Bayesian and Belief-Functions Formulas for Auditor Independence Risk Assessment

Abstract

This paper illustrates two formulas for assessing independence risk based on the Bayesian and belief-functions frameworks. These formulas can be used to assess the role of threats to auditor independence as well as the role of threat-mitigating safeguards. Also, these formulas provide a basis for evaluation of an audit firm’s independence risk and a framework to educate stakeholders about the threats faced by the audit firm and the role of effective safeguards in mitigating these risks. The formulas also provide a means for regulators and lawmakers to evaluate whether they have effective safeguards in place given the existence of threats and for auditors to signal to various stakeholders that they have identified significant threats and have effective safeguards in place. To show the potential usefulness of these analytical models, several illustrations addressing increased transparency and the potential impact of regulations are presented.