INDEPENDENCE OF AUDITORS: In Deep End

Journal of Eastern Caribbean Studies Vol. 27, No. 2, June 2002, pp. 55-79

Independence of Auditors: In the Deep End? A Barbadian Analysis * Philmore Alleyne Department of Management Studies University of the West Indies, Barbados This paper reports on an exploratory study of auditor’s independence in Barbados. Independence is a function of the mental attitude of auditors, and it affects their decision-making in resolving ethical dilemmas. The interviewees’ responses revealed important differences between the auditors and other audit report users in such important areas as the regulatory framework, longterm relationships, provision of non-audit services, independence in appearance versus fact, and the selection of auditors. The preliminary results suggest that whilst auditors and users alike are comfortable with the concept of independence, the reasons for this comfort are more complex. Key words: Barbados; Independence; Long-term relationships; Non-audit Services; Regulatory Framework.

Introduction The terms ‘independence’ and ‘audit’ have been used interchangeably for years. It has always been assumed or presumed that all auditors are independent for the credibility of audit reports to be maintained. It has been suggested that ‘the solution to this problem of credibility in reports and accounts lies in appointing an independent person called an auditor to investigate the report and report on his findings.’ (Millichamp 1996:2). Thus, the purpose of an audit is to express an opinion as to whether the

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The author would like to thank Emily Dick-Forde, Jose-ann Small and Roger Arthur for their kind support and assistance in completing this project. Special thanks is extended to the students of MS36A – Principles of Auditing for their assistance in the data collection phase of the research project. I would also wish to thank the anonymous reviewers for their constructive suggestions. Copyright © Sir Arthur Lewis Institute of Social and Economic Studies, UWI, (Cave Hill), 2002

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Journal of Eastern Caribbean Studies

financial statements are presented fairly or not. It is not only imperative for auditors to maintain an independent attitude in discharging their responsibilities, but it is also important that the users of financial statements have confidence in that independence. These two objectives are often identified as independence in fact and independence in appearance. Arens & Loebbecke (2000) explained that independence in fact exists when the auditor is actually able to maintain an unbiased attitude throughout the audit, whereas independence in appearance is the result of others’ interpretations of this independence. If the auditors are independent in fact, but users believe them to be advocates for the client, most of the value of the audit function will be lost. This paper reports on the outcome of a research project which explored the auditors’ and users’ response to auditor independence in Barbados. The primary focus is the statutory audit of financial statements and aims to discover what practitioners are doing when attesting to the truth and fairness of financial statements. The audit process is influenced by human behaviour, and independence is critical to the audit process, since it engenders public trust in auditors. Therefore, it is necessary to seek to rationalise human behaviour by introducing social theories such as cognitive perspective, human psychology, consequentialism, deontology and Gidden’s theory of structuration. The remainder of this paper looks at the applicability of the concept of independence in a small society like Barbados through the use of interviews held with auditors and audit report users. Experiences, concerns and opinions on a range of issues related to auditor independence, and conclusions and recommendations are offered. The Regulatory Fram ework The evolutionary development of the concept of independence during the early 1900s culminated in the formulation of Generally Accepted Auditing Standards (GAAS) in 1947. The rationale for the importance of independence in appearance has been present since 1963 when statements in auditing procedures were codified with standards. M ost national accounting bodies outline proper ethics for their members. For example, the Institute for Chartered Accountants in England and W ales (ICAEW ) and The American Institute of Certified Public Accountants (AICPA) stressed the need for integrity and objectivity in all professional and business relationships (ICAEW, 1997; AICPA, 1988). Statutory approval has been

Independence of Auditors: In the Deep End

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given by the Companies Acts that require auditors to be independent to show a ‘true and fair’ view of the accounts. Section 27(1) of the United Kingdom (UK) Companies Act 1989 require that: A person is ineligible for appointment on the ground of lack of independence if he is an officer or employee of the company, or a partner or employee of such an officer or employee or, in the case of the appointment of a partnership, if any member of the partnership is ineligible on these grounds. And he is also ineligible if any of these grounds apply in relation to any associated undertaking of the company. (Davies et al., 1997:540) Several other factors that are likely to affect the users’ perceptions of the auditor’s independence include the ownership of a financial interest in the audited client, directorship or being an officer of an audit client, performance of management advisory or bookkeeping or accounting services and audits for the same company, dependence upon a client for a large percentage of audit fees and loans between an audit firm or its members and an audit client. Audit literature has highlighted the controversy over auditor independence and the ability of professional bodies to serve the public and their members’ interests, thus creating the ‘expectation gap’ (Porter 1993; Humphrey 1997). Brief Historical Review Over the years, business failures have heightened the awareness of independence by users. Questions have been asked and fingers pointed when businesses have gone bankrupt and investors have lost their money. Were the auditors performing their job honestly and properly? Were they independent? Cases such as The Lincoln Savings and Loans collapse in the United States (US) and the Bank of Credit and Commerce International (BCCI) debacle worldwide illustrated the consequences of business and audit failures. For example, the Lincoln Savings and Loans demise cost the US government US$150 billion, and a high undisclosed sum in lawsuits against audit firms. In the BCCI case, Truell and Gurwin (1992) stated that: In a report issued in December 1991, they estimated BCCI’s total liabilities at $10.64 billion and its realisable assets at $1.16 billion.

