Familiarity Threat to Independence and Objectivity of Auditor

In business practices, when an auditor undertakes an auditing engagement, they have to measure and evaluate their independence and reliance on objectivity to the undertaken task. Their independence and adherence to objectivity ensure success in auditing efficiently and effectively.

The auditor’s independence is highly objective and critical to the continuation of the audit in a comprehensive manner such that all underlying threats are rooted out.

In case the objectivity is threatened, an auditor must quickly ensure that these threats are subdued and contingency plans are put in place.

Definition:

The familiarity threat is when an auditor is familiar with his or her client. This familiarity deteriorates their independence to perform an audit and further influences the auditor’s decision impacting the transparency of the audit.

This further affects the decision-making prowess of the auditor and forces him/her to make biased decisions. Similarly, if the auditor becomes too obsessed with the client or their business, the same threat may prevail dominant.

The familiarity threat may occur on the basis of multiple reasons. If the auditor is too deeply invested in the client’s business model, familiar with the client, their personnel, or family then he/she may be subjected to the familiarity threat.

Example:

Auditor James is tasked with Auditing Company XYZ, whose manager is a great friend of his. James manages to find inconsistency between some of the provided financial statements of Company XYZ.

James considers how bringing to light this inconsistency would impact his relationship with the company’s manager and decides to forgo this action in order to maintain and uphold the sanctity of his friend’s relationship.

As stated by the example above, the auditor made a biased decision to not press charges for providing a falsified financial statement against company XYZ only because of his familiarity with the company’s manager. This impacts his decision to carry out the correct auditing of the company and compromises his moral values.

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Threats to the independence and objectivity of an Auditor:

While this article focuses solely and specifically on the familiarity threat, an auditor may be subjected to five types of threats. They include:

  • Self Interest Threats

This threat denotes that the auditor may have certain interests that are in conflict with that of the client. In such scenarios, the auditor may prioritize his/her own interests over the interests of the company’s stakeholders.

The easiest way to avoid this threat is for the auditor to recuse themselves from the audit team to avoid a clash of interests.

  • Self-Review Threats

The Self-review threat is when the auditor has to review their own work, such as previously conducted work for the same client. The Auditor may not wish to bring into notice his previous fallacies which could disrupt his independence and objectivity in the audit.

This too can be avoided much like the self-interest threats by not letting the previous auditor review his/her work and avoiding the self-review threat altogether.

  • Intimidation Threats

Clients may coerce auditors into giving them a favor. This could be a viable scenario if the client has leverage over the auditor in some form or the other. In such cases where clients have an opportunity to threaten the auditor, the independence and objectivity of the auditor become severely limited.

Intimidation tactics can be quite coercive at times and disarm auditors of their freedom to conduct the necessary steps needed. In order to take preventive measures against this, it’s best for the auditor to leave the team readily or simply not give leverage to the client to be able to put the auditor in such a position.

  • Advocacy Threats

Advocacy threats can occur when the client and auditor have such a relationship that they end up being advocates of each other. When the auditor represents the client, this threat may emerge.

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The client may have asked the auditor on a separate case to represent them in the court of law while at the same time the auditor is also in charge of looking over the financial statements of the client’s company. This overlapping of responsibility is the reason for advocacy threats.

In order to safeguard against this, the auditor may take the same precautions as the other threats. This can be done by either changing the structuring of the auditing team or simply choosing one contract over the other.

They may choose to either represent the client or continue onwards with auditing the client’s company. By doing this, they may protect themselves against Advocacy Threats.

  • Familiarity Threats

How can the familiarity threat develop?

This threat tends to mature and advance based on previous relationships that have already manifested between the client and auditor.

The more history there is between the two parties the more likely it is that the familiarity threat is going to develop. The intensity of the threat tends to impact decisions on a larger scale.

Being familiar with others is not necessarily bad as long as it does not impact the auditor’s assessment and decision-making process.

The threat may also develop in the form of business associations based on past endeavors. It is the Auditor’s responsibility to identify and be vigilant about lurking threats such as these. Failure to disclose this information can further help in motivating this threat to arise.

Identifying the Familiarity Threat:

The easiest way to see the threat coming is to understand its significance and acknowledge its impact before it even occurs. The auditor should take into consideration several factors when undertaking an auditing contract.

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If he or she has a relative, friend, or colleague in the company they should recuse themselves or consciously make an attempt not to allow emotions to corrode the independence and objectivity of the Audit.

Suppose an auditor is unsure about whether or not a relationship may end up impacting the audit. In that case, it’s best for him or her to disclose this information to the auditing firm allowing them to make a conclusive decision on his or her behalf.

How to avoid this threat?

The best way to avoid this threat altogether is to employ preventive measures that ensure this threat does not come to pass. The most efficient method is to remove the affected auditor from the team.

This allows the rest of the team to function without any bias and the recused auditor to spend his time on another contract where the familiarity threat may not appear.

Another preventive measure could be for the auditing team to be regulated and rotated every now and then so that continuous association with the clients does not lead to the development of familiarity between them.

Usually, auditing firms take these threats into account and task a smaller team to uphold these safeguards in order to firmly avoid any potential risk. Conducting quality reviews is also a vital necessity that ensures the auditors’ objectivity is not compromised.

Apart from this, the auditor’s utmost responsibility is to reveal any such information regarding their familiarity with the client to the firm before the audit takes place.

If they have a close family member, they should immediately inform the relevant parties so that they can be removed or the auditing team can be restructured so that engaging with the client is minimal for the auditor himself/herself.