Question

Would it be possible to be objective when auditing a friend's financial statements? If you think, so, tell us why. If not, then describe the impediments you might encounter

Answer 1

An auditor’s independence refers to the independence of the auditor from the parties that are connected to the company or which have a financial interest in the firm. An auditor must be objective and independent while auditing the accounts of the company.

The following are the five things that can potentially compromise the independence and objectivity of auditors:

1. Self-Interest Threat

A self-interest threat exists if the auditor holds a direct or indirect financial interest in the company or depends on the client for a major fee that is outstanding.

Example

The audit team is preparing to conduct its 2020 audit for ABC Company. However, the audit team has not received its audit fees from ABC Company for its 2019 audit.

Issue

The audit team might be tempted to issue a favorable report so that the company is able to secure a loan to settle the fees outstanding for their 2019 audit.

2. Self-Review Threat

A self-review threat exists if the auditor is auditing his own work or work that is done by others in the same firm.

Example

The auditor prepares the financial statements for ABC Company while also serving as the auditor for ABC Company.

Issue

By having the auditor review his or her own work, the auditor cannot be expected to form an unbiased opinion on the financial statements.

3. Advocacy Threat

An advocacy threat exists if the auditor is involved in promoting the client, to the point where their objectivity is potentially compromised.

Example

The auditor is assisting in selling ABC Company while also serving as the auditor for the company.

Issue

The auditor may issue a favorable report to increase the sale price of ABC Company.

4. Familiarity Threat

A familiarity threat exists if the auditor is too personally close to or familiar with employees, officers, or directors of the client company.

Example

ABC Company has been audited by the same auditor for over 10 years and the auditor regularly plays golf with the CEO and CFO of ABC Company.

Issue

The auditor may have become too familiar with the client and, thus, lack objectivity in their work.

5. Intimidation Threat

An intimidation threat exists if the auditor is intimidated by management or its directors to the point that they are deterred from acting objectively.

Example

ABC Company is unhappy with the conclusion of the audit report and threatens to switch auditors next year. ABC Company is the biggest client of the auditor.

Issue

The auditor’s independence may be compromised, as ABC Company is their biggest client and they, quite naturally, do not want to lose such a client. Therefore, the auditor may issue a report that appeases ABC Company.

Given case comes under familiarity threat due to which there will be compromise of auditor’s independence and this will prevent ti present a true and fair view of financial statements.