Auditors Must Be Independent

If an auditor is hired by the company it’s supposed to audit, is it truly independent?

Independence is an important issue in statistics, so I found the article, “Ethics, Auditing and Enron,” by Denis Arter and J. P. Russell, in the October 2003 issue of Quality Progress quite interesting.

In the second section of the article the QP editor asks, “Must auditors be independent?” to which Arter responded, “No.”

The QP editor followed up on the negative response by asking for specifics. The author then explained that in the financial field, the auditor is a certified public accountant (CPA) who works for the auditing company. He goes on to say that outside auditing firms are hired by the client company and they are paid for their services when the client accepts the audit report. At that point the relationship stops. He then adds that the relationship apparently did not stop at Arthur Andersen (the now infamous auditors for Enron who helped them “cook the books”).

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Comments

Definition of the Parties

It is very important to define the parties in an audit. There is the auditor, the auditee, and the audit client. The auditor is the organization performing the audit. The auditee is the organization being audited. The audit client is the benefactor or recipeint of the report. In a first party audit, all 3 of these roles are within the same organiztion. In a second party audit, the auditor and audit client are the same organization which results in 2 parties (auditor/client and auditee). In a third party audit, all 3 of these roles are within different organiztions. For an ISO 9001 audit, the audit client or recipeint of the report is the customer of the auditee. Organizations become registered to ISO 9001 to give confidence (or a report or a copy of a certificate) to their customer. Keep these definitions or this structure in mind when you read Dennis Arter's writings.

Thinking about who pays for the audit can muddle one's understanding of the structure of 1st, 2nd, and 3rd party audits.

Achieving independence is not the goal. Achieving an absence of bias, or objectivinty is the goal. Auditors do not have to be independent, whatever that means. Indepenedence does not garuantee objectivity.

Bias and Objectivity

Thank for your comment. Well, if independence is not required for an unbiased and objective audit, then what is? Well, you kind of leave us hanging with no insight into achieving these desirable goals. Yes, auditor independence is not a necessary condition, but it is a highly desirable one if we wish to reduce the undue influence of money on the audit results. I'm surprised you have not figured this out because it has been a well known observation for more than 2000 years. For the Bible says "Money is the root of all evil" and of cooked books.

Independence

People often want to use things like titles to show independence. Or money trails or laibility. We all have bias in our thinking. The more an auditor is aware of their style of thinking, their psychology, types of bias, the more their observations in an audit will be objective. We see what we think before we look. Objectivety / a lack of bias is the goal. Indepedence is one possible means to the end goal of objectivety. Objectivity / lack of bias is not obtainable but it is the gaol in an audit. How one defines "independence" might assist in reducing subjectivity in an audit, but objectivity is the goal. Your quote from the bible is biased.

Every 3rd party auditor I have ever worked with was "independent" but had bias and was subjective for at least part of the audit.

Note that ISO 9001 does not use the term "independence" as a requirement for auditors. It does include "objectivity and impartiality."

Spend more time thinking about how you think and less time on trying to define "independence."

Finally, understanding the 3 roles in a 3rd party audit, will help you understand Dennis Arter's body of knowledge.

Why might money be considered the root of all evil?

Why might one consider money to be the root of all evil? Because it changes one's defined state of independence / dependence? Or becasue it affects one's objectivity and bias?

Independence, certification and accreditation

I think you've missed the point, John. Auditors don't work for nothing, why should they? We live in a society where we all pay for products and services, it's normal, it makes our world go round.

Independence means "free from unseen influence", it's not really about who pays whom, the bigger issue is "who wears the liability?"

Professional firms like CAs are established under partnership legislation where each partner is wholly and severally liable for the errors and ommissions of all of them. In that scenario PI insurance is both limited and expensive, but human stupidity knows no bounds as the Darwin Awards show us annually as did Arthur Andersen. In my view this is as good as it gets.

In our world, the system relies on accredited independent 3rd party certification, where the accreditation body at the top reports to a government ministry and the auditor at the pointy end reports to and is paid by a certifier/registrar who is paid by the organisation being audited. The weakness here is that the certifier/registrars are allowed to be limited laibility companies so the risk to the owners is minimal. For example, the Takata airbag scandal should see a raft of certifier/regstrars follow Arthur Andersen's into oblivion, it won't because they can avoid liability for the errors of their incompetent ways.

Wearing the Liability

It seems to me that a focus on liability will lead to bias and diminished objectivity. The biggest issue is how to attain the least amount of bias and the most objectivity.

IAN, Thank for your

IAN,

Thank for your thoughtful comments. Yes, it is true that the potential liability, just like getting a speeding ticket, can influence better behavior. However, this assumes they are caught in which case the horse is already out of the barn. Unfortunately many people can be hurt by this not just the company and the auditing firm. It seems reasonable to me that we try to reduce the motivation to cheat by taking away the finanlcial incentive and assuring the independence of the audit.

Independence how?

Hi John,

Thanks. Yes, I do get that but how do you do it?

Here in NZ we are in the middle of a political and media frenzy where a senior manager from our Transport Ministry was jailed for defrauding them of $726,000. It became evident that this had occurred under a CEO who was appointed subsequently as Audit-General; he has resigned, thank heavens!

An enquiry was commissioned by the Govt but under legal priviledge they refuse to release it.

And this is here in NZ, reputed to be the least corrupt adminstration in the world!

The only viable alternative I can think of to applying pertnership law, is that all verification auditing involving a financial transaction (to include ISO 9001 and its derivatives) should be done by civil servants funded from taxes.

Any better ideas?

Kind regards

Independence breaks the money link.

Ian,

I think you have suggested a good approach. My comments were directed at corporate financial audits, but for government activities I think your suggestion makes sense. You just have to be sure the people selecting the audit organization are not part of the government. Perhaps an outside professional organization like the one I suggested would work and of course since the money is coming from the taxpayers I don't think we need to worry about them colluding with the government agency that is being audited.