During any audit assignment, auditors must ensure that they are independent of the client’s management. It is one of the critical requirements for continuing an audit objectively. However, there are some threats that auditors may face which may endanger their independence as well as objectivity. These threats include self-interest, self-review, familiarity, intimidation, and advocacy threats. An explanation of each of these is as below.
This is one of the five threats that may affect the independence and objectivity of the auditor during the course of the audit. The self-interest threat stems from the auditor’s interests clashing with that of the client. In an audit engagement, the auditor must ensure that they consider the needs of all stakeholders. Sometimes, however, auditors may also be a stakeholder of the company or business. In that case, they may neglect other stakeholders’ needs when their interest is at stakes.
For example, a member of the audit team for a company ABC Co. owns shares in it. The member discovers an irregularity in the company’s financial statement. They believe that if they disclose this information, ABC Co.’s share prices will fall. Therefore, they choose not to disclose this information. In this case, the auditor’s self-interest goes against other stakeholders’ interests.
There are several ways in which auditors can avoid the self-interest threat. For example, any auditor that may introduce such threats to an engagement can leave the team. If auditors cannot resolve these issues, they may have to consider leaving the engagement altogether.
The self-review threat stems from the relationship that auditors have with clients. Some auditors provide additional services, apart from their primary auditing service. For example, some auditors provide account preparation or tax services. The self-review threat is when auditors are responsible for auditing their previous work.
For example, an audit company provides account preparation services to a client, ABC Co. During the audit, auditors discover issues with the financial statements. However, the audit company is responsible for these misstatements. Therefore, the auditors choose not to disclose this information to stakeholders. By doing so, they withhold critical information from stakeholders.
Similar to the self-interest threat, the self-review threat is avoidable. By using separate teams for each assignment, auditors can dodge reviewing their own work. In case they can’t avoid self-review threats, they will have to relinquish the engagement.
The familiarity threat also arises from the relationship that auditors have with their clients. Over a period of a long relationship with a client, the auditors may become too familiar with the client’s management. The longer this association between both parties is, the higher the familiarity threat for the engagement will be.
For example, an audit company has served the auditors of a client company, ABC Co. During the last audit, auditors discovered some misstatements in the company’s financial statements. The auditors believe that by disclosing this information, they will waive their relationship. For that reason, they choose not to disclose this information.
The familiarity threat is also avoidable. By not having long relationships with clients or rotating audit teams after regular intervals, auditors can avoid it. Similarly, there are several other familiarity threats and safeguards against each of those.
Sometimes, auditors may also get direct threats from the client. Usually, these threats arise when the client is in a position of leverage against the auditors. In these cases, the client may threaten the auditor. This threat represents the intimidation threat that auditors face during their audit engagements. Like other threats, intimidation poses a risk to the auditors’ independence and objectivity.
For example, an audit company has served as a client’s auditor for several years. The income from the client constitutes more than 35% of the audit company’s total income. The client is also aware of this. During the audit, the auditors discover information that may indicate fraud. However, the client’s management threatens the auditors from discontinuing their services in the future if they disclose it.
Intimidation threats can be severe sometimes. In these cases, auditors must leave the engagement readily. However, in other circumstances, it is manageable. For example, by not allowing clients to reach a leverage position, auditors can avoid getting intimidated.
The advocacy threat to independence arises when auditors are in a position where they represent the client. Usually, just doing so does not pose a threat. However, when auditors promote or represent a client in a way that someone may consider to be advocacy, it gives rise to this threat. This threat may also arise from a client’s relationship with the auditors.
For example, a company hires its auditors to represent them in court for a dispute with one of its suppliers. In this case, the auditor is responsible for being an advocate for the client. At the same time, the auditor reviews the company’s financial statements. However, due to their advocacy, they do not disclose any misstatements they find in the financial statements.
The safeguards for the advocacy threat are similar to the familiarity threat. Auditors can avoid it by segregating their teams for each task. In some cases, auditors may have to choose between representing the client or continuing audit engagements.
When auditors want to take up a new engagement or continue an existing one, they must ensure their independence and objectivity. However, there are several threats that may threaten them. These include self-interest, self-review, familiarity, intimidation, and advocacy threats. Auditors need to identify these to safeguard against them.