Take a quick glance at a dictionary, and you’ll find in-de-pen-dence; noun, the state of being independent. A bit of additional perusal leads to the understanding that someone who is independent is “not dependent,” or not subject to control by others.
This seemingly simple definition has led to much discussion. In fact, volumes have been written on the topic of independence as it relates to certified public accountants and their clients.
Statements on Auditing Standards No. 1, Section 220 (also known as AU Section 220), requires independence when attest services are being performed. And the professional standards of the American Institute of CPAs do not stand alone with respect to independence.
Often the Public Company Accounting Oversight Board, U.S. Securities and Exchange Commission, U.S. Department of Labor and Government Accountability Office provide more restrictive guidelines.
Independence comprises independence of mind and independence in appearance. An auditor must be without bias with respect to the client and matters at issue.
As noted in U.S. Auditing Standards, “Independence does not imply the attitude of a prosecutor but rather a judicial impartiality that recognizes an obligation for fairness not only to management and owners of a business but also to creditors and those who may otherwise rely (in part, at least) upon the independent auditor’s report, as in the case of prospective owners or creditors.”
In the simplest of terms, in all matters relating to an audit assignment, the auditor or auditors are to maintain independence in mental attitude at all times during the period of the professional engagement.
When certified public accountants are not independent, they cannot perform certain services for clients. And if a lack of independence arises during an engagement, the CPA must withdraw.
Indeed, a CPA lacking independence with respect to the performance of attest services violates professional standards, which could, in the most extreme cases, result in loss of licensure. From the perspective of the entity being audited, an audit not performed under applicable standards is not really an audit, which means additional costs and delays may result.
What are the practical implications of auditor independence? Both auditors and clients should take care not to run afoul of the requirements.
An auditor may not take on the role of management in any fashion and should not do the following:
- Authorize or execute transactions
- Prepare or make changes to original source documents
- Supervise client employees performing routine duties
- Assume custody of client assets, including maintenance of bank accounts
- Hire or terminate employees
In addition, the auditor may not approve invoices for payment, sign payroll tax returns on behalf of an audit client, design a client’s fiscal management system or establish a system of internal control.
Each of these prohibitions has given rise to confusion and debate – so much so that an entire audit interpretation several dozen pages in length has been written providing additional analysis and explanation.
One of the most common areas of confusion deals with non-attest services an audit client may request a CPA to perform – and the point where the line between independence and lack thereof should be drawn.
Take for example the scenario in which an audit client wishes to have the external auditor involved in an executive or employee search. AICPA Independence Standards would allow the auditor to recommend a position description, screen candidates based on client-approved criteria or act in an advisory capacity with respect to salary and benefits. Independence would be impaired if the CPA were to commit the client to compensation or benefit arrangements.
In terms of bookkeeping services, independence would not be impaired if the auditor were to post client-approved entries to a client’s trial balance, but it would be improper for the auditor to determine or change journal entries, account codings or classification of transactions without obtaining client approval.
It’s important to note that the client must actually understand and accept responsibility for approval in order for independence not to be impaired.
Of course, independence stretches far past bookkeeping services. Specific restrictions prohibit the audit partner, members of the audit team or audit firm from having or making an investment in an audit client or serving on a client’s governing board. The mere existence of such relationships is not the only consideration, but certainly a red flag that impairment of independence might be at issue.
Numerous other factors including pending or threatened litigation, hiring of past audit professionals, existence of alternative practice structures and certain loan situations must be considered in the greater context of client/auditor relations.
When considering independence, both the auditor and the audited organization should pay close attention to potential threats to independence and any safeguards they can rely on. After all, independence is of utmost importance to the profession and the general public.