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In other words, a staggering $9.48 billion has vanished through a combination of mismanagement and fraud (pp. 391-392). Furthermore, the credibility of the auditors, Price Waterhouse, received such a battering that: The US Senate’s investigation of BCCI alleged that auditor independence was compromised because auditors received loans, financial benefits, housing and other benefits from the bank (Sikka 1997:138). Recent Developments The most recent violation of independence was The Price Waterhouse Coopers (PWC) scandal in the United States. The March 2000 issue of the CPA Journal reported that: In January 1999, the Securities Exchange Commission censured PriceWaterhouseCoopers for violation of auditor independence rules and improper professional conduct… Almost half of the firm’s 2,968 partners self-reported at least one independent violation, with an average of five violations. Of 8,064 reported violations, 81.3 per cent were reported by partners and 17.4 per cent by managers. Almost half of the reported violations involved direct investments by the professional in securities, mutual funds, bank accounts or insurance products associated with a client. PWC insisted that while appearance-based rules may have been overlooked in some cases, at no time was independence in fact compromised. There was no evidence available to suggest that audit quality actually suffered as a result of the alleged violations. However, the auditors ought to have known better that independence in appearance was equally required as independence in fact. Recently, professional accounting has faced considerable economic pressure. The low profitability of traditional audit services has forced the auditors to generate further revenue in other ways such as consulting, taxation, specific investigations and information technology, to name a few. Some firms offered free audits in the hope of picking up more lucrative


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consultancy work (Sikka 1997:138). There has been a major concern that an auditor would be hesitant in qualifying the audit report of a client who pays substantial fees for audit and non-audit services. In a response to issues concerning independence violations, on November 15, 2000, the Securities Exchange Commission (SEC) adopted revised auditor independence rules (effective February 5, 2001), requiring proxy statement disclosure of all audit and non-audit fees paid by a firm to its auditors. The SEC believes that the high percentage of revenue auditors derive from the provision of non-audit services poses a threat to auditor independence (Nelson et al., 2001; SEC, 2000). The rule will restrict the amount and nature of work done by auditing firms for clients and will require that the audit committees of corporate boards consider whether nonaudit services are consistent with maintaining auditor independence. At the time of the writing of this paper, the United States (US) Justice Department was pursuing a criminal investigation of Enron, which filed for bankruptcy on December 2, 2001 and became the biggest corporate bankruptcy in US history. Kadlec (2002), writing in Time Magazine of January 13, 2002, reported that Enron had suffered a stunning $618 million loss for the third quarter of 2001 and its auditors, Arthur Andersen, had directed its staff to destroy all audit material, except for the most basic ‘work papers.’ Furthermore, Enron had paid Arthur Andersen $25 million for its audit last year and $27 million for consulting and other services, and this led one industry analyst to ask ‘How can any auditor be independent when his client is paying this kind of money?’ Current Societal Concerns The auditor’s role and performance of his duties must be looked at in the socio-economic environment within which he operates. In all societies, individuals need to feel they belong, have a sense of camaraderie and large familial ties (Lewis 1983; Haralambos et al, 2000). To be independent and report negatively on influential individuals within that society may render one as anti-social. In addition, auditors have a ‘dependency syndrome’ since their tenure, fees and livelihood depend on client’s satisfaction. In a competitive society, pressures are exerted on fees, and auditors are usually faced with the moral dilemma of issuing an audit opinion desired by management as opposed to the correct and appropriate one.

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Many clients expect that the auditor’s role and responsibilities are similar to those of the lawyer. The lawyer is engaged and paid by the client and his primary responsibility is to be an advocate for that client. The lawyer defends his client to the bitter end, even if he has to spend time in prison or withholds vital information. He is expected to look after the client’s interest at all costs. The auditor’s role is different in that he is engaged and paid by the company but the primary beneficiaries are the users. However, the determination of independence is the problem. Oliverio (1999), quoting Bazerman, Morgan and Loewenstein, concluded that: Independence remains a problem for even the most moral, honest auditor. Despite the auditor’s best efforts to place the external users’ interest 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 (Oliverio1999:1). The aim is to keep the client. Oliverio aptly summed up the main considerations that influences the auditor’s behaviour by relating the following: At a meeting of auditing professors in Providence, Rhodes Island in the mid 1990s, for example, a partner in a major public accounting firm stated candidly and clearly that ‘you academics are crazy - of course, we give the clients what they want’ (Oliverio 1999:11). Theoretical Ethical Perspectives The auditor is required to express an opinion on the financial statements as to whether they are presented fairly or not. It is assumed that he is independent and acts honestly. Independence is a function of the auditor’s mental attitude, and one must look at the various factors which influences the auditor’s behaviour to determine whether his psychological make-up allows him to be objective, honest and independent, if not at all. In his chapter on Independence, Peter Moizer argued that: …it can be seen that the directors of a company effectively determine the size of the audit fee. The word ‘effectively’ is used


