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Impossibility of Auditor Independence

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Intentional collusion of auditors and their clients is is not the major cause of Audit integrity. Most of the times, auditors find it difficult to become objective. In 1992, Phar-Mor, Inc. drugstore in the United States seeking a court protection from corruption failed a court case. The previous auditors, Coopers & Lybrand, Phar-Mor's failed to state inventory inflation and manipulation of finanicial that lead to overstating of $985 million earnings in a period of three years. The judges found Coopers ; Lybrand answerable for fraud to the joint investors.

The attorney for one investor argued that "this sends a strong signal to the accounting community that investors take very seriously the role of audited financial statements and rely on them for their integrity. "' The investors who successfully sued Coopers & Lybrand contended that Gregory Finerty, the Coopers & Lybrand partner in charge of the Phar-Mor audit, was "hungry for business because he had been passed over for additional profit-sharing in 1988 for failing to sell enough of the firm's services. "' Analysist, argue that Independence of audit was hindered by relationship with the management.

Unjustified certification of financial statement like The Phar-Mor case are of many cases where auditors have been held responsible. Investors in the MiniScribe Corporation maintained that auditors were at least partially responsible for the now-defunct company's falsified financial statements; at least one jury agreed, holding the auditors liable to investors for $200 million. In the U. S. financial reporting of savings and loan crisis has led to lose of millions of dollars by audit firms settling lawsuits and out-court suits making them collapse.

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The accounting profession claim that plaintiffs unjust actions are aimed looking for a convenient "deep pocket" towards recovery of their unplanned business decisions. The accounting profession’s role in financial reporting has experienced low reputation by investors and lenders. How could auditors not see that so many of their savings and loan clients were about to fail? How could a prominent auditing firm with a reputation for integrity overlook such large misstatements in Phar-Max H. Bazerman is the J. Jay Cerber Distinguished Professor of Dispute Resolution and Organizations at the J. L. Kellogg Graduate School of Management, Northwestern University. Kimberly P. Morgan is a certified public accountant and a Ph. D. candidate at the Katz School of Business, University of Pittsburgh. Ceorge F. Loewenstein is professor of economics, department of social and decision sciences, Carnegie Mellon University. First, the auditor-client relationship greatly influences opinions made about financial statement by auditors . Even the most professional auditors find it almost inevitable to maintain independence with the current audit procedures.

Imagine situation where professionals deliberate their duty without prejudice at all times. For example doctors treating patients without expecting salary. Teachers in schools guiding learners selflessly. However, teachers, doctors or judges are motivated by their own gains making them vulnerable to impartial judgments and not necessarily corrupt. Auditing mandated to provide direction to shareholders and stakeholders posses big losses in case it fails to detect malpractice in financial statements preparation. The management hire, mandates and even suck auditors.

Therefore, auditors serve the interests of their employer hence seem bias. The American Institute of Certified Public Accountants (AICPA) states in its Code of Professional Ethics: "In the performance of any professional service, a member shall maintain integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others. . . . Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism. ' The code of ethics acknowledges to some extent compromise on integrity and objectivity of the profession. Several parties including stakeholders, business advisors, lenders and financial institutions depend on financial statements to aid in their decision making. The management strives to maintain the reputation of the company. However, temptation to give over-ambition plans and objectives drive the management to give false information about the financial position of the company. This serves to attract external potential customers and takeholders. Financial reporting suffers from unqualified auditors. Reliability, accuracy and objectivity matter a lot in financial statements. Financial statements investigation requires generally accepted standards in accordance with International Standards of Auditing. Unqualified auditors usually communicate wrong presentations about the truth and fairness of accounting. Furthermore, independence cannot be possible in intellectually. Normally, misstatements occur during presentation as auditors interpret the data.

Accidentally, false judgment enters the audit reporting without conscience. In the process of reporting and analyzing financial statements false information may be relayed as well. One’s role in presentation of information plays a vital role in terms perception, interests and preference. This subjective factors manipulate facts altering fairness and justice. Inaccurate interpretation of data leads to misleading conclusions. People fall into the trap of distinguishing between personal interests and morality.

The rewards participants get in the exercise expose them to difficulty in liberating themselves from bias. In many circumstances, auditors consider the people who might be hurt by their independent opinion on the financial statement. The potential people to be affected by the report may be close associates with the audit. This may make them give false verdict about the fairness of the statements. On the other hand pointing misstatement ruins close relationships and in the event lose friends, contract and employment.

Auditors reappointed periodically get used to the company’s mediocre in preparation of financial statements. In the event auditors ignore small errors and frauds in the institution. Auditor often adjusts statements reporting. People mislead to rationalize a judgment that is consistent with their own interest. People justify their inaccuracy and one sided judgment about balances through manipulation of data. Serious sanctions and even hefty charges may result. On the contrary, emerging trends auditing promotes independence in the current world.

First, competitiveness increase in audit firms. Also dire results of losing a client and increased advantages of cordial relations with the client. Competitiveness Previously, junior auditors basic wage rate were at a ratio of four times the cost of the employee. Nowadays when a firm engages in corrupt reporting this amount may fall. In highly competitive markets, audit firms often accept losses audit fees in the initial years in order to "buy" the company. The client may be retained for a longer period by accepting heavily discounted fees.

