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Feb 1993

Consulting services and CPA firms. (Auditing)

by Read, William J.

    Abstract- Providing consulting services has become quite common for CPAs in public practice. To avoid confusion as to what responsibilities constitute consulting services, the American Institute of Certified Public Accountants published the first Statement on Standards for Consulting Services (SSCS). Entitled 'Definitions and Standards,' the statement also addresses the controversial issue of auditor independence which concerns CPAs providing consulting services to attest clients. Critics argue that excessive involvement in consulting engagements with attest clients can impair auditor independence, which is a distinctive characteristic of the profession and a basic element of the accountant-client relationship. In addition to seeking guidance from the SSCS, the public accounting profession can achieve auditor independence and calm critic's concerns by adopting several initiatives. Some suggested measures are briefly discussed.

The new statement also discusses auditor independence and the performing of consulting services for attest clients--an issue that has concerned CPAs and observers of the accounting profession for some time. The SSCS states that the AICPA's independence standards relate exclusively to the performance of attestation services and that consulting for an attest client does not, in and of itself, impair independence. However, the standard does advise CPAs that there may be some cases where professional and regulatory agencies disallow supplying consulting services to attest clients.

The Independence Issue

Independence is a hallmark of the public accounting profession and an important component of the professional relationship between CPAs and their clients. It is one of the primary reasons why users of financial statements value the opinions of independent accountants concerning the proper application of GAAP to client financial statements.

While the phrase "auditor independence" has been difficult for professional and regulatory bodies to define precisely, the AICPA's Professional Standards state that "independence has traditionally been defined by the profession as the ability to act with integrity and objectivity." They refer to objectivity as the "CPAs' ability to maintain an impartial attitude on all matters which come under his or her review," while integrity is defined as "an element of character which is fundamental to reliance on the CPA." The standards require CPAs to "retain their integrity and objectivity in all phases of their practice and, when expressing opinions on financial statements, avoid involvement in situations that would impair the credibility of their independence."

On several occasions during the past two decades, congressional legislators have raised questions about whether CPAs can remain independent when they perform consulting services for attest clients. The Metcalf and Moss subcommittees in the late 1970s and the Dingell subcommittee in the mid-1980s conducted hearings on the issue, but found no instances where auditor independence had been impaired following the rendition of consulting services.

For its part, the accounting profession also initiated several inquiries into the impact of CPA consulting services on auditor independence. The matter was investigated by the Cohen Commission in 1978, by the Public Oversight Board (POB) of the AICPA's SEC Practice Section (SECPS) in 1978, 1979 and 1986, by the Special Committee on Standards of Professional Conduct for CPAs (Anderson Committee) in 1986, and by the National Commission on Fraudulent Financial Reporting (Treadway Commission) in 1987. None of these studies found any instances where independence had been diminished as a result of performing consulting services. However, CPAs were urged to be aware that consulting for attest clients may be perceived by some as an impairment of auditor independence.

One of the concerns some critics raise about CPA consulting services and their impact on the appearance of auditor independence relates to the magnitude of such services as measured by the fees received. If CPA consulting services are provided in extensive amounts to attest clients, critics argue that auditor independence might be jeopardized. However, in cases where CPAs supply their audit clients with minimal consulting services, such concerns are not raised. The performance of consulting services for non-attest clients is not considered an issue.

Magnitude of CPA Consulting Services

The SECPS requires data on CPA firms' consulting services engagements. Since 1982, member firms have had to disclose certain information regarding consulting fees in their annual reports filed with the SECPS. The information consists of the number of SEC audit clients for whom the percentage of consulting services fee to annual audit fee falls into each of the following ranges: 0-25%, 26-50%, 51-100%, and over 100%. The first category has been subdivided into 0% and 1-25% since 1986. Firms must report the proportion of gross revenues earned from the rendition of accounting and auditing, tax, and consulting services to all clients and to SEC audit clients only.

To evaluate the criticism of those who have expressed concern about an increasing emphasis on consulting services by CPA firms, copies of the annual reports filed by the 15 largest CPA firms covering the years 1982-1990 were analyzed. These practice units were used in the analysis because they are widely recognized in the profession and in the marketplace as having the resources to provide consulting services. These firms serve as independent auditors for the vast majority of SEC registrants--publicly held companies that may be likely to use consulting services.

On average, consulting services contributed 17% of the firms' revenues while the proportion of fees derived from accounting and auditing and tax services was 59% and 24%, respectively, over the nine-year period ending 1990. The proportion of revenues earned from rendering accounting and auditing, tax, and consulting services to SEC audit clients over this same period on the other hand was 79%, 14%, and 7%. Consequently, the percent that consulting services contributes to total fees from public audit clients is less than half of the corresponding proportion from all clients (7% as compared to 17%).

The data show that despite the public accounting profession's increased emphasis in supplying consulting services, the largest practice units are still very much auditing firms. In both the SEC audit client market and the all client market, accounting and auditing remains the core of the firms' businesses. Revenues from these services made up over twice the revenues from either of their other two service lines (tax and consulting). This finding underscores the firms' commitment of resources to their traditional accounting and auditing practices.