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because, strictly, a company’s shareholders appoint the auditors and approve their remuneration, but in practice the shareholders merely rubber-stamp the recommendations of the directors. Hence if the auditors conclude that the financial statements do not show a true and fair view and qualify their audit opinion, they know that there is a possibility either of losing the audit or of having their fee reduced. There is also a sense of loyalty that is built up between an auditor and the managers being audited. An auditor may be reluctant to jeopardise the career of a manager who is a personal friend (Moizer 1997:55-56). An ethical conflict emerges whereby the auditor is hired and paid by the client but the auditor is required to act independently in the discharge of his duties. Independence in appearance is determined by rules about prohibited financial and familial relationships between auditor and client. While, independence has been legislated, it has proven more difficult to enforce. Section 27 of the UK Companies Act outlined the factors where an auditor may be deemed not to be independent, and Sections 390 and 391 further served to protect the auditor with the right to be heard at general meetings he attends and to comment on any resolutions to remove him. While these guidelines are statutorily given to enhance objectivity, they are rarely followed in practice, since there is no auditor or any professional who would wish to continue to hold office and be at odds with the client at the same time. Reiter and Williams (1999) identified the essential problem by quoting John L Carey and William Doherty who stated: In the literal sense, it is unrealistic to assume that anyone can attain absolute independence. No human being can free himself from all outside influences from his environment, in effect. No one, except a hermit, can avoid the influences of his family friends, what he reads and hears, and the attitudes and standards of his community (Reiter and Williams 1999:11). From the above, it is clear that sociological and philosophical issues influence the behaviour of auditors, and the position advanced by behaviouralists needs to be considered.

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Consequentialism vs. Deontology Moizer (1997) puts forward two types of ethical reasoning such as consequentialism and deontology. In consequentialism, actions are judged in terms of consequences that result, and focuses on the doctrine of ‘the end justifies the means.’ Moizer argued that the consequentialist (auditor) will ponder on the consequences of giving a ‘going concerns’ qualification or adverse opinion when there is a possibility of the client being put into receivership or liquidation. Therefore, auditors who are concerned about the consequences of their actions may, at times, report in a dishonest way because the course of action taken will bring the ‘greatest happiness to the greatest number’ or about the consequences to him. In contrast, in deontology, the assumption is that some acts are morally obligatory regardless of their consequences (Flew, 1979). The auditor may adopt the deontological position that it is wrong to report in a dishonest fashion (Moizer 1997:57). Cognitive Perspective Cognition includes all the mental processes by which people become aware of and gain knowledge about the world. Thus, the cognitive perspective centers around the individual’s learning and its influence on the morality of decisions made and actions taken. The argument here is that the auditor, being free to think and act independently, would invoke his notions of fairness in judging what is right or wrong when facing a conflict situation. The cognitive perspective treats ethical reasoning in a simplistic manner and ignores powerful contextual factors that could influence the auditor’s ability to make moral decisions (Dillard and Yuthas, 1997, p.5). The auditor’s ability to maintain complete independence does not only rely on his cognitive development but also the effect his opinion will have on users (consequentialism). Furthermore, cognitive perspective fails to take into account the social structures which may influence the auditor’s decisions. Hence, the concept of structuration is introduced for examining ethical decision making. Structuration Theory Structuration theory, formulated by social theorist, Anthony Giddens (1984), assumes that human agency and social structures are related to each


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other, in a way, that the structure is the basis for individual actions and the acts of individual agents reproduce the structure. Therefore, structures are roles, rules and resources organised as properties of social systems which guide and provide the context for human agency as role-taking and normfulfilling through reproduction and transformation (Giddens 1984; Cohen 1987). Structuration identified three major social structures such as signification, domination and legitimation which looked at the system of rules of behaviour and rewards, codes of ethics, monitoring and imposition of sanctions to ensure proper ethical behaviour (Dillard and Yuthas 1997). In the audit field, accounting bodies and institutions such as AICPA, CGA, ACCA and ICAEW were structures created to encourage ethical behaviour. Barbados Barbados has a stable political system, and a small, open economy with the key productive sectors of tourism, agriculture, manufacturing and offshore financial services. The rapidly expanding offshore financial services sector has shown the country’s ability to attract foreign investment. Investor’s confidence is maintained by a knowledgeable and adequate accounting profession. The success of the economy is driven, inter alia, by a plethora of businesses of varying sizes which have to rely on auditors to give sound professional opinions. Barbados has always been influenced by the practices of the developed countries. Prescod (1996) argued that this influence has caused the independence concept to be culturally transmitted through the structure of professional associations. Members of professional bodies are obliged to comply with the rules of conduct of their professional bodies which are foreign models from USA, Canada and the United Kingdom. These models which have not been clearly defined in concept (especially independence) in the countries of origin, have been adopted without regard to local conditions. Furthermore, a significant portion of the economic base is controlled by a minority of individuals of European and Indian descent. The European descendants comprise about 4 per cent of the Barbadian population and control about 22 per cent of the big businesses (McClean & Cummings 1994). There is the potential that auditors’ ability to acquire and maintain clients can be threatened if one of the powerful economic groups blacklists them. The auditor is therefore under tremendous pressure to capitulate to or at

