This paper aims to analyze the factors that affect the independence of external auditors. The key objectives of this study are a) to conduct a literature review to identify the factors that affect the independence of external auditors; b) to conduct a survey on the factors that can affect the independence of external auditors; and c) to provide recommendation for audit firms on how they can improve the independence of external auditors. As a methodology, this study used positivism philosophy and descriptive research design along with the inductive approach, where the research mainly focuses on the quantitative technique. Thus, the study develops a survey questionnaire with close-ended and structured questions, whereas the survey is conducted on 30 audit firms.
The finding of this research shows that a number of factors affect the independence of the external auditors. The key factors are the quality of audit service, quality of non-audit service, different audit and non-audit services, competition in the audit service market, tenure with clients, the relationship between auditors and clients and audit fees. This study suggests the audit firms increase the independence of external auditors. Firstly, the audit firms can develop standards and policies for the external auditors to increase their independence. Secondly, the external auditors and audit firms can develop relationships with clients to increase the auditors’ independence. Then, it is essential to improve audit quality, tenure with clients to beat the competitors and improve the auditors’ independence. Finally, the audit firms can increase several non-audit services along with the incentives and rewards for the external auditors to improve their independence.
External auditor independence indicates the freedom of the auditors to audit a certain firm’s financial records. It is very helpful for the shareholders and the other stakeholders of the firm. External auditor independence also affects the performance of the firm for a longer period of time. Arthur Andersen is a large accounting firm that runs its activity internationally (Vinten, 2016). Independence Standards Board (ISB, 2015) suggested that independence of auditors include freedom of audit any kinds of accounts, totally free from any pressure to compromise, freedom of taking a decision without any bias. Fact and appearance are the standards of the external auditor’s independence. Independence in fact represents the relationship between medium organizations and their clients.
It is an objective fact. Independence in appearance represents the relationship among clients & third parties of the firm (Arens et al, 2016). Arens et al. (2014) stated that independence auditing is prepared on the basis of without any bias. It also includes the quality of the audit process, the process of evaluating outcomes and the process of the submission of audit reports. The key points of independence are the performance of integrity, objectivity as well as impartiality. External auditor independence represents the basis of the position of auditor independence. Pany and Reckers (2016) discussed the importance of external auditor independence issues as well as auditing existence. External auditor’s function is needed to collect reliable and accurate financial data.
Auditor independence can be classified into two kinds. The first one is actual independence and the second one is perceived independence. Actual independence includes the auditor’s belief and mind as well as the auditor’s ability and power to create an objective and make decisions without bias (Dykxhoorn and Sinning, 2012). Actual independence represents the auditors’ mental behavior that depends on the professional skill of the auditor (Gul and Tsui, 2012). On the contrary; independence of perception indicates the estimation of third parties about the auditor’s freedom. This perceived audit independence has a great impact on the theory and concept of auditing. Appearance independence indicates the estimation of a firm’s financial statements. Appearance independence is an empirical term of auditing (Dykxhoorn and Sinning, 2011).
Most of the literature views stated that the estimation of a firm’s financial statements depends on the external auditor’s independence (Dykxhoorn and Sinning, 2012). According to Firth (2015), the absence of the independence of external auditor make the financial statements bias and it has no value of the consent of the auditors. Actual and perceived external auditor independence is very much important elements for ensuring the reliability of the financial statements of the firm and the increasing public confidence about the firm as well as the profession of auditing (Pany and Reckers, 2015). It is no doubt that the freedom of auditors affects the acceptability and accuracy of audit result. In this paper, we shall give importance to the factors that influence the auditor’s perceived independence because actual independence is not identified.
The collapses and scandals of the corporate can be happened due to the absence of external auditor independence. The media is the main equipment that increases the importance of external auditor independence. By media comments, it is found that external auditor independence becomes the main issue of corporate scandals. The study gives input and feedback that are related to the external auditor independence. This study also helps to reduce the corporate scandals and collapses of the firm (Bakar, 2015). That is why; the vital part of the auditors is Independency of The recent collapse of corporate-like Enron has identified the importance of the external auditor‘s independence. Independence helps to focus the efforts of controversy, the debate as well as analysis. Despite the above actions, there are huge problems that are not solved in this research as well as literature. Debates are happened due to the non-audit provision services are prohibited or not (Alleyne et al., 2016). Many researchers mentioned that audit provision services affect independence positively (Jenkins, 2014; Windmoller, 2015; Kinney et al., 2014).
