MALLON RESOURCES CORPORATION

1. Auditor’s independence (both internal and external) is the independence itself from parties that
might have a financial interest in the business being audited.

Independence often referred as the cornerstone of the auditing profession since it is the
foundation of the public’s trust in the accounting professional services.

Independence requires to be independence of mind: The state of mind that permits the provision
of an opinion without being affected by influences that compromise professional judgment,
allowing an individual to act with integrity, and exercise objectivity and professional skepticism;
and independence in appearance which is the avoidance of facts and circumstances that are so
significant that a reasonable and informed third party, having knowledge of all relevant
information, including safeguards applied, would reasonably conclude a firm’s, or a member of
the assurance team’s integrity, objectivity or professional skepticism had been compromised.

2. Violations of the profession’s ethical rules from timeline:

Integrity, objectivity, confidentiality, conflicts of interest, public interest
15th of February 1994 – Duane Knight did not inform his superiors about the offer from the client.
Starting from this point, his integrity had begun to be considered as questionable.

24th of February 1994 up to 28th of March 1994 – Knight prepared several drafts of “Prepared-by-
client” schedules while he had already accepted the employment offer from the client on the
date. This is a clear violation of objectivity and reflect a conflict of interest since he can no longer
be independent and was in confusion for the responsibility to live up professional standards.
He also shouldn’t be involved in Management discussion and analysis of Mallon Resources’ 1993
annual report as well since the public interest was compromised with the violation of
independency.

29th and 30th of March 1994 – Clarence Hein as managing partner of the public accounting firm,
also encourage the unprofessional attitude by asking Knight to continue reviewing unresolved
accounting and auditing issues for Mallon. Furthermore, confidentiality was broken since Knight
shouldn’t be involved in any way discussing one of those issues with SEC.

30th of March up to 14th of April 1994 – Knight prepared memorandum requested by Hein
regarding the discussion of issue with the SEC which the memo itself was included in the work
paper of the audit. Integrity, objectivity, confidentiality, independency, all have been
compromised by this wrongdoing.
 5th of July 1994 – The audit firm lied and gave false information to SEC about the employment
date of Knight on Mallon and that he already finished his work with the audit after 15th of
February.

3. We agree with the SEC that Knight’s conduct accepting the job offer while still actively auditing
the client tainted the entire audit. Because Knight cannot be independent anymore and his
professional judgement within both the position will be biased and clouded with subjectivities.

4. Auditors can be allowed to become employees of their former clients if certain measures of terms
have been fulfilled so independency and other ethical rules will not be doubted in the future.

- For the example, the audit itself must already have finished and currently no ongoing audit
works are conducted by the auditor;
- Make sure no confidentiality agreement clauses have been breached by the auditor;
- Other restrictions compromised.

This problem of ex-auditor becoming employee practice pose:

a. On the auditing profession, public’s trust can be declined due to this “common” repetition
and the white and black area will be mixed up and broaden the gray or somewhat biased.
b. From audit firms, the profession will be undermined as a mere stepping-stone and the never
ending high rate of turnover in audit firms might not be repaired after all. The service as a
business will be tougher each day since clients often get the upper hand.
c. For audit clients, the Company can be exposed to certain violations and threats that will
resulted to tainting if not cautious with hiring their own auditors.