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Auditor independence can be defined as a reference to the independence of internal or external auditors from parties that might have a financial interest in the business being audited.
- Independence of mind: The state of mind that permits the provision of an opinion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional scepticism.
- Independence in appearance: The avoidance of facts and circumstances that are so significant that a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, would reasonably conclude a firm’s, or a member of the assurance team’s, integrity, objectivity or professional scepticism had been compromised.
The use of the word “independence” on its own may create misunderstandings. Standing alone, the word may lead observers to suppose that a person exercising professional judgment ought to be free from all economic, financial and other relationships. This is impossible, as every member of society has relationships with others. Therefore, the significance of economic, financial and other relationships should also be evaluated in the light of what a reasonable and informed third party having knowledge of all relevant information would reasonably conclude to be unacceptable.
AU section 220 of the American Institute of Certified Public Accountants (AICPA) states that for auditor independence the auditor "must be without bias with respect to the client since otherwise he [or she] would lack that impartiality necessary for the dependability of his [or her] findings, however excellent his [or her] technical proficiency may be."
The International Federation of Accountants (IFAC) provides a framework of principles that members of assurance teams, firms and network firms should use to identify threats to independence, evaluate the significance of those threats, and, if the threats are other than clearly insignificant, identify and apply safeguards to eliminate the threats or reduce them to an acceptable level, such that independence of mind and independence in appearance are not compromised.
In situations when no safeguards are available to reduce the threat to an acceptable level, the only possible actions are to eliminate the activities or interest creating the threat, or to refuse to accept or continue the assurance engagement.
In the US context independency is governed by the SEC, PCAOB and AICPA.
In the case of Enron collapse in 2001, auditor’s independence was violated and Arthur and Anderson fell along with its client, leaving us with only big four audit firms, 'the big four', rather than five, as previously.