External Auditor Independence: A Crucial Element for

Protecting the Interest of Shareholders of a Firm.

Prepared by:

Mohammad Imran Hossain

Student ID: 172018

Prepared to:

Dr Mohammad Kamal Hossain

Date of Submission: 30 April 2021

Abstract
Auditing service is the verification of the gist of all activities of a company for a year.
Auditors are in a position to verify those activities through financial statements or
other reports and documents. Because auditors act as agents of the shareholders and
prospective investors. Shareholders do not check out all the accounts, activities, and
transactions and are not in a position to control the use of that account which lives on
the capital provided by them. Shareholder just wants to see that their assets are
harmless, their investments are in a safe position, the capital they provide are being
used in specific purpose and in a specific way, all the activities are being done for the
betterment of their interest and their company, any activities do not go against their
interest and all the activities are being presented in front of them through financial
statements in a true and fair view requirement. To verify all of those requirements
shareholders and prospective investors are dependent only on the information
provided by the auditor and on the expertise and efficacy of the auditor. But auditors
are only able to provide a true and fair view of the company when they get enough
independence in their audit work. Independence is the crucial element in auditing
service which allows auditors to do their duties and responsibilities with proper
professional skepticism and expertise and plays a major role in certifying the financial
statements as transparency and fairness. Just a lack of independence of the auditor can
change his/her opinion on the client company. Depending on that influenced opinion
shareholders and prospective investors may change a decision which could the most
dangerous threat for their interest in the company as well as the capital market. Thus,
auditors’ independence is the precondition for the protection of the interest of the
shareholders.

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Table of Contents
Abstract.....................................................................................................................................i
Introduction..............................................................................................................................1
The role of an independent external auditor to protect the interest of shareholders of a firm:. .2
The way auditors may lose their independence:........................................................................2
Self-interest Threats..................................................................................................................2
Self-review Threats...................................................................................................................3
Advocacy Threats.....................................................................................................................3
Familiarity Threat.....................................................................................................................3
Intimidation Threat...................................................................................................................4
Audit tenure..............................................................................................................................4
Competition among audit firms................................................................................................4
Non-Audit Service (NAS)........................................................................................................4
Low Balling..............................................................................................................................4
How the independence of auditor can protect shareholders’ interest:.......................................5
Conclusion................................................................................................................................6
References:...............................................................................................................................7

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Introduction
The independence of the external auditor is a crucial element in the profession of
auditing. Stakeholders rely on the information of the financial statement of the
company because they try to measure the health of the company through the financial
statement. But company management always tries to maintain the steadiness of the
company’s profits and growth that may not always satisfy true and fair view
requirements. Thus there is a need to verify the true and fair view requirement which
is done by the external auditor. The stakeholders of the client company keep trust in
the audited financial statement only. Because it is very much material in considering
any decision about that client company. Stakeholders believe that an external auditor
assesses all the requirements and gives independent opinions on the audited financial
statement. But sometimes it is difficult for auditors to give independent opinions if
they do not get enough independence during their audit work. A lack of independence
can influence external auditors to provide biased judgments, which indicates a failure
in the audit process (e.g., Church and Shefchik 2012; Peecher and Solomon 2014
cited in Church et al. 2015). Generally, the independence of auditors can be defined in
two forms, independence of mind and Internal and external independence. The former
requires that the sense of the auditors' independence mentally and professionally
without any pressure or intervention by any higher authority or a particular body on
the auditors' role in checking the integrity and accuracy in the presentation of the
financial statements. While Internal and external independence requires that the
auditors should be independent of parties that might have a financial interest in the
business being audited and must be free from such threat that may reduce the
independence of the auditor (Al-Sabban 2003 cited in Ghadhab et al. 2019).

