Discuss about the Auditing for Auditors Independence.
Auditor independence is a key concept used to portray the image of auditors as viewed by users of the financial statement. Users of financial statements rely on the opinion given by the independent auditor to make economic decisions pertaining to an entity . Therefore, this is a concept which can make or break the auditing profession depending on the extent to which it is safeguarded by the practising auditors.Auditors independence has been a matter of interest in business world in recent times due to occurrence of financial crisis,corporate frauds and business failures (Nasution, 2013)
Over the years , auditors independence have been questioned at different capacities by different stakeholders as result economic damages they have experienced.This is evidenced by the fact that many auditors /audit firms have been mentioned as parties to the scandals reported in the past. For example, Earnest & Young were incorporated into the case pertaining the collapse of Lehman Brothers during the 2008-2009 financial crises . Auditors were mentioned as part of the scheme used by the bank to hide the bad debt loans which were not reported prior to the collapse of the company (Nigash, 2011)
As a result of the problem identified pertaining auditors independence, this essay will discuss the Toshiba Accounting fraud case .The objective will be to determine whether the auditors involved were independent in both mind and appearance or if there existed any form of threat to their independence.The structure of the essay will involve a description of the specifics of Toshiba accounting fraud case.This will be followed by a discussion of auditors independence in the context of the case ,followed by identification of threats which can compromise independence of auditors involved and finally, a conclusion on whether the auditors were independent or not (Blann, 2012)
Toshiba was incorporated in Tokyo Japan in the year 1938 . It operates in the information technology industry with a rich portfolio of products which includes computers, fridges, communication devices, systems , household equipment among others. It is among the market leaders is computer sales sector and was ranked the fifth position in 2010 in the sector. In early 2015, the market regulator in Japan realised the accounting scandal in Toshiba. For a period range of seven years, it was discovered that Toshiba had overstated their profits by approximately $1.2 billion (Gandhi, 2015)
This scam was a result of dubious accounting methods employed by the company in preparing their accounts. It involved failing to recognise losses of projects, overstating their profits margins in computer supplies, overvaluation of stocks and failure to accrue expenses accordingly. This was necessitated by the high targets set for the staff and also the Japanese social culture of performance which made the managers manipulate accounts to reflect continuity in growth and meeting targets. (Toshiba, 2015)
The external auditors of Toshiba at the time the scam was detected was Earnest & Young. From the report of investigations into the scandal, the management had formulated complex systems to hide the accounting malpractices used hence making it hard for external auditors to detect . Therefore, the auditor’s opinion was misguided by the management scheme of inappropriate accounting policies of Toshiba in assuring the user of reliability and objectivity of the financial statements. The report of the accounting scandal did not question the independence of Earnest & Young in carrying out their work. This is because it was not in scope of the report This necessitates a thorough investigation of EY independence in this case (Toshiba, 2015)
According to (Musa Abdel Latif Al Nawaiseh, 2015) ,an auditor’s independence is the extent of which the auditor will give his opinion on the financial statements without any interference .EY should be seen to be independent in both aspects of mind and appearance. Independence of mind will be identified in EY if it takes the assignment with the right mental attitude of giving an objective opinion based on the information given and carrying the necessary substantive tests to establish the integrity of the accounts . In practice, this is hard to identify. Independence of appearance occurs when the auditor conduct as observed by the public does not indicate any form of compromise . Practically, this can be identified by the auditor (Blann, 2012).
The objective way to determine whether the EY was independent in their work is to look for evidence of threats which could have compromised their independence. (Musa Abdel Latif Al Nawaiseh, 2015), (Curtis E. Clements, 2012) and (Christopher Akpotu, 2013) in their studies agree that threats in reality exist which could compromise on auditors independence if not managed appropriately. They all identify threats such as conflict of interest,self-review,intimidation, familiarity , advocacy among others as identifiable threats to the independence of auditors .Conflict of interest occurs when the auditor has some personal interest in the company he is auditing . For example , the auditor may own shares in the company he is auditing . Intimidation threats occur when some powerful managers in client companies fail to co-operate during the audit process. Advocacy threats occur when the auditor is still representing the client in other matters like acting as the client’s portfolio manager .
