Auditor Independence

1. Group Member : WONG SOON TAK (110399) CHAI YEE JENG (110402) LOKE CHAN HOE (110405) KAN WAI KHEN (110423) Auditor Independence Current Issue In Accounting & Auditing (ACT 4215)

2. Contents 1.0 Introduction 2.0 Literature and Issues 2.1 Auditor Independence and Provision of Non Audit Services 2.2 Audit Rotation 2.3 Selection of Auditor 2.4 Client Relationship 3.0 Conclusion

3. 1.0 Introduction Auditor Independence

4. Auditor independence - focus of media comments in the wake of Enron & other corporate scandals. • Potential threats to auditor independence has long been considered by regulators.

5. Definition : • the probability that the auditor will report a discovered breach in the financial reports (Watts and& Zimmerman 1983; 1986) • International Federation of Accountants (IFAC) in its code of ethics • (1) Independence of mind • (2) Independence in appearance • Thus “independent auditor” refer to external auditors Managers have incentives to reduce agency costs by hiring independent auditors (Jenson & Meckling)

6. 2.0 Issues Auditor Independence

7. 2.1 Provision of Non Audit Services • Non – assurance services includes internal audit services, IT services and preparing accounting records and financial statement • Provision of non – assurance service create threats to independence especially to an audit client. • Bartlett (1993) conducted a study and touched on the issue

8. As it has always been said that, independence is the cornerstone of an auditor’s training and& professional ethics. • Views that audit firms with audit related and & other services can brings a great deal of value to their audit clients. • Market – based incentives & threats to auditor independence

9. IFAC perception • MIA & MICPA perception about the situation in Malaysia • Actions taken by regulating bodies to address the problem – propose audit fees for public listed company < 15% of firm’s revenue.

10. Results from previous findings indicated: • No association between non – audit service fees &auditor’s independence. • Positive association between audit fees auditor’s independence. • Market – based institutional incentives, provide incentives for auditors independence that outweighs dependency on higher fees.

11. Thus in our opinion, we believe that • the provision of non – audit services to audit client will not jeopardize auditor’s independence in providing a true & fair view on the status of the audited financial statement.

12. 2.2 The Rotation of Auditors • The issue of audit rotation has been debated for over 25 years. Periodically & normally after the occurrence of some corporate scandal, the issue re-emerges. • Few countries that require compulsory rotation: • Italy (Having experienced it since 1974) • Austria • Brazil • South Korea • Singapore

13. Why The Rotation Of Auditors Is The Best Solution ? • The Closeness to Management • The nature of auditing requires that auditors interact extensively with their clients. • Long-term relationship may result in a troublesome degree of closeness between management and the auditor.

14. Enron and Andersen, its long-time audit firm, provide a graphic example: [Andersen auditor and consultants were given permanent office space at Enron headquarters here and dressed business-casual like their Enron colleagues. They shared in office birthdays, frequented lunchtime parties in a nearby park and weekend fund-raisers for charities]

15. The Staleness and Redundancy • Stale and view the audit as a simple repetition of earlier engagements. • Rely on prior-year work papers to help plan the audit, set the budget, and provide valuable information needed for the current-year audit.

16. Why The Rotation Of Auditors Is NOT The Best Solution ? • The loss of “corporate memory” of a client, reducing audit effectiveness • Increased costs of doing business • Impact of rotation on the audit profession

17. 2.3 Selection of Auditor • Fundamental Issue : the apparent control of the hiring and firing of auditors by company management. (Saul 1996) • the board of directors should represent investor interests makes auditor related decisions • most public companies this decision is delegated to the audit committee

18. Sarbanes-Oxley Act • selection of auditor become responsibility of the audit committee • management will choose the auditor based on the likelihood of receiving a ‘clean’ audit opinion rather than on auditor competence

19. Chung and Kallapur 2001 • management dominate 60% of board of directors using the joint appointment of Chairman and CEO • affect operation independent, investor driven audit committee • Malaysia Code on Corporate Governance • Chairman and CEO should not be the same person • to ensure a balance of power and authority

20. Public companies • seek ratification of their auditor selection by investors through annual proxy ballots • however, it is ratify the auditor nominated by the audit committee • investors can reject an auditor, but cannot effectively nominate a preferable auditor

21. Auditor selection by investors • significantly decreases independence violation • increases the surplus in the markets resulting in a higher level of economic efficiency • have real consequences to the overall market

22. As auditors independence increases, • the prices investors are willing to pay for assets with High, Agree reports also increase • reflects the increased confidence in the auditors’ report

23. Our Opinion • Placing control over the hiring and firing of auditors in the hands of a party separate from client management can substantially improve auditor independence

24. 2.4 Client Relationship In year 2000, • Ernst & Young announced that it would sell its management-consulting business to Cap Gemini Group SA in France. • KPMG sold preferred stock convertible to between 18.2% & 19.9% of its outstanding stock to Cisco Corporation, & announced its intention to sell additional shares to the public in an initial public offering. • PricewaterhouseCoopers has publicly announced its intention to re-structure its audit & consulting businesses along similar lines.

25. Growing complexity of financial & economic relationships between clients & audit firms increase potential of conflicts of interest & threatens the independent audit function. • Extended auditor-client relationships affect auditor independence because auditor’s objectivity about a client reduce with the passage of time . (Mautz & Sharaf, 1961) • Relation between auditor tenure & findings of fraudulent reporting is more likely to occur in the first three years of the auditor-client relationship. (Carcello & Nagy, 2004)

26. Threats categorized as self-interest, self-review, advocacy, familiarity & intimidation. • The level of threat is higher, & likely to be unacceptable, if the interest is neither acquired or held on standard commercial terms nor negotiated on an arm's length basis. • Business relationships between the audit parties that influence the outcome of the audit & the audit client, its affiliates, or its management may course different threat.

27. In Malaysia, • MIA & MICPA have restrictions regarding family & financial relationships, between auditor & audit client, employment of directors & management & staff of the audit client by the audit firm. However, • There still lacking in addressing the question of employment by the audit client of the audit partners & staff engaged on the audit.

28. Conclusion Auditor Independence

29. Independence is the foundation of the public accounting profession. • Professionals must maintain its stature as the determinant of the profession’s strength. • Issue of non audit services & rotation of auditors can be addressed by having a fully independent audit committee. • Audit committee should be made fully responsible with the independence & objectivity of the auditors. They should have the authority to appoint and change the auditor.