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least accommodate some of the demands of management and directors. He has to be concerned not only with possibly losing audits if this company is part of a conglomerate group. In light of the multiplicity of interlocking directorates amongst certain groups in Trinidad and Tobago, losses of the audits of other companies on whose boards an aggrieved director may sit are also quite possible (Prescod 1996:16). Therefore, the influence of powerful groups can alter structures in such a way that new moral forms and ethical behaviour develop. It is against this background, Barbados has been considered as an ideal case for consideration. Research Design This research was designed to determine the similarities between the perceptions of auditors and audit report users with respect to the audit issues of regulatory framework of auditors in Barbados: independence in fact versus appearance, long term relationships, provision of non-audit services, and criteria for the selection of auditors. In the Barbadian context, auditor independence is concerned with the safeguarding of auditor’s integrity against powerful pressure groups that are in a position to influence the auditor’s judgement and subsequent reporting. This research project is very much an exploratory study into whether or not auditor’s independence exists in Barbados. As a first step, a qualitative analysis was conducted using a semi-structured interview schedule which was developed based on the audit issues outlined above. The data collection methods available were either to use face-to-face interviews, mail questionnaires or telephone interviews. The telephone interview was considered a lengthy process. Given the sensitivity of the topic, the response rate of mail questionnaires was expected to be low (McDaniel & Gates 2001:177). Therefore, face-to-face interviews were selected as the main research method because of the likelihood of a high response rate and the need to discover underlying motivations, feelings, values, attitudes and perceptions about auditor independence. Each interview lasted from one to two hours and interviews were undertaken from March to November 2000. The initial target for this study was 100 auditors and 100 audit report users. The final response comprised 72 auditor and qualified accountant respondents, of which, at least three audit partners plus three audit managers were drawn from the major


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accounting firms, and the individual practitioners; and 42 audit report user’ respondents which included managers, bankers, credit unions, investors, lawyers and members of the general public. Interviewees were asked to comment about their personal experience and interests and about the experience and policy of their firms, where applicable. Those interviewed are not intended, or claimed, to comprise a representative sample of auditors or audit report users. Presentation of Findings Regulatory Framework of Auditors in Barbados The Institute of Chartered Accountants of Barbados (ICAB), incorporated in 1974, is the regulatory body for the accounting profession in Barbados. Its objectives include the regulation of ethics, discipline, professional conduct and standards of its members. The Institute is a member of the International Federation of Accountants and all of its members are members of other recognised accountancy bodies, primarily in the United Kingdom, United States of America and Canada. Under Section 153 of the Barbados Companies Act, individuals can generally qualify for appointment as auditor of a company if they are a member of the Institute and hold a practicing certificate or are, for the time being, authorised by the Minister of Trade to be appointed as an auditor. The Institute has adopted International Accounting Standards and International Auditing Guidelines. As of December 2001, ICAB had a membership of over 500 fully qualified chartered accountants, of which 162 persons held practicing certificates to audit. ICAB’s member’s handbook stressed the need for independence amongst its members, by stating that: A member in public practice should be, and seen to be, free in each professional assignment he undertakes, of any interest which might detract from objectivity (Section B.2.02 Professional Independence). The Barbados Companies Act is similar in most respects to the UK Companies Act and is very clear when it sets out in Section 154 (3) that an auditor is presumed not to be independent if he is a partner or director, or officer of the company, owns or control shares in the company or is a receiver or liquidator of the company. Any breaches of independence may

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be viewed seriously, and as such the ICAB Members Handbook, Section B.1 General, item 13 supported this by stating that: The Disciplinary Committee, determines whether the facts in question constitute misconduct, and if necessary, decides upon appropriate disciplinary measures against the member. These disciplinary measures may be exclusion from or suspension of membership, withdrawal of practicing certificates or other forms of censure. In the context of the present discussion, it would appear that the relevant authorities (structures) were unanimous in their pronouncements for auditors to be independent. There is a small, full time secretariat of two persons servicing the administrative needs of ICAB. None of the Council members or Committee members are full-time, and consequently, there is a ‘thinness’ of resource base available for administration of the type envisaged by the Incorporation Act (Prescod 1996:35-36). The Code of Ethics and rules are in place but the machinery to administer the local profession is inadequate. ICAB is responsible for setting guidelines for the accounting profession in Barbados, and as such, should be in the forefront on regulatory matters. It is interesting to note that about 26 per cent of the users were unaware of ICAB and its functions. Furthermore, about 22 per cent of the auditor respondents believed that ICAB ‘sits on the fence’ on many issues. The fact that there have been no publicised or known cases of censure by ICAB, in Barbados, has led one auditor respondent to conclude that :‘…either there have been no cases of professional misconduct by auditors, or none have been publicised or known, or there is a reluctance to discipline members.’ In fact, no member has ever been brought before the Disciplinary Committee for not acting independently. One Council Member of ICAB agreed that: ‘There have been no concerns expressed publicly by users of reports over the past three years. No members have been brought before the Disciplinary Committee during the same period that I have been on Council. There are adequate safeguards in Barbados to ensure the


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independence of auditors. However, I cannot recall these safeguards being tested through litigation, since Barbados is not a very litigious society in the professional sphere.’ The closest that the local audit establishment came under scrutiny was when the government launched a major commission of inquiry (Worrell Commission) into the collapse of Trade Confirmers Limited, a financial institution in the 1980s as a result of suspected management fraud (The Daily Nation, July 21, 1989). There was no actual litigation brought against the auditors or management in this case. Another auditor pointed out that: ‘Most users of financial statements in Barbados are not fully informed of the legal liability which auditors possess, and as a result, auditors are not sued. If something is done wrong, the current auditor is replaced by another.’ It would appear that the Institute has taken the similar position of its counterpart in USA, that is the AICPA, in not regulating its members. The AICPA preferred the SEC to do its laundry. Independence in Fact vs. Independence in Appearance The auditor respondents indicated that their firm or practice or organisation, where applicable, were independent in fact and that the profession was responding favourably to the needs of the society and that is why there has not been too much criticisms. One auditor respondent argued that: ‘In this small society, everybody knows everybody. Although independence is difficult to completely maintain, it is still the duty of each auditor to ensure that the auditor-client relationship is an independent one. Auditor independence is applicable in any environment regardless of its size.’ However, it was the auditors who viewed their perceptions of independence as of paramount importance. For example, a question was raised as to whether there was knowledge of any single client that had significant influence in terms of fees over the firm. An immediate response

