ule 101 of the AICPA Code of Professional Conduct has long required CPAs who perform any attest services to be independent of their clients. Recently the SEC has also issued new rules applicable to SEC registrants. Underlying both the AICPA and SEC rules is the belief that the auditor is engaged to serve the public trust—the interests of investors and creditors. As a consequence, it is vital to the audit function that a CPA engaged in an attestation be independent of the client both in fact and in appearance. Independence in both fact and appearance is also crucial to maintaining professional autonomy and the high esteem in which the profession is held. As a result, no violation of existing independence rules is too trivial to be glossed over.
INDEPENDENCE IN FACT
In Accounting Series Release no. 269, the SEC defined independence in fact and independence in appearance as separate but equally necessary factors in establishing the auditor’s objectivity and integrity when certifying financial statements filed with the commission by an issuer of securities.
Few would debate that independence in fact—that is, that the auditor is actually unbiased—is absolutely essential to the validity of an audit. The problem is that the lack of independence in fact sometimes is not readily seen. Actual bias would occur if, for example, an auditor who owned shares in a client company allowed that client to engage in overly aggressive accounting in the hope that higher earnings would increase the company’s stock price (a violation of independence in fact).
Indeed, such bias ultimately could lead to the destruction of the very function of the audit and thus drastically reduce (if not totally eliminate) its value to financial statement users. The short- and long-term effects of independence violations to the auditor and the audit firm are quite obvious: sanctions from the SEC and professional organizations, lost revenues, lost opportunities to cross-sell nonaudit services, damaged reputations, and potentially devastating legal liability. In addition, in the absence of an effective audit function, capital providers would demand higher returns to compensate for possibly unreliable financial information. In the long term, independence violations would hurt the financial markets because loss of integrity in auditor independence would mean increased costs of capital for all users. In light of these potentially negative consequences, independence in fact is clearly indispensable to the audit function.
INDEPENDENCE IN APPEARANCE
Unlike actual bias, independence in appearance is based entirely on perceptions. Consider the case of a partner who is not involved in an audit but whose child is given a share of stock in one of the firm’s audit clients—a client served by a firm office located halfway across the country. It is unlikely that anyone would view this indirect ownership interest—a child’s single share of stock—as impairing the firm’s objectivity and integrity. The question is, though, at what point could the public perceive this as problematic?
What if it were 10,000 shares owned by the partner’s parents? Or ten shares owned by a staff accountant who is not personally involved in the engagement but who works in the same office as the audit team? It is unlikely that either of these situations would affect the outcome of the audit. However, the fundamental problem is that independence in appearance has become a surrogate for independence in fact, because the former can be observed while the latter may not be. Though imperfect or even altogether inaccurate, the public’s perceptions are its only practical measure of auditor independence. The public may believe a firm is not truly independent even when that is not the case, and that perception may be as damaging to the firm as an actual independence violation.
THE CASE FOR SELF-GOVERNANCE
Why should we care so much about public perception when independence in appearance is at issue? It is often said that CPAs—auditors in particular—are held to the highest of professional standards. One of the distinguishing characteristics of a profession is that it is permitted to govern itself when it comes to such issues as controlling entry into the profession, establishing codes of conduct and engaging in peer review and discipline.
CPAs will continue to maintain their status as autonomous professionals as long as ethics standards are preserved. This autonomy, however, is a privilege and not a right. The trend is toward increased government regulation in all sectors; the SEC’s new independence rules supplementing the AICPA’s Code of Conduct are just one example. Public loss of confidence in accounting professionals’ conduct could result in further government intervention and externally imposed standards.
This means CPAs could lose the ability to decide for themselves how their businesses should expand and what engagements are appropriate. It is this potential loss of the privilege of self-regulation that should concern and motivate accounting professionals most as they consider whether perceptions of independence are impaired.
ANN MORALES OLAZABAL, MBA, JD, is an assistant professor of business ethics and business law at the University of Miami School of Business Administration in Coral Gables, Florida. Her e-mail address is email@example.com . ELIZABETH DREIKE ALMER, CPA, PhD, is an assistant professor of accounting and auditing, also at the University of Miami School of Business Administration. Her e-mail address is firstname.lastname@example.org .