More Compelling Evidence

Further insight into the magnitude of CPA consulting services can be obtained by analyzing the firms' average number of SEC audit clients for whom the ratio of consulting services fee to audit fee fell into the 0- 25 percent category for each of the years 1982-1990. For the 15 CPA firms whose consulting services fee data were analyzed, in each year the proportion of SEC registrants audited by the member firms that either were not rendered consulting services or, for which the consulting fee was less than 26% of the audit fee exceeded 90%. Based on this analysis, it would seem difficult to understand why the accounting profession faces any criticism of its scope of practice, particularly when for more than nine out of ten public audit clients the audit firms performed little or no consulting services.

The argument that the profession should not face a serious independence concern seems even more compelling when data regarding the number of SEC audit clients for whom no consulting services were rendered in each of the years 1986-1990 are analyzed. These additional disclosures show that, on average, 84% of the firms' SEC audit clients in the 0-25% consulting fee/audit fee category did not purchase any consulting services from their incumbent auditors.

When considered collectively, this data make a very persuasive case that the performance of consulting services at existing levels is not a serious threat to independence. However, some observers continue to believe that the growth of CPA consulting services creates potential problems. To address the issue, the profession can implement several initiatives that may help to ease critics' concerns.

A New Framework for Auditor Independence

The current maze of rules and regulations that attempt to define independence may actually thwart the ability of practitioners to serve effectively the public interest and to perform a wide range of professional services for their clients. Despite the best intentions of the profession and regulators to address complicated issues, current independence requirements may be tantamount to a minefield through which CPAs find it virtually impossible to traverse without triggering concerns about independence. In response to these concerns, a special task force of the AICPA has begun to develop a new framework for auditor independence that intentionally lacks detailed rules and requirements. It is the goal of the "Special Committee on Concepts of Independence" to develop fundamental concepts of independence that could become the foundation by which individual CPA firms would establish specific rules and policies of independence. Peer reviewers would evaluate whether firm policies and procedures are consistent with the overall framework and if so, whether firm personnel have complied with them.

The new principles would be grounded in the AICPA's Code of Professional Ethics and as such, would emphasize the auditor's state of mind and the need to act with integrity and objectivity in all matters. The notion of the auditor's state of mind is at the heart of making sound, ethical, and independent judgments in all financial reporting and auditing issues.

When it is completed, the new code of independence could help to bring the profession "back to basics." Since it will not have the trappings of detailed rules, it may also help to minimize future perception problems that can arise when CPA firms perform consulting engagements. To the extent the new framework assists in changing the mindsets of those who historically have been critical of CPA consulting services and their impact on the appearance of independence it is a step in the right direction.

Other Steps to Help Assure the Appearance of Independence

The profession has undertaken additional steps that may enhance the appearance of independence. One involves an extension of the original peer review process as it applies to SECPS number forms.

Current peer review standards require a triennial independent examination of a firm's quality control system through, among other things, a review of a representative sample of its accounting and auditing engagements. Under the extended requirements, peer reviewers must also now evaluate the consulting services rendered to selected SEC audit clients, first, to determine that such engagements were not proscribed by the SECPS; second, to make sure the engagement personnel did not function in a capacity equivalent to management; and finally to consider whether all significant accounting, auditing, and reporting judgments seemed to be objective. In addition, peer reviewers must be apprised of all public company audits where fees for consulting services exceed audit fees and, if any such situations exist, choose at least one such engagement for examination. This situation only occurs in approximately one percent of all SEC registrants.

No Evidence of Foul Play

In the thirteen-year history of the peer review program, review teams applying these procedures to selected consulting engagements performed for SEC registrants have not developed any evidence which indicates 1) that rendering consulting services has impaired a firm's independence or objectivity or 2) that any proscribed consulting services have been rendered. By any measure, it would seem that the profession has developed a comprehensive self-regulatory system. In the interest of further deflecting criticism that the performance of certain consulting engagements may impair the appearance of auditor independence, the peer review program could consider selecting a larger sample of accounting and auditing engagements for which the firm also rendered consulting services. Furthermore, in selecting consulting engagements for testing compliance with the independence requirements, reviewers might contemplate giving greater weight to engagements performed for SEC audit clients for which consulting fees exceed audit fees. While these proposals would need to meet a stringent cost-benefit test, their implementation would represent additional evidence of the profession's commitment to ensuring auditor independence when performing consulting services.

Other ways the appearance of auditor independence could be enhanced involve measures designed to assure that CPAs do not assume a management responsibility when performing consulting services for attest clients. Some steps the profession might consider to help assure that CPA consultants function in a nondecision-making capacity are:

* A statement in correspondence with the board of directors and/or the audit committee that distinguishes between management operating in a decision-making capacity and CPA consultants acting as business advisors;

* Work schedules that clearly delineate the client's managerial obligations and the CPA consultant's advisory duties;

* A record of the decisions required of and made by management as they relate to the consulting project;

* Periodic meetings with the client that coincide with the completion of significant project milestones. These meetings could be used to reiterate the client's decision-making role and the CPAs advisory function as well as to evaluate the client's managerial expertise to perform required duties and to oversee the operation of the entire project.

The Stakes Are High

Independence is perhaps the single-most important attribute that the CPA brings to the relationship with his or her client. Independence and the appearance of independence must be preserved at all costs.

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