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from an audit partner was that: ‘The reality is, there are some clients who account for a significant percentage of our revenue. However, when hired by them to engage in an audit, we are performing an audit for the users of the financial statements, and in this case, there is no bias involved since the reputation of our firm must be maintained to avoid any speculation.’ This position runs counter to the professional accounting bodies’ requirements. The international position is set out in section 4.2 of the Guide to Professional Ethics issued by ICAEW instructing members that an auditor: ‘….SHOULD NOT accept an audit appointment or similar financial reporting assignment from any entity which regularly provides him or an office within the firm with an unduly large proportion of his or its gross practice income’ (ICAEW, 1997:183). An unduly large proportion would normally be 15 percent. In contrast, ICAB’s Members’ Handbook, at items 4 and 5 of the general explanatory notes, stated: 04. When the receipt of recurring fees from a client or group of connected clients represents a large proportion of the total gross fees of an accountant in public practice, or of the practice as whole, the dependence on that client or group of clients may come under scrutiny and raise doubts as to objectivity. 05. It is not intended to give precise guidance on the proportion of fees which should come from one client or a group of connected clients. However, if such fees are the only or the substantial part of the gross income, the accountant should carefully consider his position. Allowances will be made for new practices seeking to establish themselves, practices which are winding down operations, or for a branch office which is reliant upon one client or group of connected clients. While the ICAEW stressed ‘should not,’ ICAB mentioned that ‘the accountant should carefully consider his position.’ ICAB’s position is open


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to the auditor’s own interpretation and self-regulation which supports the cognitive and consequentialist views. ICAB as a structure should be more forceful in its settings of rules. The major international firms were found to be duty-bound to comply with their international affiliates who required set procedures to ensure compliance with proper professional conduct. A determination or declaration of interest is required on engagements and strict rules were put in place. Of particular concern was the fact that the sole practitioners did not have these procedures in place, given their size. The sole practitioners have countered this argument by claiming that independence was based on their maintaining an independent mental attitude and acting ethically. The findings further revealed that all of the respondents agreed that a partner or a manager of an audit firm should not hold shares in or sit on the Board of Directors of an audit client, as this was forbidden. For example, one of the major accounting firms had the following measures (structures) in place to prevent the compromise of independence: 1.

2. 3.

4.

The firm should not take on the audit engagement of a client where the partner, and/or his immediate family (being spouse, children or other dependents) (trusts are not specified) have a financial interest (for example, owning shares) in that client. An auditor providing consulting services for a company is not allowed to participate in the audit of that same company. Where the immediate family of the partner, manager or other audit staff are employed in client companies, the partner, manager or audit staff would be excluded from the audit. No one company may contribute more than a specified amount (15 per cent) of revenue to the audit firm thus ensuring that they are not financially dependent on any one company.

At partners’ meetings, issues concerning independence are discussed and resolved, with members having to declare any interest in the client. This was commendable in light of the prescriptions of the profession’s code of conduct. Provision of Non-audit Services The auditor respondents did not hesitate to point out that they did not have a problem with the provision of non-audit services. All of the auditing

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firms and practitioners approached, admitted that they offered other services to their clients. These services included tax planning, real estate agency, corporate services, information technology (IT) and other management advisory services. All respondents viewed these services as being necessary and did not believe that the provision of these services violated independence. In response to this, some have created ‘chinese walls’ by departmentalising services within the firm, thus creating a mental separation between the audit and consulting functions of the firm. One user pointed out that where auditors performed both the bookkeeping and attestation services for the same client, it may be construed as a case of the auditor auditing himself. A partner of a major audit firm countered that: ‘Non-audit services and the audit of the financial statements are performed by different individuals at different times. Clients expected a total package and considered that their auditor was in the best position to advise them.’ In general, the users agreed that they did not have a problem with their auditors performing non-audit services. Internationally, it was argued that most firms used the audit as a loss leader to provide the more lucrative services of consulting and that the practice of ‘lowballing’ (the auditor charges a low fee to get the client) was prevalent. This practice could influence the independence of the auditor, and certainly affect his ability to spend the time in performing a proper audit within the budget. Worldwide, the major firms have responded, with some degree of hesitancy, to separate out their consulting practices to conform with the regulatory bodies. In Barbados, audit practitioners were not in favour of giving up their consultancy services. However, the Securities Exchange Commission has recently prescribed strict guidelines in the audit of international companies listed on the Stock Exchange. For example, the processing of payroll and provision of bookkeeping services by the auditors were forbidden. Long Term Relationships Auditor respondents did not see anything wrong with having longstanding relationships with audit clients. They felt that the duration of their tenure provided them with a good knowledge of the client’s business


