An independent audit is an external accounting function conducted by a public accounting firm or private certified accountant (CPA). Audits are usually an objective review of a company’s financial information. Two types of audits may be used in the business environment: internal and external. Internal audits are usually conducted by company employees for management review purposes. External audits are usually an independent audit conducted by individuals outside the business to provide an objective opinion regarding the company’s financial accounting process. The development of the independent audit process arose after major accounting scandals were discovered in the business environment.
Independent audits may be conducted by a variety of organizations. Government agencies may conduct independent audits on other government entities or private companies. These audits ensure organizations are following specific regulations or laws imposed upon their business operations. Independent audits have also gained importance after significant financial situations occur in the business industry. Examples of these situations are the Great Depression, or more recently, the major accounting scandals of the early 2000s.
During 2001-02, major companies like Enron, WorldCom, and Sunbeam were found to have manipulated significant portions of their financial information. In the case of Enron, the company’s public accountant and auditor, Arthur Andersen, was determined to have an inappropriate relationship with Enron. Arthur Andersen offered Enron general accounting, consulting and auditing services for its accounting functions. Federal regulators determined that Arthur Andersen was unable to provide an independent audit opinion for use by the external stakeholders of Enron’s financial information due to the close professional relationship and multiple accounting services completed by Arthur Anderson.
In the United States, the Sarbanes-Oxley Act of 2002 limited the amount of accounting functions a public accounting firm was allowed to offer a corporate client. A significant change of this Congressional legislation was the fact that publicly held corporations could not use the same public accountant for general accounting services and the independent audit opinion released to investors. While the public accounting firms could offer internal audit services for management review, official audit opinions released for external purposes is not allowed.
Companies following International Financial Reporting Standards (IFRS) can be subject to independent audits based on the application of these accounting standards on foreign entities. Independent audits performed on foreign companies may also follow the auditing guidelines prepared by the International Auditing Practices Committee (IAPC). The rise of international auditing standards and increasing audit regulations in the United States have greatly changed the accounting and auditing profession.
The changes to traditional audit services in the accounting industry have increased the business costs for companies operating in the business environment. Companies may now be required to use multiple accounting firms depending on the type of service needed by the company. Failing to maintain an independent relationship with external auditors may result in significant financial penalties for the company and the revocation of the public accounting firm’s ability to audit publicly held companies.