In the current period audit firms treat clients with great regard. Today, clients can be lured intensified competition among audit firms takes place within and without. These rules of audit business and implications in market share determine profits and even effects of losing a client in a negative audit. . Second, big partnerships such as tax and consulting firms grow rapidly due to audit. Not only do the auditing profession generate profit but also serves as a consultancy agency. In many cases, a Firm's audit client gets consultancy services from the same firm.

Notably, the consulting client benefits a lot from the consultancy than from the audit. Therefore, the views about the accounts also poses a risk on the consultancy service. On the same vein, the integrity of the reporting can be at risk too. Actually, involvement in both consultancy and audit further posses questions on whom the auditor is accountable to and working For. Focused on the obvious conflict of fulfilling responsibility to external users versus the financial benefits of pleasing the client.

This conflict is typically viewed as a moral trade-of f on the auditors Face. The larger problem, however, is not with the auditors' morality, but with limitations in the way that they process information. Thus independence remains a problem For even the most moral, honest auditor. Despite the auditors' best efforts to place the external users' interests For the above the client's and to maintain objectivity, they may be unable to overcome cognitive or psychological biases that make them arrive at marginal decisions in the client's favor.

The larger problem facing society is that there is good reason to believe that auditors will unknowingly misrepresent facts and will unknowingly subordinate their judgment due to cognitive limitations. While audits are done for external criitics, the negotiated relationship between the auditor and the client creates them. Both the auditor and the client benefit From auditors' self-serving bias. We believe that the auditing profession and external users of financial statements should actively seek fundamental changes in the current structure of the auditing relationship.

Observers of the profession have suggested various possibilities, such as prohibiting a firm that conducts a company's audit from simultaneously providing other services for that client, prohibiting audit Firms From providing any related services, having external bodies appoint auditors or set fee structures, requiring companies to periodically change auditors, increasing oversight of auditing practices, or, the most drastic, having governmental agencies rather than the private sector conduct audits.

While we do not know that any of these suggestions would be optimal, we believe we have made a convincing case for reform of the current auditing relationship. External users pay a huge price for the flaws in the current structure of audit.

Work Cited

  1. Adapted from M. Murray, "Coopers & Lybrand Is Found Liable by Jury to Investors," Wall Street Journal, 15 February 1996, p. A-8.
  2. Adapted from M. Pitz, "J'-'O' Finds Phar-Mor s Auditors Negligent," Pittsburgh Post-Cazette, 15 February 1996, pp. A1-A6.
  3.  American Institute of Certified Public Accountants Code of Professional Ethics, 1988.
  4. W . Burger, U. S. Supreme Court: 1984, United States v. Arthur Young & Co. , US Supreme Court Reports, IG April 1984, 79 L Ed 2d, 826-838.
  5.  J. C. Robertson, /! W/>/>/g-(Homewood, Illinois: Irwin, 1990).
  6. E. Waples and M. K. Shaub, "Establishing an Ethic of Accounting," Joumalof Business Ethics, volume 10, 1991, pp. 385-393.
  7. C. E. Jordan and J. G. Johnston, "Auditor s Independence: A Proposal to the Profession and the Public," The Woman CPA, volume 49, July 1987, pp. 3-9.
  8.  D. M. Messick and K. P. Sentis, "Fairness and Preference," Journal of Experimental Social Psychologf, volume 15, 1979, pp. AMi-A'iA.
  9. K. A. Diekmann, S. M. Samuels, L. Ross, and M. H . Bazerman, "Self-interest and Fairness in Problems of Resource Allocation,"/O;»7M/ of Personality and Social Psychology (in press).
  10. D. M. Messick, "Equality, Fairness, and Social Conflict," Social Justice Research, voune 8, 1995, pp. 153-173; and D. M. Messick and A. E. Tenbrunsel, eds.. Codes of Conduct {New York: Russell Sage Foundation, 1996).
  11.  L. Thompson and C . Loewenstein, "Egocentric Interpretations of Fairness and Interpersonal Conflict," Organizational Behavior and Human Decision Processes, volume 51,1992 , pp. 176-197; C . Loewenstein, S. IssacharofF, C. Camerer, and L. Babcock, "Self- Serving Assessments of Fairness and Pretrial Bargaining," Journal of Legal Studies, oV vtll, 1993, pp. 135-159; L. Babcock, G. Loewenstein, S. Issacharoff, and C. Camerer, "Biased Judgments of Fairness in Bargaining," American Economic Review, volume 85, December 1995, pp. 1337-1342.
  12. K. Jenni and G. Loewenstein, "Explaining the Identifiable Victim Effect," Journal of Risk and Uncertainty (forthcoming, 1997); D. M. Messick, and M. H . Bazerman, "Ethical Leadership and the Psychology of Decision Making," Sloan Management Review, volume 37, Winter 1996, pp. 9-22; and L. Babcock and G. Loewenstein, "Explaining Bargaining Impasse: Th e Role of Self-Serving Biases," Journal of Economic Perspectives (in press).
  13. SeeG. Loewenstein andj . Elster, Choiceove>- 7/>H(? (New York: Russell Sage Foundation Press, 1992); G. Loewenstein, "Behavioral Decision Theory and Business Ethics: Skewed Ttade-offs between Self and Other," in Messick and Tenbrunsel (1996).
  14. See J. C. Corless, R. W. Bardett, and R. J. Seglund, "Psychological Factors Affecting Auditor Independence," The Ohio CPA Journal, volume 49, Spring 1990, pp. 5-9. Reprint 3848
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