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which was in keeping with generally accepted auditing standards. Firms felt that they had necessary structures in place to preserve independence such as rotating their audit staff or partners to give a fresh approach. In one firm, clients are rotated between partners periodically. For publicly traded companies, the time-frame is every seven (7) years and for private companies, the time span is every ten (10) years. The radical position of the United States and Europe of rotating firms was not preferred by any of the interviewees. Potential loss of revenue and high costs of recurring ‘first audits’ were cited as reasons for no mandatory rotation of firms. Whilst all user-managers felt that the long term relationship was no problem as they wanted to feel comfortable with their auditor, the userinvestor group felt that this air of familiarity did not augur well for the protection of their investments. One manager at a leading audit firm contended that: a close professional relationship is like a two-edged sword. On the one hand, it facilitates the enhancement of the auditor’s knowledge of the client’s business, thus improving the quality of the audit. On the other hand, close clientele relationships tend to impair the users’ perception of the auditor’s degree of independence. Several interviewees felt that the size and closeness of the Barbadian society placed auditors in a difficult position because of competition amongst audit firms to acquire new clients and keep them. It was pointed out that it is quite possible that in cases where independence has been compromised they have gone unreported. In such a case, the offended party may be contented to acquire the services of another auditor to provide the desired opinion. Criteria for Selection of Auditors Respondents agreed that audit services are normally tendered out. Table 1 below shows the contrasting views of the auditors and audit report users in choosing one another:

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Table 1: Criteria given for the Selection of Auditors and Clients Auditor Respondents Reputation and integrity of the client Concerns about legal liability Client’s ability to pay its bills, including audit fees

Audit Report Users Reputation of the audit firm Size and Capacity of the audit Experience in the industry Familiarity with the auditor through fraternities, social clubs and as old schoolmates The nature of the business

It was interesting to note that independence was not mentioned as part of the criteria. It is presumed that independence is taken into consideration since it is enshrined within the profession’s Code of Ethics. Overall, there was a feeling that auditors were professional and competent. General Perceptions on Independence Both users and auditors were asked to express their views on the applicability and relevance of independence in Barbados. The Financial Controller of a public limited company pointed out that: ‘Auditor independence does indeed exist even within a small society and that it was up to the auditor to exert a certain level of professionalism not only to sustain his independence but also to provide him with some sort of competitive advantage within his field. After all, it is important for us to have a credible opinion on our financial statements.’ However, the difficulty of auditor independence was shown by an auditor’s response that: It is good in theory since it should lead to objectivity and credibility of the auditor’s opinion in practice, but it will not be successful in a small open economy, where competition among audit firms of all sizes take place and furthermore, wages, salaries and other expenses


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have to be paid. The above contrasting views clearly demonstrated that a gap does exist between users’ expectations and auditors’ performance. It was also agreed that many clients are small in nature and cannot sustain independent professional services and as such the auditor at times have to ‘wear several hats,’ thus creating synergistic benefits. Furthermore, questions were raised with respect to partners of the audit firm and clients socialising on golf courses and dinners under the guise of entertainment. Auditors’ and clients’ representatives were comfortable with this issue of socialising since it served the twofold purposes of promotion and getting to know the client better. However, some of the general public raised eyebrows at this revelation by stating that whereas the auditor may be independent in fact, however, he certainly would not be independent in appearance. Recommendations This section addresses the above concerns by putting forward recommendations which should create confidence in the auditing profession. Peer Reviews Peer Reviews were one of the most recommended measures. The peer review would check that the original audit firm had performed all the audit work that was necessary and that all significant errors and omissions had been corrected or disclosed in the audit report. The audit work should be reviewed by another person who has not been involved in that particular audit. The review could be another partner within the same office of the firm of auditors or perhaps a partner from another office. In addition, several interviewees recommended that ICAB appoint a board or committee of auditors with the sole responsibility to routinely review practising auditors’ files. The overriding question was ‘who will bear the costs of the review: the client or the auditor?’ These interviewees suggested that the answer was simple: it should be the auditor since he has more to gain from this exercise. Several auditors, including the small practitioners, were not in favour of this proposal and cited cost as the main factor.

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Seminars and Training Programmes ICAB needs to provide ongoing seminars and training programmes to make members aware of proper professional conduct. The existing programmes did not cater for such. Members were of the view that mere attendance at some seminars is purely satisfying ICAB’s requirement in continuing professional education. Some of the topics had little or no bearing on enhancing or maintaining their professional capability. A comment was noted to the effect that these seminars provided an avenue for ‘getting away from the office.’ Independence Standards Committee An Independence Standards Committee with a diverse representation of users and auditors should be created to regulate the audit profession effectively and efficiently. Institutional Strengthening of ICAB ICAB’s secretariat needs to be funded and staffed more adequately so that it can better regulate the activities of its membership. It was felt that the level of volunteerism that obtains, do not permit an efficient and effective running of operations. A full time manager needs to be appointed, with the task of implementing programmes, proposed by Council, to carry the profession forward and responding quickly to needs of members. The current feeling amongst members is that Council is reactive rather than proactive, and the regulation of ICAB’s affairs usually took a backseat to the personal and business affairs of Members of Council and other Committees. The funds (cost) of this proposed institutional strengthening could come from membership and be allocated to membership on a basis relative to the size of the firm. Education of Users Users of financial statements should be educated on the responsibilities of auditors and the need for independence, per se. Audit interviewees felt that if management was fully cognisant of the implications of independence, potential conflict would be more easily resolved. Majority of users


