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Self-Interest
The presence of financial interest of the auditor in the audited firm can impair
objectiveness, and hence independence. Consider an auditor who is also a
shareholder. The (independent) auditors duty is to ensure that financial
performance is accurately reported, even if this implies reporting poor performance.
However, as a shareholder, the auditor may prefer that bad news is withheld, at
least until the auditor-shareholder can sell his/her position. Similar arguments hold
for an auditor-lender (for example, through the holding of corporate bonds).
As a second example of a self-interest threat to independence, consider the case
where the external auditor carries out some non-audit work for the client. This is
quite a common situation. The auditor therefore may need to scrutinize and
evaluate the non-audit work carried out by colleagues in the audit firm. Many
auditors may be quite reluctant to confront their colleagues and would have the
self-interest to minimize any exposure that could risk his audit firms reputation.
Familiarity and Complacency
Familiarity can blunt the skepticism that is expected of the auditor. This may be
because the auditor develops a degree of overconfidence in his or her knowledge of
the client firm. It may be that the repetitive nature of a long-term engagement
between the auditor and his/her client leads to complacency and, consequently, to
the underweighting of warning signs. Some commentators speak of the need for
fresh eyes and mind that lead to a better scrutiny of the client.
Yet familiarity also has a positive aspect as it implies a better understanding of the
client and helps the auditor to perform better. Research on auditor tenure suggests
that, as the auditclient relationship lengthens, audit quality improves.
Social Bonding
Long-term audit engagements bring the external auditor and members of the client
firms management team closely together. It is not unusual for friendships to form in
the workplace. Moreover, to the extent that a clients managers nominate auditors
from their own circle of friends, the likelihood of objectivity on the part of the
auditor decreases. This self-serving bias is grounded in psychology theory and
arises when, as a consequence of close relationships, one cannot separate ones
own interests from those of others.
It is not entirely clear, however, how powerful this threat is. Auditors need to follow
certain professional and ethical norms, and they are bound by social norms.
Moreover, concerns about reputation may be quite powerful and sufficient to rein in
such a threat, even if only at the subconscious level.
Relationship threats are broad and generally cover anything that involves the
auditor knowing the SMSF trustees, members, or accountant on a personal level. "If
you have a close family or business relationship with a trustee or member of the
SMSF, you can't achieve independence in auditing that SMSF," says Ghandar. Due to
the family nature of SMSFs, it is an issue the ATO pays particularly close attention
to.
How to deal with threats
If any of these threats occur, it doesn't necessarily mean an auditor can't complete
the audit. Rather, safeguards must be put in place to eliminate the threat and these
safeguards must be documented in the audit report. When doing so, it is important
to note that a single circumstance may give rise to more than one threat and each
threat must be addressed.
"One of the issues we come across a lot is that people have considered
independence and they probably could achieve independence according to the
code, but they just haven't documented their thought process around it," says
Ghandar.
Ghandar adds that auditors should use the framework provided in the APES 110
Code of Ethics for Professional Accountants as a template for documenting
independence threats. That is:
1. Identify the threat
2. Evaluate the significance of that threat
3. Consider safeguards you can put in place to address the threat.
Safeguards
Auditors can use safeguards to eliminate threats. In the case of a multiple referrals
threat, for example, Ghandar says the auditor can have an external reviewer look at
certain files within the SMSF.
An external review may also make it possible for ex-staff and partners to safely
work with former employees.
"It can be a real positive because they will know the business and have a good
working relationship, but it is also making sure that independence has been fully
considered and that the appropriate safeguards are in place," says Ghandar.
However, as each situation is unique, the code says auditors must use their
professional judgement to determine if the safeguard is appropriate.
In some cases, the nature of the threat may be so significant that even a safeguard