and After Enron: CPAs’ Views on Auditor Independence
Deborah L. Lindberg and Frank D. Beck
independence is often referred to as the cornerstone of
the auditing profession because it is the foundation for
the public’s trust in the attest function. Although
many have stated that the collapse of Enron has negatively
affected the perception of auditor independence, we do not
need to rely on anecdotal evidence alone. In October 2001,
approximately two months prior to Enron declaring bankruptcy,
an extensive survey instrument on auditor independence had
been sent to 1,500 CPAs. After Enron declared bankruptcy
in December 2001, the survey was sent to another 1,500 CPAs
drawn from the same database.
results indicated that CPAs’ perceptions of the effects
of nonaudit services on auditor independence are more negative
after the Enron bankruptcy. In addition, after Enron declared
bankruptcy, CPAs held a more conservative view of whether
a material transaction or event detrimentally affects auditor
independence. Furthermore, the findings suggest that auditors
perceive that nonaudit services and other issues that threaten
auditor independence detrimentally affect the public’s
perception of independence to a greater extent than they
adversely influence actual independence.
Discussion of Auditor Independence
independence helps to ensure quality audits and contributes
to financial statement users’ reliance on the financial
reporting process. Several major instances of misstated
earnings prompted the SEC in 2000 to adopt rules prohibiting
nonaudit services inconsistent with auditor independence.
independence has long been couched in terms of independence
“in fact” and independence “in appearance.”
An auditor who is independent in fact has the ability to
make independent audit decisions even if there is a perceived
lack of independence or if the auditor is placed in a potentially
compromising position. Nonetheless, even when the auditor
is in fact independent, one or more factors may lead the
public to believe the auditor does not appear independent.
This may cause users of financial statements to believe
they cannot rely on financial information.
auditor independence in fact is a mental state, investors
and other users of financial statements cannot accurately
assess actual auditor objectivity; they can only evaluate
an auditor’s appearance of objectivity. Thus, even
when an auditor acts independently in fact and issues an
unbiased audit opinion, investor confidence is eroded if
investors and other users of the financial statement information
do not perceive that the auditor was independent in appearance.
Arthur Andersen, Enron’s former auditor, was perceived
as lacking independence, because the accounting firm earned
more revenue from nonaudit services than from audit services.
While independence in fact and in appearance are both required
in order to achieve the goal of independence, the Enron
debacle, and the negative publicity that the auditing profession
received, may have altered the public’s expectations.
bonding. In 2000, the SEC adopted amendments
to its rules governing relationships between independent
auditors and their SEC clients. These rules identified nine
nonaudit services inconsistent with auditor independence
1). The rules regarding management functions and human
resources were consolidated into a single rule, resulting
in eight rules that were subsequently made into law by the
Sarbanes-Oxley Act of 2002.
the independence rules allow audit firms to offer consulting
services such as information technology (IT) and internal
auditing, those services are subject to certain restrictions.
Among other things, the rules now require annual disclosure
of audit firms’ fees received for auditing, IT consulting,
and all other services.
commentators have stated that the Enron bankruptcy has forever
altered the public’s view of auditor independence,
because Enron’s auditors had previously issued unqualified
opinions on Enron’s financial statements. Regulators
and critics of the accounting profession view an audit firm’s
provision of consulting services to an audit client as a
conflict of interest. There is also a stream of critical
literature, dating from the early 1980s, which argues that
the provision of most nonaudit services threatens auditor
independence, because an economic bond, which the auditor
does not want to lose, develops between the client and the
authors expected that CPAs would perceive the provision
of nonaudit (consulting) services to auditing clients as
weakening auditor independence, more so after the bankruptcy
of Enron than before.
October 2001, before Enron declared bankruptcy, the authors
had developed an extensive survey instrument on auditor
independence and sent it to 1,500 CPAs. After Enron declared
bankruptcy, the survey was sent to another 1,500 CPAs drawn
from the same database, asking their views on auditor independence.
participants were asked to provide their opinions about
issues that may impair auditor independence. For one set
of questions, survey participants were instructed to provide
their opinions about specific nonaudit services on a scale
from “definitely weakens independence in
fact” (1) to “definitely strengthens
independence in fact” (5). Respondents were also asked
to provide their perceptions of how the same nonaudit services
affected independence in appearance. In a similar vein,
participants were asked to provide their perceptions, in
several different formats, of how several other issues affect
auditor independence (Exhibit
of Economic Bonding
test the economic bonding hypothesis, the authors predicted
that the post-Enron respondents would be more negative toward
a particular nonaudit service on independence in fact and
independence in appearance than the pre-Enron respondents.