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The role of an independent external auditor to protect the interest of
shareholders of a firm:
The chief purpose of the audit is the corroboration of the financial statement that gives
a true and fair view of the audited firm. It also certifies that whether it follows
updated criteria of the international financial reporting framework or not as well as
the whole condition of that firm. Auditors give actual true and fair views only when
they get proper independence and can implement professional skepticism in their
audit work. According to accounting literature, the traditional role of the audit was
mainly the detection and prevention of fraud. If the external auditor does not get
appropriate independence during their audit work, they will not able to give a true and
fair view of the financial statement. It can represent a bias opinion. Therefore it can
damage the stock market as well as the interest of shareholders of the firm.

The way auditors may lose their independence:

 Self-interest threat
 Self-review threat
 Advocacy threat
 Familiarity threat
 Intimidation threat

Self-interest Threats
Self-interest threats occur when the auditor has financial or non-financial interests
with the client i.e. it includes sensitive, monetary, or any other private interests
intentionally or unintentionally (Allen and Seigel 2002, p.528). Auditors include the
benefits of his family from the client, the dependence on fees from only one client, the
anxiety of losing the client, and any other privileges from the client (Al Makademh,
2006; ICAIW & Kaplan, 2004 cited in Nawaiseh and Alnawaiseh 2015). For all of
these interests sometimes auditors may somehow dependent on the client and lose
their independence in audit work.

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Self-review Threats
The auditor or any others in audit firm provide non-audit service at the client
company at the-same-time they are in a position in the audit firm which may influence
the audit process ominously, or auditor or any others in auditing firm organize a basic
data which is used in the financial statement or audit work (ICAIW cited in Nawaiseh
and Alnawaiseh 2015). As a result of providing NAS service to the client company
where they work as an audit worker may be unable to give a true and fair view of
relevant aspects of those financial statements i.e., they lose their independence (Ojo,
2006. p.21)

Advocacy Threats
Advocacy threat occurs when the auditor tries to do something on behalf of the client
and takes the clients position i.e. the auditor supports the client in his performs and in
his opinions, or promotes the clients' shares or any matter or protect him in court
cases against the third party, or intervene to support the client position against others
in any disputable matter (Nawaiseh and Alnawaiseh, 2015). Auditors or any others in
auditing firms stimulate or advocate against the third party by acting as a position or
opinion of the client rather than provide a true and fair view of the financial statement
which clarifies that they lose their independence (Allen and Siegel, 2002).

Familiarity Threat
Familiarity threats arise when an audit firm works its audit work with a specific client
for a long period, influenced by the close relationship, and readily accept an auditee’s
viewpoint without putting proper professional skepticism to that client company
(Allen and Siegel,2002). Working too much time with the same client may build up
between them the nepotism, favoritism, and competition among auditing firms
(Sufyan & Bishtawi, 2003, cited in Nawaiseh and Alnawaiseh, 2015). Familiarity
threat also occurs if an intimate member who holds a sensitive position in the client
firm that will significantly affect the audit engagement team’s functions (Eilifsen et
al., 2006, p.580, 589,591; Hayes et al., 2004, p.89 and IFAC Handbook 2008 cited in
Chia-Ah and Karlsson, 2010). Working for a long period in the same client company
reduces the auditors' experience and altering him will raise the cost and disturbs the
independence of the auditor (Titus et al., 2014 cited in Nawaiseh and
Alnawaiseh,2015).

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Intimidation Threat
Intimidation threat arises when auditors feel pressure to give bias opinions or deterred
from acting objectively (Chia-Ah and Karlsson, 2010). The auditors are explicitly or
implicitly forced by the client company or any other interested parties (Allen and
Siegel, 2002). Intimidation threat can happen in a way where the client intimidates to
terminate the contract of the auditor to reduce his fees; this may reduce the
independence of the auditor (Nasution, 2013 cited in Nawaiseh and Alnawaiseh
2015).

Audit tenure
Audit tenure refers to how long an auditor works with a single client uninterruptedly .
Long tenure can be more than nine years where short tenure can be less than three
years (Johnson et al. 2002, p.640 cited in Chia-Ah and Karlsson, 2010). The more an
auditor works with a single client uninterruptedly the more chance of losing
independence in audit work (Herath and Pradier, 2018).