In addition , (Nasution, 2013) identified social factors as a real threat to auditors independence. Social factors determine how subordinates follow directions given by the persons in authority . Social pressures which affect the independence of auditors can be classified into obedient pressures and conformity pressures . Obedient pressures are the ones associated with strictly following orders of the senior persons without necessarily doing what is right. In such cases, auditors will be influenced by their powerful clients during the audit and they will be required to be obedient to such seniors hence compromising their independence. Likewise, conformity pressures relate to making decisions based on the expectation of the client when auditing. This should also be investigated in EY to see if there was independence (Nasution, 2013)
(Times, 2016)EY Japan was seen to lack independence of mind. This is because seven accountants from EY who were involved in the audit of Toshiba were reprimanded by FSA on the grounds of not carrying out due diligence during their audit assignment. A case was given by FSA of one accountant in the auditing team who identified some questionable figures in the computer vendor business but failed to share the information with the audit team. This is a clear indication of lack of mindset on the overall objective of the entire audit process.
Independence by appearance was also under threat because EY had been auditing Toshiba for more than a decade before the scandal was realised (Times, 2016). This brought about familiarity threat as the EY long stay as Toshiba auditor (Musa Abdel Latif Al Nawaiseh, 2015). (Waldron, 2015) the fact that EY could not identify the material misstatement of $1.2billion in a period of 8 years raises eyebrows and shows presence of self-interest threats. Toshiba by its value is an important customer to EY which brings substantial revenues to the company , therefore, they failed to disclose the material misstatement to safeguard their major source of revenues (Musa Abdel Latif Al Nawaiseh, 2015)
According to (Toshiba, 2015), there was an evidence of social factor threats. In japan, there is a culture for subordinates to fully obey orders from their seniors. EY auditors were subjected to this hierarchical pressure and conformity pressures from Toshiba CEO and other senior management persons hence ended up not identifying and questioning the inappropriate accounting application which is a matter of concern. Also, (Times, 2016) case of an accountant who realised the inappropriate accounting but ended up not reporting to his colleagues is a clear evidence of conformity pressure.
Therefore, the analysis of EY independence shows that there were numerous threats to independence on EY which lead to the accounting scandal in Toshiba in 2015. The key identified threats according to Toshiba case included Social factor threats, familiarity threats and self-interest threats . These findings confirm to the hypothesis that, lack of auditors independence is a key contributor to the accounting scandals as evidenced in studies by (Friday E. Akpan, 2014), (Mentha, 2014) and (Bello, 2011). They all agree that lack of auditors independence of mind and appearance contributes to economic losses witnessed by users of financial statements.
(Su, 2015) shows how the failure of companies due to lack of auditors independence have negatively affected the auditing firms themselves. Auditors who gave an unqualified opinion on company financial statement which subsequently ceases to be a going concern or a scandal is realised thereafter, suffer negatively due to penalties imposed on them and negative public image.This is because the auditor independence is seen to be under threat which is a key violation of the profession norm. In addition,lack of auditors independence adversely affects the users of financial statements who rely on them to make economic decisions. This is evidenced in the case of Toshiba and EY whereby, the audit firm was fined to a tune of $59.8 million and a suspension of three months and investors lost 12% of the investment one day after the announcement of scam (Times, 2016)
There is a need to reinforce auditors independence issue due to significant losses which have been witnessed in the past . It is evident that it affects negatively both the users and the auditors themselves. Some of the key factors which have identified to enforce auditors independence include one, professional commitment whereby practising auditors are supposed to make judgements based on the profession set norms and ethical judgements . Two ,auditors should have a locus of control which entails taking full responsibility for their actions. Three,awareness to auditors independence which will affect how auditors will make judgement and finally perceived stress levels (Nasution, 2013)
References
Bello, A., 2011. Corporate Failure : Accounting and Auditing Resolution. Researchgate, pp. 1-18.
Blann, S. W., 2012. Auditor Independence :In the Public Sector, Revisited. Governance Finance Review, pp. 37-42.
Christopher Akpotu, O. I., 2013. External Auditors Unethical Behaviour and Corporate Business failure in Public owned organisations in Nigeria. International Journal of Business and management Invention, II(4), pp. 12-18.
Curtis E. Clements, J. D. N. S. S., 2012. Inherent Conflicts Of Interest In the Accounting Profession. The Journal of Applied Business research, 28(2), pp. 1-8.
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Mentha, K., 2014. Audit Negligence. Forensic Matters, IV(6), pp. 1-9.
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Nasution, D., 2013. Essay on Auditors Independence. School Of Business & Economics Abo Akademi University, pp. 1-32.
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Times, F., 2016. EY’s Japanese unit reprimanded by the regulator over Toshiba audits. [Online]
Available at: https://www.ft.com/content/e6357710-a89a-11e5-955c-1e1d6de94879
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Toshiba, 2015. Independent Investigation Report, Tokyo: Toshiba Corporation.
Waldron, M., 2015. Toshiba Accounting Scandal: Should Auditor Ernst & Young ShinNihon Get a Mulligan?. [Online]
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