On the other contrary; other researchers mentioned that audit provision services do not seriously affect independence (Quick and Rasmussen, 2015). Various regulatory bodies have implemented new and standards of independence of the external auditor due to the smooth flow of auditing (IFAC, 2014; ICAEW, 2014). The new regulatory standards in respect of auditing, accounting and ethical guidelines are the continuous process that is applied by the firm (Beattie et al., 2014). However, still, now many audit firms need to identify the auditor’s independence level and how it affects the public confidence in the auditors (ICAEW, 2014). Therefore, this study aims to critically analyze and evaluate the factors that affect the independence of external auditors and find out the ways of improving the independence of external auditors. The key objectives of this study are:
- a) To conduct a literature review to identify the factors that affect the independence of external auditors;
- b) To conduct a survey on the factors that can affect the independence of external auditors; and
- c) To provide recommendations for audit firms on how they can improve the independence of external auditors.
3.0 Literature Review
3.1 Theories on independent of external auditors
External auditor independence is considered as one of the important issues to the controlling bodies and stakeholders of audit firms. Most importantly, it has now been a significant issue due to the collapse of a reputed firm call Arthur Andersen (Vinten, 2016). According to a report published by Independence Standards Board (2015), independence of the auditors refers to the freedom from any kind of pressures that compromise the ability of auditors to make a fair and accurate audit decision. The independence of external auditors depends on two basic standards that are facts and appearance. The fact of independence refers to the objective relationship between audit firms and their clients, and the appearance of independence refers to the subjective state of audit firms and their clients (Arens et al., 2016). Another study by Arens et al. (2014) defined the term ‘auditor independence’ as the fair and unbiased viewpoint of auditors in the way of audit test, audit evaluation, and audit reports issuance. Auditor independence focuses on quality, integrity, impartiality as well as objectivity.
Pany and Reckers (2016) stated that auditor independence depends on the presence of auditing, freedom of auditing and reliable financial information. According to Dykxhoorn and Sinning (2012), there are two types of auditor independence; actual and perceived independence. Actual independence can be defined as the auditor’s state of mind objective and unbiased audit decisions Actual independence represents the auditors’ mental behavior that depends on the professional skill of the auditor. Gul and Tsui, (2012) said actual independence is considered as the mental attitude of auditors in the perspective of professional objectivity that is considered as the millstones of auditing theories. Dykxhoorn and Sinning (2012) stated that perceived independence depends on the perceptions of clients regarding the financial statement that is an explorative concept, where the credibility depends on the viewpoint of users and clients. However, Firth (2015) debates that if the external auditors do have full independence in auditing, the users and clients will lose their confidence in sharing opinions and giving financial information that in turn will reduce the reliability of audits. Thus, the credibility of auditors is needed related to the sensation and facts of independence. Pany and Reckers (2015) said both perceived and actual independence of external auditors are complicated to be achieved. Thus, these terms significantly affect audit performance and quality.
3.2 Factors affecting external auditors’ independence
Provision of non-audit services
Several studies have found a close relationship between the provision of non-audit services and the independence of external auditors. Ashbaugh et al., (2016) stated that the provision of non-audit services significantly affects the perception of auditor independence. Winifred (2016) stated that incentives and rewards for auditors significantly compromise the independence of auditors and client confidence. The clients who provide higher fees during the audit time can expect better quality audits from the auditors. This means in this term incentives are compromising the independence of auditors. On the other hand, Frankel et al. (2012) stated that better provision of non-audit service can increase the quality of auditing because this increases the independence of auditors. Along with the financial incentives, other factors of provision of non-audit services affect the auditor independence that as the recent audit environment, external auditing place, and substantive testing of transactions. However, Frankel et al. (2012) debated that if the external auditors do not fully control the internal audit employees they would face difficulties to effectively evaluate the system designed by consulting agency or clients………..