The problematical nature of auditor independence: a historical perspective

ABSTRACT

Much of the utility of the external audit derives from a presumption that professional auditors are independent and will therefore provide impartial opinions – premises that have often been challenged in recent decades. Focusing initially on a nineteenth-century phenomenon, the ‘continuous audit’, this study provides a historical perspective for reviewing contemporary concerns with the audit function by revealing that failings in auditor independence date from the naissance of the professional audit. It is shown that the continuous audit served primarily the needs of management. That is, in modern parlance, it was a form of management consulting carried out under the guise of an independent service for the benefit of shareholders. Eventually this deception proved unsustainable as the emergent audit profession sought to strengthen its claim to independence and company managers sought more cost-effective means for the routine monitoring of operations. Lack of independence and conflict of interest persisted, however, continuing to be masked by a rhetorical discourse that protected the occupational territory and authority of the audit profession through to the present day.

KEYWORDS:

• Continuous audit
• audit independence
• auditing history
• rhetoric

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Other motivations for voluntary audit arrangements include the desire to avoid the threat of regulation (Edwards 1985) and to shift the risk of financial loss through litigation from the directors to the auditors (Wallace 1980, 2004).

2 Sometimes the independent audit was structured from the outset as a continuous audit; on other occasions it was introduced as an extension of existing external audit arrangements.

3 This study does not examine the history of the continuous audit when conducted internally by companies, such as those supervised by the Finance Committee of the Second Freeholder Building Society and by the Audit Committee of the London Joint Stock Bank (Second Freeholder Building Society 1873; Meetings of Joint Stock Banks 1879).

4 The 19th Century British Library Newspapers digital archive provides a full run of 48 British newspapers from 1800 to 1900, comprising roughly two million pages of the British Library’s newspaper holdings available digitally as a fully searchable database.

5 The Select Committee on Trustee Savings Banks (BPP 1889 (301), vii) recommended that banks should have the power to appoint ‘professional accountants as auditors … to secure a continuous audit and a continuous examination, at uncertain times, of the pass-books and their comparison with the ledgers’. A bill (BPP 1890, s. 12) requiring savings banks to appoint a public accountant to undertake a ‘continuous audit’ was presented to parliament the following year but did not survive the legislative process.

6 It is acknowledged, consistent with DeFond and Zhang’s (2014) review of archival auditing research, that no conclusive evidence exists to show that lack of auditor independence – for example, because of the provision of non-auditing services – necessarily affects negatively audit quality.

7 See also the comments of Mihill Slaughter, statistical officer at the London Stock Exchange, at BPP 1849 (371), minute 1056, minute 1079; James Foster, stockbroker, at minute 2389; John Swift, solicitor to the London & North Western Railway, at minute 2510.

8 See also: Kemp 1875, 4; Pixley 1882, 4; Leading Article 1875c, 3; and the following comment from the President of the Manchester Chartered Accountants Students’ Society in 1902: ‘those who have the best opportunities of judging will admit that the public do not as yet greatly believe in us’ (Crewdson 1902, 216).

9 The auditor can also benefit, of course, by avoiding audit failures that lead to loss of reputation, and possible litigation costs, while management benefits from lower cost of capital and higher share prices if investors believe the firm has higher financial reporting quality.

10 ‘The Auditors shall make a Report to the Shareholders upon the Balance Sheet and Accounts, and in every such Report they shall state whether, in their Opinion, the Balance Sheet is a full and fair balance sheet, containing the Particulars required by these Regulations, and properly drawn up so as to exhibit a true and correct View of the State of the Company’s Affairs … ’

11 All of these authors were partners in firms of auditors. Pixley was President of the ICAEW in 1903–1904.

12 The founder of Deloitte, William Welch Deloitte, was appointed in the same year to assist the shareholder auditors at the Great Western Railway (Great Western Railway 1850).

13 These audits were superficial ones where shareholder auditors might spend the morning simply comparing figures reported in the accounts with the balances in the books before lunching with the directors.

14 Waterhouse conducted other engagements on behalf of LNWR, such as the examination of the affairs of the Cambrian Railway in 1868 (Jones 1988, 84).

15 Partners, respectively, in the firms George Swithinbank & Co. and Monkhouse, Goddard & Co.

16 Moving beyond Britain, Dattin (2014) reveals that the auditors of two major French companies – Pont-à-Mousson from 1886 and Saint-Gobain from 1907 – functioned principally as advisors to the boards of directors rather than as guardians of the shareholders’ interests.

17 The remainder focused on continuous audits conducted in the public sector, by companies internally, or referred to developments overseas.

18 One notable exception was the famous prosecution of the chief executive (Lord Kylsant) and auditor (Harold Morland of Price, Waterhouse & Co.) of the Royal Mail Steam Packet Company in 1931 (Edwards 1976).