Auditor Independence Principles and Applications †Free Samples

Question: Discuss about the Auditor Independence Principles and Applications. Answer: Introduction: A host of business risks are present with regards to the insurance business and are outlined below (Gay Simnett, 2012). Market Risk Considering that the value of the portfolio tends to fluctuate as the asset prices change in the real time, thus there is the risk of suffering downfall due to crash of asset markets particularly stock markets. Operational Risk There could be potential human errors which could lead to loss being incurred by the company. Credit Risk There is a risk of default with regards to the various debt instruments. Underwriting Risk Considering the nature of business, if the insurer does not take the requisite prudential norms into picture, then this risk could be potentially huge. Considering that the above risks are present in the insurance business, it is easy to conclude that the business is highly risky and profitability in this business is dependent on the risk management related norms that are adhered by the given entity. It is quite surprising that despite being exposed to the above mentioned risks, the company has chosen the reinsurance model which is not a recommended manner to managing risk in the insurance business. HIH instead of reducing the inherent risk enhanced the same by venturing into insurance segments which only seasoned companies with highly effective risk management practices tend to enter. To further worsen the situation, HIH in order to expand business indulged in carrying out reckless acquisition that were destructive to the shareholder value as is apparent from the FAI insurance acquisition. Further, the internal processes of the company with regards to controlling risk were either dysfunctional or non-existent. On the basis of the a bove description, it may be concluded that the company is extremely risky. The key factors impacting the risk that exists inherently for HIH Insurance are outlined in the discussion below (Arens et.. al., 2013).. Despite being part of a very risky business where prudent risk management needs to be practiced in order to conduct the business, the company chose reinsurance model while ignoring the prudential risk norms which the leaders in the industry were following and was comparatively less risky. HIH Insurance went ahead and acquired FAI insurance at a premium price which was not justified but the process lacked appropriate due diligence and thereby made the company more vulnerable. Overall risk for the business enhanced when the ex-external auditor partners were represented on the board as the underlying independence was compromised in a bid to ensure that there is no change in the faulty business practices. The business risk enhanced on account of a quid pro quo relationship with the external auditor which never reported these faulty practices while never bringing to light the immense business risk due to imprudent management of the same by the same. There was acquisition of stake in certain companies with business relations with rivals which led to compromised business interests as there was potent and realistic risk of key business secrets and other competitive information being passed on. A relevant case worth highlighting in the defence of the auditors is Equitable Life Assurance Society v Hyman [2000] UKHL The case involved an insurance company which floated a particular insurance policy and provided customers with the choice of either desiring fixed returns or market linked returns based on the individual preference since the premium charged was same for each of the two options. The directors had the requisite discretion to alter returns and acted by lowering the return for fixed option so as to create parity with the market linked version especially when the market linked version underperformed the fixed rate version. Since the interests of the takers of fixed return version was adversely impacted as a result of the discretion, hence these aggrieved policyholders filed the case in court and the court held that the partnership directors would be considered liable for the losses of the aggrieved fixed policyholders (Swarb, 2015). A relevant case which may be cited as a defence of auditors in the event of liabilities originating from the creditors would be Raskov vs. Stapke Harris [2010] CA2/7. This case highlighted the fact that if legal determination can take place or is feasible, then the partnership would hold and endorse a particular view. The end result of this legal determination is that the underlying liability of outstanding creditors rests on the partnership along with the respective partners, thus ensuring that there is no need to pay by the auditor (Notforlaw, nd). The objective is to prove negligence tort which is contingent on satisfaction of mainly three conditions. The first one in this regard relates to duty of care arising on behalf of the defendant directed towards the plaintiff due to the categorisation of the plaintiff as a neighbour of defendant thus establishing that action/inaction by the defendant could cause damage for the plaintiff. In the existence of this duty, the defendant requires taking relevant measures for protection of plaintiff interest by ensuring that no damage is suffered by the same (Pendleton Vickery, 2005). The care extended by the defendant for the plaintiff would be contingent on the level of risk and also the nature of potential damage that can be caused. If in a given circumstance, the defendant fails to take the requisite measures which a reasonable person would have taken in the situation at hand, then there has been a breach of duty (Lindgren, 2011). Even though there has been breach of the duty to care, but unless there are damages suffered by the plaintiff, negligence cannot be claimed. Even though the damage covered is quite wide within the aegis of this tor but it needs to proved that a causal existence occurs between the damage and duty breach. For conclusively proving the same, it requires to be ascertained i the prevention of damage would have been possible through non-breach of duty to case. In case the answer is affirmative to the causal link, then the negligence tort is established. However, if the causal link cannot be established, then defendant