Competition among audit firms

Competition among audit firms is another factor that affects auditor independence. If
one auditor puts too much rigidity in his/her audit work, the client switches to another
auditor (Herath and Pradier, 2018). If an audit firm compromises in the nature of its
audit by entering a competitive audit market then it may lose its independence.
(Shockley 1981 cited in Herath and Pradier, 2018)

Non-Audit Service (NAS)

Non-audit service refers to service that is provided to an audit client and which is out
of the audit work (Ojo, 2006, p.18). Independent auditors may lose their job if they
involve disputes with their clients (Simunic, 1984 cited in Fashami et al. 2020). Non-
audit service reduces the true and fair audit opinion’s issuance and motivates auditors
to comply with their clients view to continue receiving their income, regardless of
potential harms to their independence (Hay et.al. 2006a cited in Fashami et al. 2020).

Low Balling
In low-balling, external auditor wants to make a long-term engagement with a client
company by providing a discounted audit service at the time of the initial assignment
of the auditor with an expectation of getting a higher fee for the following year (Lee
and Gu, 1998 cited in Kuntadi 2020). Lowballing encourages the auditor to the

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judgment that aids the client at the beginning of the period i.e. auditor are complying
with the client that may reduce independence (Dye, 1991 cited in Kuntadi 2020).

How the independence of auditor can protect shareholders’ interest:

Independence has a great relationship with the duties and responsibilities of the audit
work. If auditors get proper independence in their audit work, they can make actual
judgments by their professional skepticism and expertise.

 The independence of the auditor helps auditors to find out all the information
in detail and the effects of that information in the financial statement that are
the desired matter for all shares holders.
 The independence of the auditor helps the auditor to detect and analyze all the
information founded by their belief and competency.
 It helps the auditor to check out all the records, books, ledger, vouchers, etc.
that give the clarity of every transaction.
 It helps the auditor to visit any branches of the client company and the asking
power to ask any officer, employee, or related person for the explanation of
the asked issues.
 It also helps auditors to go to a third party such as a customer, Bank for
verification.
 It helps auditors to contacts the previous auditors and to collect information
from them.
 It helps the auditor to check whether the company is using the updated
international reporting method or not.
 It helps the auditor to comment on the health of the company and its ability to
protect itself.
 It helps the auditor to provide any opinions on the overall matter of the
company. It can be adverse or satisfactory which he considers in his/her audit
work.
 It helps auditors to present in the client company’s Annual General Meeting
(AGM) and express his/her opinion.
 It helps the auditor to study the article of Association, Memorandum of
Association, Prospectus, important contracts of the company, etc.

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  It helps the auditor to study the minutes of any important meetings of the
client company.
 It helps auditors to comments on the director's report and chairman's report.
 It helps auditors to check whether the loan and advances made by the
company based on the securities are safe or not.
 It helps the auditor to suspect on transaction presented in the record of the
client company.
 It helps auditors to check whether any account has gone under the
inappropriate heading or not.
 It helps the auditor to check whether or not the client company is using the
same method for depreciating any assets.

Conclusion
The paper described the basic meaning of auditing, how auditor may lose their
independence and how the independence of the auditor can protect shareholders and
their interest. Auditors may lose their independence in many ways such as being
involved in self-interest threat, self-review threat, advocacy threat, familiarity threat,
and intimidation threat. The auditor may also lose their independence for the size of
the audit firm, audit tenure, competition among audit firms, non-audit service, non-
existence of the audit committee, and low-balling. The paper displays that auditor's
independence is very much vulnerable to these factors of a threat. These factors of
threat have a local relationship with the independence of the auditor and independence
has a great relationship with the duties and responsibilities of the audit work which
can surely influence their judgment on financial statements. If auditors get proper
independence in their audit work, they can make actual judgments by their
professional skepticism and expertise. Depending on the judgment provided by the
auditor, shareholders can take proper decisions and can save their interest. Thus
independence of the auditor ultimately protects the interest of the shareholders.

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