How Independent Are Auditors? When Audit and Advice Come From One Firm

Why auditor independence matters to small businesses too

Banks, buyers, and shareholders outside management rely on figures that someone else has checked: in larger companies the statutory auditor, in smaller ones often the tax adviser. The value of that check depends on one property: the reviewer must be able to say what they see, even if their client does not like it.

This is where a conflict lies that is built into the arrangement. The auditor is chosen and paid by the company whose figures it assesses. Often the same firm also sells the client advisory services. This article therefore pursues one question: Can an auditor judge independently when it is paid by the company it audits and advises it at the same time?

To answer it, we first clarify terms and the thinking model, then look at research, rules, and a case from 2020, and finally at what an owner can adopt.

What does independence mean for auditors?

A statutory auditor is a certified public accountant or audit firm that examines a company's annual financial statements and records the result in the audit opinion. In Germany, medium-sized and large corporations, including the GmbH, the German limited liability company, must be audited. Since April 2024, a corporation counts as small if, on two consecutive balance sheet dates, it does not exceed at least two of three thresholds: 7.5 million euros in total assets, 15 million euros in revenue, and 50 employees on annual average.

In auditing theory, independence has two sides. Independence in fact describes the inner attitude: the auditor judges free of interests unrelated to the matter. Independence in appearance describes how this looks from the outside: a reasonable third party has no reason to suspect bias. Both matter, because readers of the accounts see only the auditor's relationships, not its attitude.

Non-audit services are all services an auditor sells to a client in addition to the audit: tax advice, valuations, IT projects, HR consulting. The problem is called self-review: anyone who introduced a system or prepared a valuation will be checking their own work the following year.

The thinking model: an auditor serving two masters

The basic conflict is explained by principal-agent theory. A principal, such as an owner, engages an agent, such as management, to act in the principal's interest. Because the agent knows more and has goals of its own, the principal needs oversight. The auditor is one form of that oversight. Yet the auditor itself is in a second engagement, and of all parties, with the very agent it is supposed to monitor.

In a review article, DeFond and Zhang (2025) describe this as serving two masters: management, which pays the fees and has a say in reappointment, and the owners, who rely on the opinion. The conflict is sharpened because an audit is a credence good. Its quality can hardly be judged from the outside. It usually becomes visible only years later, when a company collapses, financial statements have to be restated, or a regulator finds deficiencies.

An analogy from sport makes the situation tangible. Imagine a referee chosen and paid by the home team who, during the week, runs that team's training for a fee. He may referee correctly. But the visiting team has good reason to doubt it.

Independence is not a character trait of the auditor but a property of the relationship in which the auditor works.

What does research show? Two readings

How often audits fail can only be measured indirectly. DeFond and Zhang (2025) name three indicators: large collapses, by their estimate one or two per year worldwide, restated financial statements, and deficiencies found in regulators' inspections. According to the 2024 report of the audit regulators' forum (IFIAR) they cite, 34 percent of inspected audits by the six largest networks had at least one significant deficiency. Because regulators tend to select riskier engagements, this rate does not apply to all audits.

First reading: advisory work weakens the audit

Sinha, Gaynor, and Mishra (2026) studied companies on the Fortune 500 list. Firms whose auditors provided substantial advisory services were, by their measure, more likely to violate accounting rules. Meuwissen and Quick (2019) presented cases to German supervisory board members in an experiment. Respondents saw the auditor's independence impaired when it also provided advice, most strongly in the case of HR consulting. This is a finding about perception, that is, about independence in appearance, and it is remarkable precisely for that reason: the judges are the people tasked with overseeing the auditor.

Second reading: advisory work does not necessarily harm

Other work paints a mixed picture. Arnold, Bateman, Ferguson, and colleagues (2017) found no evidence in a large Australian dataset on private pension funds that additional services impaired independence. Geiger, Paik, Kim, and colleagues (2025) found that higher advisory fees were usually associated with less efficient investment by clients, especially smaller clients. However, the association was much weaker when the advice came from high-quality auditors. Proponents also point to a knowledge effect.

I consider the first reading the sounder one, because what counts for readers' trust is appearance. Whether advice measurably lowers quality cannot be derived from the studies in general. That it creates doubt can.

