified sentiment sing their clients audited fiscal statements. The bonding between audit clients and audit house would decidedly act upon the independency of the hearers in measuring the internal control system of their clients.

6.0 Critical Analysis and Opinions

Based on our research and mentions from researches done by assorted experts, we personally felt that in order to heighten hearer independency, the undermentioned issues must be taken into consideration. It is undeniable that there are still many other safeguard stairss that can be taken in order to guarantee that hearers perform their responsibility with unity and credibleness. However, in our sentiment, we think that the followers are few chief stairss that should be taken in heightening hearer independency.

1. Forming an independent audit commission

Members of audit commission

An audit commission is a community that is formed by the managers or the top direction of a company. The chief undertaking of an audit commission is to move as oversight commission in guaranting the company ‘s fiscal statements are being presented in good religion and back up the function of the hearers. An audit commission should dwell of independent non-executive managers that do non hold involvement in the companies. This will further heighten the inadvertence responsibility of the commission through an independent point of position. Furthermore, we all know that non-executive managers do non describe straight to CEO. Besides, they are besides non being involved in the day-to-day operations of the company ‘s concern. Therefore, it is most likely that they will convey new position for the other point of position in back uping the direction to obey the jurisprudence and to follow with the industry best patterns.

Furthermore, the audit commission should dwell of members from different background and equal cognition of the operation of the company, for case, people who know about the accounting criterions and besides the ordinance with sing to the listing demands. In add-on, the audit commission should besides derive support from the main audit comptroller in the company. This is because the internal hearer will be the one who provide relevant information to the audit commission. In add-on, an audit commission should hold some kind of ordinances to protect their oversight function in order to guarantee the independency point of position. During certain occasions, the executive managers will be act uponing the judgement position of the audit commission and utilize their power to end the audit commission in order to derive self involvement. Therefore, company should put up a regulative authorization in order to protect the audit commission. This will surely heighten the independency quality of an audit commission.

Active and responsible Audit Committee

Zulkarnain Muhamad Sori et Al. ( 2009 ) found out that the frequence of audit commission meetings would be a mark of the sum of attempt by members of audit commission in presenting their duties. So, to be effectual in guaranting company ‘s operation are being carried out in good religion, an audit commission should be active and responsible. The audit commission should pass more clip in executing their responsibilities. Due the altering dynamic concern environment, audit commissions should besides ever maintain themselves updated so that they can execute their occupation good and expeditiously. Furthermore, they should pass more clip in discoursing issues associating to the hearers undertakings and besides the fiscal coverage of a company. If they are active plenty, it should non be a job for them to understand the issues and observe any misstatement being reported. Therefore, they should carry on a few meetings a twelvemonth to maintain everything updated. Owing to the function of audit commission that is formed to supervise the fiscal coverage and operation of a company, they must foremost understand the nature and how the company conducts their day-to-day operations.

In this sense, regular meetings will decidedly heighten their understanding towards the nature and behaviors of the day-to-day operations of a company. Not to lose out, the audit commission should co-operate good with external hearers. This is to do certain that they will supply information that are dependable and has credibleness. In short, an audit commission should understand the codification of behavior of a concern in order to heighten their ability to execute their occupations.

The study of the audit commission

As we know, the stakeholders are incognizant of information generated from audit commission activities. This is due to the private and confidential categorization of their proceedingss of meetings. However, we think that the study of audit commission should be publicized. With that, it will increase the independency of the hearers every bit good as benefit to those in demand for the information. Every company should include audit commission study in their one-year studies. Other than that, they should do certain that the audit commission studies are reported in good religion and with independency. Furthermore, the studies should cover action that they have taken to prolong the best patterns in the operation of the company every bit good as their sentiment towards the audit public presentation of the external hearer.

Determining the degree of audit fees

Recently, there are a batch of menaces and force per unit area faced by the hearers during the dialogue procedure of sum of audit fees. Due to the ferocious competition in the auditing environment, hearers might experience threatened and via media with the company in bring forthing non-independent position on the fiscal coverage. In our sentiment, we think that this job could be solved if the audit commission were to borne the duty of O.K.ing the appropriate audit fees. An independent party O.K.ing the audit fees will certainly better than an executive manager who might hold personal interest in the company.