not responsible even though the duty breach would have still occurred (Harvey, 2009). The appointment of the previous external audit partners to the board cannot be justified on any valid grounds. The only plausible explanation is the existence of a mutually beneficial relationship between the top management and the auditors where the investors and other stakeholders would end as the loser. During the time when the auditor partners were providing audit services, HIH insurance provided them with consulting contracts for the cooperation extended to the company during audit where an unqualified certificate was given despite glaring deficiencies and high risk where were never reported. There is no other possible explanation in this regard because acting as both the consultant and the auditor, the inherent business risk and the faulty internal policies to manage the same would have been the primary observation. The directors wish to continue the profitable relationship by appointing these members to the board so that the various incorrect practices could continue and there was no pressure to mend ways even though the company was staring at a certain failure (Arens et. al., 2013). In order to work as a consultant, the first essential process is to understand the business model coupled with the underlying risks which is quite helpful for conducting audit as we since there is enhancement in the understanding of business risks. Based on the underlying risk involved in the business, the audit plan and tests can be accordingly planned which would enable the auditor to meet the goal of minimising the overall audit risk (Gay Simnett, 2012). Better quality of consulting services extended to client Working in the capacity of a auditor, the concerned individual would have a superior understanding of the weak aspects of the company which need to be strengthened especially where the inherent business risk is high. Further, since the overall business model is well understood, hence the consultant can offer pragmatic suggestions which are implementable for the client while being effective (Arens et. al., 2013). Hence, it makes sense that despite the concerns regarding the abuse of the same, it can also yield positive returns for all stakeholders involved. Safeguarding the independence of the auditor should be a key priority for the professional as with the proliferation of the services provided by the auditor, the risk of independence being compromised is on the rise. The relevant law does not forbid the auditing firms to offer other business services to the same client but it is essential that in wake of the falling standards, the auditor on their own must stop engaging in this practice (Livne, 2015). A prime example of the compromised independence is apparent from the unfolding of the incidents tht transpired in the HIH case on account of the comprised independence of auditors which led to a scam of this magnitude. Thus, in view of the potential dangers to perceived and actual independence, it is essential that auditors take requisite measures to safeguard integrity of the profession (Kaplan Williams, 2013). The main objective behind implementing the guidelines indicated by CLERP 9 is to being about improvement in the framework related to corporate governance so that shareholders interest must be safeguarded. Major provisions are mentioned below (Clout, Chappelle Gandhi, 2013). Extra disclosures including remuneration report along with directors report must be included in the annual report of the company. The auditor has to mandatorily rotate after a tenure of particular duration which would ensure lack of formation of mutually beneficial relations with management. As the focus on corporate governance would increase, the investors would be more confident considering the underlying transparency and disclosures would rise under a sound framework (Arens et. al., 2013). Ramsay report primarily focused on the issue of auditor independence and provided certain recommendations to improve the same (Parker, 2002). The rise in the scope of work an underlying mandate of internal audit committee Adequate gaps must exist in the form of measures to avoid any relationship which may threaten the interests of users including shareholders Declaration to be furnished by auditor in the annual report regarding his/ own independence along with a declaration for the independence of board must also be included. The objectives that is expected to be served by Ramsay report is an increase in the auditor independence and an enhanced understand of the potential measures that be undertaken to safeguard the interests of the shareholders especially minority (Gay Simnett, 2012) References Arens, A., Best, P., Shailer, G. and Fiedler,I. 2013. Auditing, Assurance Services and Ethics in Australia, 2ndedn., Sydney: Pearson Australia Clout, V, Chappelle, E and Gandhi, N 2013, The impact of auditor independence regulations on established and emerging firms,Accounting Research JournalVol. 26, No. 2, pp. 88-108 Fearnotlaw nd, Raskov vs. Stapke Harris, Available online from https://www.fearnotlaw.com/wsnkb/articles/raskov_v_stapke__harris-33634.html [Accessed May 9, 2017] Gay, G. and Simnett, R. 2012, Auditing and Assurance Services in Australia, 5thedn., Sydney: McGraw-Hill Education Harvey, C. 2009, Foundations of Australian law. 3rd eds., Prahran: Tilde University Press Kaplan, S. and Williams, D 2013, Do going concern audit reports protect auditors from litigation?A simultaneous equations approach.The Accounting Review, vol. 88, no. 1, pp. 199-232. Lindgren, KE 2011,Vermeesch and Lindgren's Business Law of Australia, 12th eds., Sydney: LexisNexis Publications Livne, G 2015, Threats to Auditor Independence and Possible Remedies, Finance Practitioner Website, Available online from https://www.financepractitioner.com/auditing-best-practice/threats-to-auditor-independence-and-possible-remedies?full. [Accessed May 9, 2017] Parker, C 2002. Auditing at arms length, CA Charter, February, pp. 38-40 Pendleton, W Vickery, N 2005.Australian business law: principles and applications, 5th eds., Sydney: Pearson Publications Swarb 2015, EQUITABLE LIFE ASSURANCE SOCIETY V HYMAN; HL 20 JUL 2000, Available online from https://swarb.co.uk/equitable-life-assurance-society-v-hyman-hl-20-jul-2000/ [Accessed May 9, 2017]