A Declaration of Independence
What every CPA needs to know about the Independence Standards Board.
| EXECUTIVE SUMMARY |
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| CPA FIRMS HAVE BEEN OFFERING consulting services to their audit clients, leading the SEC to question their commitment to auditor independence and the nature of independence itself. THE INDEPENDENCE STANDARDS BOARD, a private-sector body containing four CPAs and four public members, was the result of that questioning. The board’s authority extends to all auditors of public companies. THE BOARD IS DEVELOPING A CONCEPTUAL framework for independence and is also working on independence standards. | WORKING WITH THE INDEPENDENCE STANDARDS BOARD is an eight-member independence issues committee that identifies emerging issues and a four-person staff—in the AICPA’s New York offices—that fields inquiries from auditors by phone, e-mail and postal mail. THE BOARD RECENTLY ISSUED ITS FIRST STANDARD, requiring auditors to confirm their independence annually to audit committees. Other items on its agenda include employment of former firm personnel by an audit client, family relationships between firm personnel and an audit client and alternative practice structures for accounting firms. |
| J. GREGORY JENKINS, CPA, PhD, is assistant professor of accounting, North Carolina State University, Raleigh. His e-mail address is greg_jenkins@ncsu.edu . | |
The system needed fixing, and the SEC required a solution. In the early 1990s, CPA firms began providing many different nonaudit services to their audit clients: investment banking assistance, strategic planning, human resource planning, computer hardware and software installation and implementation and internal audit outsourcing services. The question arose: Were these auditors still independent? Chairman Arthur Levitt, as well as senior SEC staff, warned the profession about making financial statement audits a loss leader to attract lucrative consulting engagements. In September 1996, the GAO recommended the SEC consider new forms of auditor oversight, and, three months later, Levitt said audit firms needed to continue to ensure “that audit quality was not compromised and that auditor performance continue to meet public expectations.” The solution for firms trying to be all things to their clients was the creation of a new private-sector body—the Independence Standards Board (ISB)—charged with establishing, maintaining and improving independence standards for external auditors of SEC registrants. Established in May 1997 as part of an agreement between the AICPA and the commission, the board has started issuing standards. What has it done so far and what are its future plans? Indeed, what is this board? How does it operate and how might it affect your firm?
THE ISB AT A GLANCE
Like the AICPA’s ASB and the professional ethics executive committee, the ISB addresses CPAs’ professional behavior. But key differences include the ISB’s scope of authority—its rules apply only to auditors of public companies—and its composition—half of the 8-person board are non-CPA “public” members. Three practicing accountants (all of whom are senior partners of AICPA SEC practice section firms) and the AICPA president or designee represent the profession. The chairman and three other business leaders, all of whom have substantial business experience, represent the public.
Two groups support the ISB: the board’s executive director and staff and the independence issues committee (IIC). The executive director, who is hired by the board chairman, is responsible for the day-to-day operations of the ISB. The director and the staff respond to inquiries from practitioners and other interested parties, develop internal materials and press releases and provide any other assistance required by the board or the IIC. Currently, there are four ISB staff members including the executive director. They work out of the AICPA’s offices and are funded by the SECPS. The general structure and composition of the board and staff are shown in the exhibit.
The SECPS executive committee selects the eight members of the IIC, all of whom are practicing accountants employed by SECPS member firms. Practitioners are chosen to serve on the IIC based upon their knowledge of existing independence regulations and their ongoing exposure to emerging independence issues.
The ISB has three main tasks:
- Developing a conceptual framework so that future independence standards are more consistent and less fragmented than current SEC standards.
- Identifying emerging independence issues through the IIC.
- Providing practitioners with guidance on matters regarding independence by phone, letter and e-mail.
The IIC has two primary functions, both of which are forward looking. First, it identifies and studies emerging independence issues. This responsibility is particularly relevant to the IIC, given the members’ positions in public accounting. Second, the group is expected to address “broader interpretative issues” stemming from practitioner inquiries. Each of these functions could lead to a consensus that could help the board in its deliberations.
DOWN THE ROAD
Soon after the ISB was established, the AICPA sent the board its version of an independence framework, Serving the Public Interest: A New Conceptual Framework for Auditor Independence— often called the White Paper. Although the White Paper contained a number of thoughtful proposals, both the board and the SEC said the proposed framework would benefit from further deliberation. Accordingly, the board chose not to adopt the White Paper, but to study the issues surrounding a conceptual framework for independence in greater detail.