If the audit fees is decently negotiated and there were no force per unit area by the direction utilizing audit fees as purchase, the hearers will decidedly be able to voice up their positions without the fright of service expiration. Other than that, it is more appropriate for the audit commission to O.K. the audit fees because they have a better apprehension sing the audit procedures and the resources that needed by an hearer. However, the bulk figure of members in an audit commission should dwell of the board of managers to avoid struggle to emerge. For case, there will less likely to be a difference over the audit fees if the audit commission is consists of a big figure of board of managers as this indirectly indicates that the determination is really come from the board of managers.

2. Employee turnover of scrutinizing house ( Audit term of office )

Audit term of office, or in other words, the turnover of auditing houses is necessary after a few old ages of battle to guarantee that hearers still perform their occupation with independent point of position. This is because the hearers might hold a strong bond of relationship with the company if the battle has been carried on for many old ages, for case, 10 old ages. They will someway be wavering to publish negative sentiment sing their client. This will travel against the pattern that hearers should be independent in scrutinizing the fiscal coverage of their clients. Besides, hearers might be given to pretermit the indispensable stairss in executing their auditing activities as they feel that they already gain full understand of the company. Furthermore, there is more likely for collusion between the direction and the hearers in scrutinizing the company. Therefore, the demand of scrutinizing houses ‘ turnover should be emphasized to diminish the likeliness of scrutinizing houses to compromise with the direction because of strong bond of relationship.

3. Non-audit services

Non-audit services are other services except external audit that an audit house will supply to their clients, for case the design of internal control system. Auditing houses are prohibited to execute non-audit services to clients that they are scrutinizing. This is because it will make a struggle of involvement. Imagine that you need to supply rating on the undertakings that you had performed, will you give bad remarks or judgements towards them? The likeliness scenario is that an hearer will be in a state of affairs of measuring their ain designed internal control system. They might hold a self-reviewing involvement and supply sentiments that are non from an independent point of position. Therefore, regulations and ordinances should be rigorous and stress on the importance on non holding external and non-audit services at the same clip.

4. Regulations and criterion of patterns

We all know that rigorous Torahs will make lawful society. In most of the states, regulations and ordinances might non be rigorous plenty to make fright among hearers in guaranting them to transport out their responsibilities with good religion. They might hold the feeling that the maximal punishment they will confront is non terrible plenty. Therefore, it indirectly creates a inclination for them go against their independent point of position and supply unsound sentiments. This is because they feel that the immense benefit they received by traveling against their independent point of position outweighs the maximal countenances they might confront. Therefore, it is a must for states to revise the Torahs and ordinances and enforce much stricter Torahs in order to heighten the independency of the hearers.

Of class, we ca n’t deny that there are still many other stairss that could be taken to guarantee hearer independency. However, in our point of position, we felt that the 4 issues above if taken proper action, will truly heighten the independency of hearers.

7.0 Conclusion and Recommandations

Tanlu et Al. ( 2003 ) mentioned that despite the difficult plants of many different parties over the past decennaries to come up with solutions to modulate the scrutinizing profession, hearer independency remains an semblance, and current ordinances are unable to do it a world unless there is an a extremist reorganisation in the auditing industry. And this will let the term of “ auditor independency ” to be used to absolutely in depicting hearers.

In order to keep good corporate administration, hearers must supply true and just position to continue the involvement of assorted stakeholders. However, are hearers independent plenty to take attention of the involvement of all the stakeholders? In our research, we found out that there are a batch of factors that will act upon hearer independency. For illustration, the sum of audit fees and the competitory environment of scrutinizing. Given these sorts of enticement, how would auditors guarantee that they are executing their occupation with unity and moralss? Therefore, everyone related to this issue should take full duties by playing their functions in continuing hearer independency.

Audit commission, particularly, could significantly guarantee hearer independency if all of the members are dedicated, independent and knowing in bettering good corporate administration regardless of fright and favour. Hearers and audit houses themselves should besides ever retrieve their chief aim while executing audit work – to safeguard the plus of the absent stockholders. Therefore, they should execute their responsibilities with full independency and good religion to function the best involvement of the stockholders.

To reason, independent auditing will certainly guarantee good corporate administration. Good corporate administration will certainly forestall corporate dirts to go on and make a healthy corporate environment.


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