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interviewed knew about auditor independence but did not deem it necessary to apply to their circumstances. One interviewee observed that ‘the only Independence in Barbados was November 30, (being Independence Day).’ Audit Committees The employment of an audit committee is another extensive way of ensuring independence. An audit committee includes executive and nonexecutive directors and exists to provide a ‘bridge’ between management and the external auditor. Most interviewees felt that an audit committee would assist in resolving issues. Furthermore, companies should ensure that persons with relevant audit experience should serve on the audit committee. Management Advisory (Non-audit) Services It is recognised and accepted that all audit firms will wish to provide non-audit services. However, the prescriptions of the Securities Exchange Commission in USA, and the related impact on the major accounting firms separating out their consultancy services from the audit practice, will serve as guidelines for Barbados. In addition, in the same way that there is full disclosure by directors required by the respective Companies Acts, financial statements should disclose information concerning fees for audit and nonaudit services, length of audit relationship and any familial and financial interest in the client by the auditor for the user to determine the degree of independence. There should be a focus on avoiding dependence. Rotation of Auditors Many critics have suggested mandatory rotation of auditors to combat the compromise of independence which is created by long term relationship. The accounting profession has countered by saying that mandatory rotation is too expensive and will, in fact, increase the number of audit and financial reporting failures. In a study on mandatory rotation, preliminary evidence suggested that neither side had compelling evidence to support its position (Walker et al, 1998). Recently Spain and Italy have experimented with mandatory rotation. In any case, the local accounting profession will not undertake this proposal. To this end, a compromise needs to be brokered. It is recommended that audit staff be rotated from time to time, in order to

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bring a fresh approach to the engagement. Conclusion In large societies such as the USA, the notion of independence in the audit profession is a critical issue. Within small communities such as Barbados, the concern about independence within the audit profession grows in significance. The alternatives may be even fewer than those available in the more developed societies. Whereas in the USA, there is a choice among a large population and many states are separated by large distances, the options in Barbados are fewer with all of its approximately 265,000 inhabitants living within 166 square miles. The concept of the auditor’s independence within Barbadian society may best be analysed bearing in mind the thinking embodied in a paper published by Frederick E. Nunes, entitled ‘The Nonsense of Neutrality,’ which examined the role of public servants vis-à-vis the political directorate in the Caribbean. Nunes made the point that, in small closely- knit Caribbean societies where there are vested interests to protect, it is impossible to act in a neutral manner (Nunes 1976). What may be pertinent in looking at the independence of the auditor in Barbados is: ‘What is an acceptable level considering the inter-connectivity of the Barbadian Society?’ The guidelines of this framework impose an onus on the auditor to ensure that any evaluation and subsequent action should be supported by evidence collected before accepting the engagement or even whilst the engagement is being performed. Within this framework, independence would only be impaired where the auditor knows or could reasonably be expected to know of situations or relationship that could compromise independence. Moizer (1997) aptly illustrated from Southey’s life of Nelson, Chapter 7, that ‘In 1801 at the Battle of Copenhagen, when Lord Nelson put his telescope to his blind eye to avoid seeing the signal commanding him to withdraw his ships from battle, he was reported as saying, ‘I have only one eye—I have a right to be blind sometimes ¼ I really do not see the signal.’ (p. 56) Is this the appropriate position to be taken? The answer should be ‘no.’ It is assumed that the profession is in agreement with this answer. Auditors should always be objective and honest, and be fully cognisant of the effect of independence, or the lack thereof. The key factor in auditor effectiveness is the mindset of the auditor making the decisions.


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Paul F. Williams in ‘Accounting and the Moral Order: Justice, Accounting and Legitimate Moral Authority’ pointed out that: Most professionals e.g. physicians are expected to know their expertise and to also know its limits. The first ethical norm of the physician is to do no harm. Can the same be said for accountants? (p. 18) A limitation of the study should be mentioned before any definite conclusions are drawn and extrapolations are conducted. The analysis involves the comments of those individuals and organisations chosen. It cannot be concluded that these views represent a systematic sample of the population who are affected by independence. As a result, in a sense, a certain degree of non-response and other biases are certain to exist. However, since a major focus of the study is the investigation of the degree of independence, this is not viewed as a serious constraint on the validity of the findings. Given the exploratory nature of the research and given that this research constitutes uncharted ground for Barbados, this research can be used to generate hypotheses for further study. The interviews revealed a gap, which is known as the audit expectations gap, in perceptions between auditors and audit report users. It would be interesting to conduct future research and examine in more detail the gap identified. In conclusion, the preliminary evidence suggests that auditors and users alike are comfortable with the concept of independence and the practice of auditors in Barbados. However, it is customary that comfort can produce inadequacies and inefficiencies of poor audits. The regulatory bodies have to ensure and insist that the highest standards of service are maintained. Given the international concerns, these findings raised important issues as to the relevance of the local practice to the international arena. Submission date: June 2001 Accepted for publication: January 2002 References AICPA. (1988). Code of Professional Conduct. New York: American Institute of Certified Public Accountants. Arens, A.A., Loebbecke, J.K, Elder, R.J., and Beasley, M. S. (2000). Solutions Manual Auditing:An Integrated Approach. New Jersey: Prentice Hall.

