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CPA Independence, Present and Future My last two columns have discussed the origins of CPA independence and its development as the foundation for CPA ethics. In essence, independence at the turn of the 20th century referred to an objective, neutral, unbiased state of mind, with restrictions on the accountant being an advocate for, a manager of, or an investor in a client entity. The general expectation was that an accountant would take the perspective of the business owners.Entity Focus and the Appearance of Independence Two developments that began in the 1930s—federal legislation, which created the demand for a national set of accounting principles, and the general acceptance of Paton and Littleton’s entity and going-concern assumptions, which focused accounting on the transactions of the entity rather than on the value of its owners’ interests—changed the cultural setting for accountants’ independence. Over the next three decades, independence came to mean a neutrality of interest implemented through the commitment to standards: An accountant did not take the owner’s interest, management’s interest, government’s interest, or any other interest; first allegiance was to standards in order to serve the public interest. The independence standards developed during this time primarily addressed the appearance of independence, especially financial interest in clients and family connections to client management. In the last 25 years of the 20th century, the appearance of independence rose in importance because of developments in the equity markets, the consolidation of public company audit firms, and the expansion of their consulting and nonlegal advocacy services to clients. The Independence Standards Board attempted to bring order by creating a set of independence principles for auditors. Public-policy setters eventually concluded that any potential conflict of interest for an auditor tarnished the appearance of independence. The SEC also faced a double-edged sword. On the one hand, it wanted company management to take complete responsibility for functions often outsourced to auditors; on the other hand, it wanted auditors to adopt an investor protection orientation. Auditor independence became the lever to accomplish both. Today, the appearance of a potential conflict of interest in the mind of investors is enough to impair independence. The most striking change to auditor independence, however, has been who determines whether an auditor is independent. For most of the history of independence, the accounting professional was the focal point. Independence was part of the accountant’s code of professional conduct, and CPA firms tracked the requirements of independence for every client. The Sarbanes-Oxley Act, however, essentially removed the accounting professional from the decision-making process on independence as it relates to scope of service issues by giving it to audit committees. Audit committees determine whether any work by the external auditor of an SEC registrant impairs the appearance of independence. The effects of investment and familial relationships on independence for SEC registrants are covered in recent regulations that reflect an engagement team approach. In the interest of common ethical standards, the code of professional conduct tends to reflect changes in federal regulatory activity for SEC registrants, albeit with some variations. The AICPA and conforming state societies, including the NYSSCPA, adopted an engagement team approach to auditor independence that mostly mirrors the SEC’s regulations. In addition, shortly after the Sarbanes-Oxley Act was passed, the AICPA revised Rule 101-3 to deal anew with scope of service issues. Revised Rule 101-3 places the burden on the CPA to ensure that nonattest services do not create a conflict of interest that would compromise the appearance of independence. It originally took effect December 31, 2003, but the AICPA recently postponed its effective date until December 31, 2004, with early adoption encouraged. Individual Responsibility Over the last century, independence has evolved from a focus on state of mind to a focus on appearance. Nonetheless, the ethical accountant will continue to be alert to situations that satisfy the requirements of independence in appearance but may impair independence in fact. The most common case of such a situation occurs because an accountant becomes so close to the client as to be unable to function objectively. The independence rules and the oversight of audit committees for public companies cannot plumb an individual’s feelings. Although an audit committee may determine when the appearance of independence is impaired, no one other than the individual CPA can determine when impairment of independence in fact occurs. CPAs with the highest ethical standards will act responsibly when they know that independence in fact is at risk. Responsible individual actions are the bedrock of professionalism. Regulations prohibiting certain services because they impair the appearance of independence should be understood and followed, but they cannot substitute for the more fundamental ethical responsibility to remain independent in fact.
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