Independence and Public Perception: Why We Need to Care

Abstract

Rule 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. …