The Importance of External Auditor’s Independence

According to Gillespie, Lewis and Hamilton (2004:221) an audit is:
“a scrutiny of the accounts by a qualified auditor who carries out checks on the figures so as to establish whether the accounts show a true and fair view of the results and the financial position of the entity.”
According to Wikipedia (2011a), auditor independence refers to “an attitude of mind characterized by integrity and an objective approach to the audit process”. Independent auditing has been an important part of the corporate monitoring system since the mid-1930s, when it became a legislation requirement after the Great Depression. This was caused by reckless spending by corporations in the late 1920s (Kim,
Lehman Brothers’ auditor, Ernst and Young, has been accused of “malpractice”, “negligence” and “failure to exercise professional care” after they apparently “failed to raise alarm on the bank’s accounting practices” (Watkins, 2010). Ernst and Young were accused of knowing, supporting and advising Lehman on its “Repo 105” transactions which led to the ultimate collapse of the bank. These transactions were labelled as sales in order to make the bank look less risky than it actually was (Newquist, 2010). This just goes on to show the consequences of collaboration between external auditors and the firms they audit. In conclusion, we have established that it is critical for external auditors to be independent of the firms they audit. There are some key reasons for this. Firstly, it is a legal obligation for an external auditor to be independent. Failure to oblige could lead to massive fines, expensive court cases, jail time and ultimately the collapse of the auditing firm (like in the case of Arthur Andersen). Secondly, if external auditors are not independent of the firms they audit and overlook bad accounting practices; there is a relatively high chance that these corporations will become bankrupt when their “bubbles burst”. This would lead to large numbers of people being unemployed which is a negative thing as it could cause a recession or even a depression if too many firms in a