Differences existed between CPAs surveyed before and after
the Enron bankruptcy for independence in fact on nine out
of the 10 nonaudit services surveyed. The largest difference
was the effect that the provision of internal audit services
by an audit firm has on independence in fact. The provision
of management functions, broker-dealer services, or legal
services concerned CPAs as well, both before and after the
Enron bankruptcy. Financial information systems design,
the nonaudit service for which no significant difference
existed pre- or post-Enron, was perceived as the least problematic
for the maintenance of independence in fact (Exhibit
opinions regarding the effect of audit firms providing nonaudit
services to clients on independence in appearance grew more
negative for only five of the 10 nonaudit services surveyed.
The largest difference was for the provision of internal
audit services. In addition, after the Enron bankruptcy,
concern about independence in appearance was greater if
the audit firm also provides bookkeeping or legal services,
financial information systems implementation services, or
appraisal valuation. The results, summarized in Exhibit
3, also indicated that providing nonaudit services is more
of a concern for independence in appearance than for independence
Role of Materiality
is an issue that accountants and auditors have long grappled
with. There are no pronouncements that specify a dollar
amount to use as a materiality cutoff, or that help determine
whether an item is material. Rather, professional standards
state that the determination of materiality is a matter
of professional judgment, and should be based on such factors
as the size or nature of an item, the expected users of
financial information, and the cumulative effect of items
under consideration. Thus, materiality judgments are subject
to much subjectivity. Since Enron, the financial press has
extensively covered materiality issues. Because of reactions
by CPAs to such negative publicity, the authors expected
CPAs would take a more conservative view of materiality
after Enron declared bankruptcy. In other words, all other
factors remaining the same, the Enron debacle has motivated
CPAs to lower their materiality threshold.
of the Role of Materiality
survey question asked participants to indicate whether the
materiality of the amount of nonaudit fees impairs independence
in fact and in appearance. The results show that CPAs did
lower their materiality threshold for nonaudit fees impairing
independence after Enron. This is another indication of
the validity of the economic bonding hypothesis before Enron.
a factor analysis identified nine items that were related
to each other, including materiality, dollar amount of waived
audit adjustments, client audit revenue, estimation of a
valuation allowance, outsourcing of internal audit services,
low-balling of initial audit fees, potential for nonaudit
revenue, compensation for referrals, and contingency fees.
Because these items were part of an underlying and unmeasured
concern with the effect of dollars on auditor-company relations
and independence, the authors performed the same test on
the other eight items tested regarding the materiality of
nonaudit fees (Exhibit
difference between CPAs’ concerns over independence
in fact before and after Enron was statistically significant
for five of the nine items, including materiality. CPAs
surveyed after Enron were also more concerned that the size
of audit clients affected independence in fact, as well
as about the outsourcing of internal audit services, the
potential for nonaudit revenue, and compensation for consulting
referrals of nonaudit services. There was no difference
in views of independence in fact pre- and post-Enron, (once
experience, firm size, and gender were held constant), regarding
the effect of the size of waived adjustments, the estimation
of valuation allowance, or low-balling of fees.
independence in appearance, CPAs had a more conservative
view of whether a material transaction or event detrimentally
affects auditor independence in appearance after Enron.
The differences were statistically significant for eight
of the nine items, all expressing more concern after Enron.
The strongest differences were for the materiality of nonaudit
fees, the outsourcing of internal audit services, the potential
for nonaudit revenue, and compensation for consulting referrals
of nonaudit services. Interestingly, the differences between
pre- and post-Enron CPAs were greater when asked about independence
in appearance than independence in fact.
discussed, an auditor is considered independent in fact
if she has the ability to make independent audit decisions
even if there is a perceived lack of independence or if
the auditor is placed in a potentially compromising position.
Even when the auditor is in fact independent, however, one
or more factors may lead the public to conclude the auditor
is not independent. Many commentators on the Enron debacle
note that perception becomes reality where auditor independence
is concerned. If perception becomes reality for CPAs, too,
there would be no statistically significant difference between
their perceptions of independence in fact and in appearance
before and after Enron.
of Independence Perceptions
of paired difference t-tests demonstrates that respondents
were more concerned about many nonaudit services and audit
practices affecting independence in appearance than they
were about those same issues affecting independence in fact.
Of the 31 tests performed on the responses before the Enron
bankruptcy, 29 were statistically significant and indicated
more concern about independence in appearance. Twenty-eight
of the 31 tests were statistically significant after Enron
and more concerned about independence in fact.
respondents, concern over a certain issue affecting independence
in appearance increases directly with concern over the same
issue affecting independence in fact. The average concern
for each issue was higher for those surveyed after Enron
declared bankruptcy than it was for CPAs surveyed before.
L. Lindberg, DBA, CPA, is an associate professor
in the department of accountancy at Illinois State University.
She can be reached at firstname.lastname@example.org.
Frank D. Beck, PhD, is an associate professor in
the department of sociology and anthropology at Illinois State
University. He can be reached at email@example.com.
American Accounting Association and Illinois State University
provided financial support for the study summarized in the
article. Research support was received from the Illinois
Society of Certified Public Accountants.