Independent Auditor Definition

What is an independent auditor?

An independent auditor is a accountant (CPA) or Chartered Accountant (CA) who reviews the financial records and business transactions of a company with which they are not affiliated. An independent auditor is generally used to avoid conflicts of interest and to ensure the integrity of the performance of an audit.

Independent auditors are often used, or even commissioned, to protect shareholders and potential investors from occasional fraudulent or unrepresentative financial claims made by public companies. The use of independent auditors became more critical after the implosion of the dot com bubble and the passage of the Sarbanes-Oxley Act (SOX) in 2002.

An auditor may perform a variety of auditing, tax, and consulting services for individuals, corporations, non-profit organizations, or government entities.

How Independent Auditors Work

An independent auditor works for an accounting firm or is self-employed. An auditor reviews financial statements and related data, analyzes business operations and processes, and makes recommendations on how to achieve greater efficiency. They assess the company’s assets for depreciation and appropriate valuation and determine the tax liability, ensuring compliance with tax code and laws.

The auditor develops an opinion affirming the reliability and fairness of clients’ financial statements, and then communicates the information to investors, creditors and government agencies. Additionally, an auditor may perform other audit, tax, and advisory services for individuals, corporations, non-profit organizations, or government entities.

Procedures for an independent audit

An independent auditor asks questions of management and staff for a better understanding of the business, its operations, financial reporting, internal control system, and known fraud or error. They can perform analytical procedures on expected and unexpected discrepancies in account balances or transaction categories, and then test the documentation supporting those discrepancies. The auditor also observes the physical inventory of the company and confirms accounts receivable (AR) and other third-party accounts.

Sarbanes-Oxley (SOX) Act

The Sarbanes-Oxley Act of 2002 was passed after Enron, WorldCom and several other technology companies went bankrupt due to accounting irregularities. SOX’s goal was to improve corporate governance and restoring confidence to corporate investors. However, many business players are against SOX, seeing it as a politically motivated decision resulting in loss of risk taking and competitiveness.

Many are concerned about the mandate requiring public companies to obtain independent verification of their internal control practices. The cost of the requirement is felt the hardest by companies with a market capitalization $75 million or more. Auditing standards were changed in 2007, reducing many firms’ costs by 25% or more per year.

Key points to remember

  • Independent auditors are certified or licensed public accountants who review companies’ financial statements and are not affiliated with the companies being audited.
  • Independent auditors have a mandate to protect shareholders and potential investors against possible fraud and accounting irregularities of a public company.
  • Business leaders can use the results of an independent audit to improve business processes.
  • Independent audits provide a clear picture of a company’s value, which helps investors make an informed decision when considering buying a company’s stock.

Benefits of an Independent Auditor

Despite the high initial costs of the internal control mandate, companies can reap many benefits from the independent audit process. Managers can use this information to continuously improve internal processes. Companies often find that over time internal control testing becomes more cost effective.

Additionally, markets use audit information to value companies more effectively. Audits provide a clear picture of a company’s value, which helps investors make an informed decision when considering buying shares in a company. Financial analysts and brokerage firms also rely on the results of an audit when making investment recommendations to their clients.

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