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Arens, A. A. & Loebbecke, J. K. (2000). 8 th ed. Auditing: An Integrated Approach. New Jersey: Prentice Hall Barbados Companies Act, Cap 308 L.R.O. (1985). Edited, Division G: Financial Disclosure. Bradshaw, W illiam. (1989). ‘Trade Confirmers Report’. The Daily Nation. July 21. p. 10. Cohen, Ira J. (1987). ‘Structuration Theory and Social Praxis’. In Anthony Giddens and Johnathan H. Turner (ed.). Social Theory Today. UK:Polity Press, pp. 273308. Davies, Paul L. and Prentice, D. D. (ed.). (1997). 6 th ed. Gower’s Principles of Modern Company Law. London: Sweet & Maxwell. Dillard J. F. and Yuthas, K. (1997). ‘Ethical Audit Decisions: A Structuration Perspective.’ Paper presented at Interdisciplinary Perspectives on Accounting Conference on July 7, 1997. Available from: http://les.man.ac.uk/ipa97/papers/dillar83.html. Flew, Antony. (ed.). (1979). A Dictionary of Philosophy. London: Pan Books Ltd. Giddens, Anthony. (1984). The Constitution of Society. Berkley: University of California Press. Haralambos, M & Holborn, M. 8 th ed. (2000). Sociology Themes and Perspectives. London: Harper Collins. Hendrickson, H. ‘Accounting Ethics Sacrificed for the Myth of Auditor Independence: Let’s Amend or Abandon the Debilitating Myth.’ Paper no. 6015 presented at Critical Perspectives on Accounting 1999 Conference. Available from: http://panopticon.csustan.edu/cpa99/html/Hendrickson.html. Humphrey, C. (1997). ‘Debating Audit Expectations’, in Michael Sherer and Stuart Turley (ed). Current Issues in Auditing. London: Chapman, pp. 1-30. Institute of Chartered Accountants in England and W ales. (1997). Members’ Handbook. Volume 1, London: ICAEW . Jamaica Companies Act 1967. Kadlec, Daniel (2002). ‘W ho’s accountable?’ Time Magazine. 13 January, pp. 1-6. A vailable from : http://www .tim e.co m /tim e/b usiness/article/ 0,8599,193520,00.html. Lewis, Philip V. (1983). Managing Human Relations. Massachussets: Kent. McClean, M. P. & Cummings, D. A. (1994). ‘Entrepreneurship in Barbados: A Preliminary Investigation’. W orking Paper. St. Augustine: Institute of Social and Economic Research, University of the W est Indies. McDaniel, C. and Gates, R. 3 rd (ed.). (2001). Marketing Research Essentials. Ohio: South Western College. Millichamp, A.H. (ed.). (1996). Auditing, 2 n d ed. London: Letts Publishing. Moizer, Peter. (1997). Independence, in Michael Sherer and Stuart Turley (ed).: Current Issues in Auditing. London:Chapman, pp. 55-69


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Nelson, K. F., Johnson, M. F. & Frankel, R. M. (2001). ‘Auditor Independence and Earnings Quality.’ Paper no. 1696R, Graduate School of Business, Stanford University. Available from: http://gobi.stanford.edu/ResearchPapers/Library/ RP1696.pdfl. Nunes, Frederick. E. (1976). ‘The Nonsense of Neutrality.’ Social and Economic Studies, 25(4):347-366. Oliverio, Mary Ellen. (1999). ‘Auditor Independence: Is It Impossible?’ Paper no. 6018 presented at Critical Perspectives on Accounting, 1999 Conference. Available from: http://panopticon.csustan.edu/cpa99/html/oliverio.html. Porter, B. A. (1993). ‘An Empirical Study of the Audit Expectation-Performance Gaps.’ Accounting and Business Research, 24(93):49-68. Prescod, Lennard. (1996). ‘True and Fair View’: A Confused Notion in West Indian Financial Reporting. London: ACCA. Reiter, S.A and P. F. W illiams. (1999). ‘The History and Rhetoric of Auditor Independence Concepts’. Available from http:les.man.ac.uk/IPA/papers/44.pdf. Securities and Exchange Commission. (2000). ‘Final Rule: Revision of the Commission’s Auditor Independence’. W ashington, DC. Available from: http://www.nyscpa.org/home/independence/finalrules.htm. Sikka, P. (1997). ‘Regulating the Auditing Profession’, in Michael Sherer and Stuart Turley (eds). Current Issues in Auditing. London: Chapman, pp. 127- 145. The CPA Journal. (2000). ‘Price W aterhouse Coopers Addresses SEC Report on Independence Violations. March. Available from: http://www.nysscpa.org/cpajournal/2000/0300/nv3a.htm. The Institute of Chartered Accountants of Barbados Member’s Handbook. Truell, Peter and Gurwin, Larry. (1992). BCCI. UK: Bloomsbury. W alker, Paul F, Lewis, Barry L., and Casterella, Jeffrey R. (1998). ‘M andatory Auditor Rotation: Arguments and Current Evidence’ – November. Paper no. 6017 presented at Critical Perspectives on Accounting 1999 Conference. Available from: http://panopticon.csustan.edu/cpa99/html/walker.html. W illiams, Paul F. (1999). ‘Accounting and the Morale Order: Justice, Accounting, and Legitimate Moral Authority.’ Paper no. 6024 presented at Critical Perspectives on Accounting 1999 Conference. Available from: http://panopticon.csustan.edu/cpa99/html/williams.html.