Which rules apply today in the EU and in Germany?

Lawmakers have taken a position on this question. The 2014 EU Audit Regulation applies to public-interest entities, mainly listed companies, banks, and insurers. Germany tightened it further in 2021 with the Financial Market Integrity Strengthening Act (FISG).

For the Mittelstand, Germany's small and mid-sized companies, these provisions usually do not apply directly. A medium-sized GmbH subject to audit may still receive tax advice from its auditor, as long as the auditor is not involved in, say, bookkeeping or preparing the financial statements. The logic of the strict rules is still worth a look.

What a documented case from 2020 shows

The tightening through the FISG was a reaction to the collapse of the payment services company Wirecard in June 2020. According to press reports, the audit firm EY had audited its financial statements from 2009 to 2018 and issued unqualified opinions. For the 2019 financial year, it withheld its opinion on June 18, 2020, because sufficient evidence was lacking for bank balances of around 1.9 billion euros in trust accounts. The article Chronicle of an accounting scandal recounts the sequence of events.

Since then, debate has focused on whether balance confirmations were obtained directly from the banks or came via trustees and the company. In April 2023, the German audit oversight body APAS imposed a fine of 500,000 euros on the audit firm and barred it for two years from taking on new audit mandates at public-interest entities. Five auditors received individual fines. EY has stated that there were clear indications of an elaborate fraud involving multiple parties around the world.

The case does not prove that advisory work or long tenure was the cause. It does show where an audit is vulnerable: where the auditor relies on confirmations that pass through the audited company, and where the same relationship has existed for many years. The criminal proceedings have not been concluded; the presumption of innocence applies to everyone involved.

How to protect the independence of your reviewers in your own business

Even without a statutory audit, you have reviewers: the tax adviser who prepares your financial statements, a bank that asks for figures, perhaps an advisory board or co-owners. From the thinking model, a simple test can be derived that I call the three-distances test. It asks whether there is enough distance between the reviewer and the reviewed.

1. Distance from the work

   Whoever prepares a figure does not confirm it. If your tax adviser prepares the financial statements, they are not also the independent check. Important items need a second view, such as a balance confirmation obtained directly from the customer or a look by the advisory board.

2. Distance from the money

   Check how much an adviser earns from you and from what. If a large part of their fees depends on additional engagements they recommend themselves, the same dependence arises as with audit and advice from one firm.

3. Distance in time

   Long relationships create knowledge and habit. Every few years, have a third party look at one area, such as the valuation of inventory.

If there are co-owners or an advisory board, they should select the auditor and know its fees. The article An advisory board for the Mittelstand describes how such a body can be set up, and Corporate governance for small businesses covers the wider framework.

Scope and limits

The problem is structural, not personal. DeFond and Zhang (2025) therefore propose changes to the relationship: disclosure of which corrections the auditor proposed and the client rejected, compensation for audit partners not tied to their clients' fees, and, most far-reaching, assignment of auditors by a regulator. Each step has costs that are hard to predict, as the authors themselves stress.

A second limit: the studies mostly examine large, listed companies. In a business with 30 employees, the tax adviser is often the only outside expert with insight into the figures. Replacing them because of a theoretical conflict would be disproportionate. It makes more sense to separate the roles visibly. Due diligence on business partners shows what such checks look like for business partners. Why a few large audit firms shape the market is explained in The Big Four, and Enron 2001 shows how an earlier case changed the rules in the US.

Conclusion: an auditor is only independent with distance

To the guiding question: an auditor can judge correctly even when paid by the audited company and advising it. But nobody can rely on that, because the quality of an audit becomes visible from the outside only when it is too late. Research disagrees on whether advisory work measurably worsens the audit. It agrees that it raises doubts about independence. Lawmakers have drawn clear limits from this for large companies.

For your business, this means that independence cannot be ordered from the auditor; it arises from how the relationship is designed. Where one person prepares, confirms, and passes on the figures, oversight is missing, even if everyone works honestly.

• Note the five most important figures in your financial statements and record for each who prepares it and who confirms it.
• Request a breakdown of all fees from your tax adviser or auditor by type of service.
• For the three largest receivables, obtain a balance confirmation directly from the customer.
• Agree with co-owners or the advisory board who selects the auditor and who approves its fees.