Constructing a conceptual framework is perhaps one of the most challenging tasks facing the ISB. However, with its development of a framework, the ISB promises to accomplish two very significant goals. The ISB will more easily develop future independence standards through reference to a single set of ideals and principles. ISB standards will garner greater credibility among the business community and investing public since a conceptual framework will explain the ideals and principles underlying the board’s decisions.
The ISB will confront several complex issues throughout the conceptual framework project. For instance, how do you define independence? Currently, there is no universally accepted official definition of the term in the profession’s authoritative literature. Rather, there is an extensive array of specific interpretations of, and rulings on, independence in the Code of Professional Conduct, as well as various rules and regulations promulgated by the SEC, that could be used to develop a general definition. So, while the task will be difficult, a wealth of information is available to the ISB.
There’s another aspect to independence: ISB Technical Director Richard Towers observed that existing SEC independence regulations assume that a single set of rules fits all firms regardless of their size. Given the changes facing the profession such as new firm ownership structures (allowing non-CPA ownership, as in the case of American Express) and the technological advances allowing smaller firms to audit SEC companies, a conceptual framework must be applicable across many different situations and audiences—an issue that the board must bear in mind.
The framework also will need to address the dynamic relationships between accounting firms and their clients. For instance, nonaudit consulting now represents the fastest growing revenue source for many accounting firms. Accounting Today reported that, from 1994 to 1995, the nation’s 100 largest accounting firms experienced a growth rate of 36% in their consulting revenues but only 1% in accounting and auditing revenues. As firms continue to offer more services to their audit clients, the economic dependence between the two parties will expand, possibly resulting in conflicts of interest. In fact, the board’s first statement affects these firms by requiring auditors to confirm their independence to a company’s audit committee or board of directors on an annual basis. (See “ISB Lays Down the Law on Discussions With Audit Committees,” JofA, Apr.99, page 12.) Auditors and clients must systematically revisit their relationship, thus avoiding circumstances that might lead to independence problems.
In addition to the conceptual framework project, the ISB is studying two specific independence issues: employment of former firm personnel by an audit client and the presence of family relationships between firm personnel and the audit client. The board is concerned that independence may be impaired by actions of a former firm member or remaining firm members during an audit of their former colleague. (For example, there may be a problem if Mary Smith, a partner of Doe and Roe, CPAs, leaves to become CFO of Acme Inc., a public company and an audit client of Doe and Roe.) Deliberations continue, and a task force is studying the matter in greater detail. As for family relationships, a key concern is whether there should be a “new and stronger differentiation” between auditors who work directly on a client engagement and those the firm merely employs. Another task force is studying the matter and is expected to provide information to the board in the near future.
ISB TO THE RESCUE
The ISB staff truly operates on the “front line” by acting as the first source of information and advice to practitioners. Staff members can provide informal interpretations and guidance to practitioners. However, a word of caution is in order. According to the ISB’s operating policies and the SEC, staff interpretations and guidance apply only to the specific parties directly affected by the interpretation or guidance and do not have substantial authoritative support unless the board ratifies them. In other words, neither a CPA nor an SEC registrant can rely on staff interpretations or guidance given to another party unless the board has ratified the interpretation.
You can obtain advice from the ISB in several ways. For an informal inquiry you can simply call the ISB staff. You can request an interpretation by completing an online inquiry form on the ISB’s Web site, www.cpaindependence.org/feedback/ . And you can also seek advice through written correspondence. ISB staff will give only informal advice over the telephone; a written request is necessary for a formal, binding decision.
EVERYTHING OLD IS NEW AGAIN
The ISB may be new, but the concept of an auditor’s independence is as old as the profession itself. That independence is vital to the profession’s continued existence; protecting it is the responsibility of all CPAs. In fact, upon his retirement, FASB Chairman Dennis Beresford told the Journal , “I hope the CPA consultants realize that auditing and accounting are still the foundation; they’re what being a CPA is all about.” The ISB has a heavy responsibility, and its role and influence will certainly expand as the relationships between accounting firms and their clients become more complex.
