Auditor Independence: An Impossible Dream
In recent months there has been much discussion about the independence of CPA auditors; the leadership of the AICPA, the Auditing Standards Board, the Public Oversight Board, the Independence Standards Board, and most recently the proposed independence rules promulgated by the SEC have all attempted to clarify and strengthen auditor independence. Several newspaper and magazine articles have also addressed the issue. In my opinion, all the efforts to tinker with rules of stock ownership by relatives of CPAs and restrict the scope of services provided to attest clients will fail to bring auditor independence until the biggest strain of all on auditor independence is acknowledged and properly dealt with—the fact that the client pays the audit fee. The ideal of auditor independence has been clearly stated for a long time. The second general standard of Generally Accepted Auditing Standards states that “In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor or auditors.” In spite of all that has recently been said and written about the matter, I believe the best explanation of independence is contained in Paragraph 2 of Section 220 of Statement on Auditing Standards #1. It states that the auditor “must be without bias with respect to the client under audit”. Further, “independence does not imply the attitude of a prosecutor but rather a judicial impartiality”.
Since the internal auditor is an employee of management and is dependent on management for raises and promotions, it may be argued that he/she will be biased in favor of management. On the other hand, an agent for the Internal Revenue Service may be expected to have a prosecutorial bias. The public accounting profession has held itself out as the group of auditors with the impartial mental attitude. In an ideal world this may be the case, but in reality I will argue that these auditors may be less independent than the other auditors.
In the first place, the CPA auditor is dependent on the client to pay the audit fee. The public accounting profession may argue that losing an audit client is nowhere near as serious as losing one’s job (as might happen to an internal auditor who is critical of management). Indeed, if an auditor has 100 clients all of equal size, it may not matter much if the auditor loses one of the clients. However, if the auditor only has 2 clients of equal size, it is obvious that the consequences of losing a client will be rather serious to the auditor; in this case it would be hard to argue that the auditor is not biased in favor of the client. Perhaps we could agree that if the total fees from a client do not exceed 1% of an auditor’s total billings, that auditor is independent of that client. But what if the total fees from a client exceed 20% (or 10% or 30% or 60%) of an auditor’s total billings? At what threshold does the auditor lose his/her independence? This is an issue that needs to be addressed. Whenever maintaining "good client relations" with a particular audit client is important to the career of a CPA auditor, he/she may be even less independent than an internal auditor. If an internal auditor is fired because he/she has a disagreement with management, the internal auditor has the right to sue for wrongful termination. Management has to bear this in mind when deciding to fire the internal auditor. On the other hand, if an audit client decides to engage another CPA firm, there is no recourse for the audit partner who loses the engagement (and management realizes this in making the decision to engage another CPA firm). Thus, it must be recognized that external, CPA auditors are not necessarily more independent than internal auditors. Some may argue that as long as the fees received from a client are small relative to the total revenues of the CPA firm, independence is maintained. However, CPA firms have to keep...
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