Independent Auditor: Definition, Rules, Importance

What Is an Independent Auditor?

An independent auditor is a certified public accountant (CPA) or chartered accountant (CA) who examines the financial records and business transactions of a company with which they are not affiliated. An independent auditor is typically used to avoid conflicts of interest and to ensure the integrity of performing an audit.

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

How Independent Auditors Work

An independent auditor either works for a public accounting firm or is self-employed. An auditor examines financial statements and related data, analyzes business operations and processes, and provides recommendations on achieving greater efficiency. They evaluate company assets for impairment and proper valuation and determine tax liability, ensuring compliance with tax code and laws.

The auditor develops an opinion asserting the reliability and fairness of clients' financial statements, then communicates the information to investors, creditors, and government organizations. Also, an auditor may perform other auditing, tax, and consulting services for individuals, corporations, nonprofit 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 may perform analytical procedures on expected and unexpected variances in account balances or transaction classes, then test documentation supporting those variances. The auditor also observes the company’s physical inventory count and confirms accounts receivable (AR) and other third-party accounts.

The Sarbanes-Oxley Act (SOX)

The Sarbanes-Oxley Act of 2002 was passed after Enron, WorldCom, and several other technology companies collapsed due to accounting improprieties. The goal of SOX was to improve corporate governance and restore the faith of companies' investors. However, many in the business world are against SOX, seeing it as a politically motivated move leading to a loss of risk-taking and competitiveness.

Of concern to many is the mandate requiring that public companies obtain an independent audit of their internal control practices. The cost of the requirement is felt most acutely by companies with a market capitalization of $75 million or greater. The audit standards were modified in 2007, reducing costs for many firms by 25% or more annually.

Benefits of an Independent Auditor

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

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