Introduction
Audit independence is a public policy turned into auditing firms and their clients’ principle. This is so to assure that financial information that serve as the public’s decision criteria to invest their scarce resources are objective and with integrity. Otherwise, a national situation of some form of “cheating” may emerge. We, especially the government, do not like that. In this paper, we will tackle American and Australian versions to implement and guard this principle. Evaluations are inserted for active discussion that ultimately aims to compare these versions, their effectiveness and implications to auditing firms, clients and the public. Information is gathered to web pages of government bodies for the respective countries supplemented by professional organizations.
US Rationale on Non-Audit Services Limitation
The limitation aims to provide investors with financial information from a publicly-listed firm that has reliability and integrity which has undergone scrutiny from auditors. Thus, auditor’s independence from the audited firms are crucial for investors to place their money on such firms and prevent adverse speculations (like collusion or bribery) that can discourage/ delay investments. Such investments have micro- as well as macro-benefits in the economy. Almost half of American households have money in the stock market. Considering this and the reliance of investors to technological advances like Internet, intensifies the need for impartial auditors and strict assurance that the only basis of engaging into risks (FS) is really “impartial” and objective.
As a result, providing non-audit services by auditing firms to their respective initially auditing clients was a long concern to auditor’s objectivity. There could be manipulation and insider’s under-the-table agreement due to dualism of services that may hinder the interests of investors with regards to reliable FS. Because of this, US-SEC firstly considered historical relevance of non-audit regulation as far as 1970s when Congress was unease on independence issue. This is followed by 1994 and 1996 reports from AICPA, US-SEC Staff and GAO relating to same apprehension due to increasing number of services offered by auditing firms. In general, US-SEC had released and adapted non-absolute ban on non-audit services of auditing firms.
The US-SEC took into consideration in analysis before setting the policies the fact that there are two divergent/ opposing issues in the “statement that non-audit services create economic incentives that may inappropriately affect audit.” One side said that when Congress allowed direct transaction and payment between auditing firms and clients, the body also accepted economic benefits that may arise therein.
In contrast, the other side characterized non-audit services as the platform for “self-serving bias” by auditors and will affect behavior away from independence. In addition, one reputable public policy adviser, Earnscliffe, was also acknowledged by the office in its report that increased non-audit services adversely affected investor’s confidence on FS. The office also refused to accept the argument that there should be no restriction to non-audit services due to absence of evidences that prove its departure to audit independence (theory of prophylactic rules).
In general, the restriction of non-audit services applies in condition when: (1) it creates conflicting interest, (2) places accountant in the position of auditing its own work, (3) results in accountant acting as management or employee and (4) places accountant’s advocacy on the client. These restrictions, however, are considered relative to the stance of either the accountant of the audit firm or client.
Major Characteristics of the Non-Audit Limitation (US Version)
Bookkeeping is one non-audit service that is prohibited by the office. The function is considered a managerial function, thus, passing directly condition number 3. However, the prohibition is relaxed at instances where bookkeeping is done to a foreign subsidiary or local division of the client. With this as initial consideration, there is a need to prove other things such as absence of competent employee of the client and impracticality for the client to seek the service other than the audit-accountant.
The assessment, design and implementation of financial information systems of the client should also be limited to its employees and management. This prohibition, however, views the audit quality theory and is willing to limit the restraint to issues wherein the client is performing at the advisee level not the decision-maker on matters pertaining to information systems. Since it is beneficial for audit firms and clients to have the same hardware and software even local area network connections, the office is less restrictive to this respect as long as there is independence to final decision-making.
Appraisal and valuation services are prohibited since this will trigger number 2 condition wherein the auditor evaluates its own valuation criteria despite of the fact the inadequacy of involvement of accountant in the transaction. However, there are several exceptions like when valuation is done to aid clients to forecast future cash flows. This is enforced by the general exception that such specific service is done with fairness opinion (adequacy of consideration) and the results would be a minimal part of clients’ FS and such part of FS will not be reviewed by the same accountant.
Actuarial services that were previously and generally considered as prohibited with regards to insurance firms was relaxed and specified towards such firms’ basic operation and management particularly the determination of company policy reserves and related accounts. This is supported by crucial instances to quote the service a departure to audit independence such as the primary role of management or third party about actuarial strategies and the non-continuous nature of such service.
Internal audit services are deemed restrictive when the client has at least 0 million of assets and outsource more than 40% of internal audit to its audit accountants. The exception is given to small businesses with less than 0 million of assets despite outsourcing internal audit in excess of 40%. The client, however, should have competent internal manager who is responsible in final execution of financial findings although most are outsourced.
The Australian Landscape and Comparisons
In the contrary, Australian (AU) standards approached non-auditing services as quite liberal. The principle does not prohibit auditing firms to conduct non-audit services to their clients. However, the safeguard to prevent impairment of audit independence, which also serves as the rationale behind US regulations however with stricter provisions, should be supported by clients who is required to indicate in their annual report the extent of audit being done and non-audit fees being paid to auditing firms. As noted, this policy falls short of the US since the latter practitioners are bound the disclosure of the nature and the split of non-audit services.
The country based their apprehension not only on the US shocks due to Enron and World Com scandals but also to UK. Internally, regulators also have their concern of another giant insurance crash such as HIH. And like the US, the country also draws much concern to the public’s confidence on FS being made by auditors which have perceived or actual impairment of independent. In effect, intensified scrutiny is regarded as fitted to the current ambiguous situation of the national economy.
The reason of guarding non-audit services in AU stemmed behind monetary rewards that auditors may have when they are performing other services for clients outside their primary duty which is public in nature. This reason is more intensified rationale than the US as non-audit services are considered as the greatest threat to independence. Another, the four conditions that set-up by US-SEC to identify emergence of independence impairment is added by AU with the provision of the presence of intimidation from the part of clients. This supplementary condition is unique to AU.
In comparison with non-audit service that could create threat to audit independence, AU is more general especially when the condition of self-review is observed. Bookkeeping and valuation services (US Version) is summarized by AU under the circumstance wherein the auditor is posing independence threat when it actually prepares original data to be used in financial reporting that itself to be audited by him. Also, self-review AU version includes the threat when a former officer or significant employee of the audit-client will perform non-audit services (as being now an employee/ officer of the auditing firm).
In addition, intimidation applied by the audit client in the AU version implicated that the default could come from the client. This is a departure to the US version unique to AU since non-audit services are now considered vital to the objectivity and integrity principles of the auditing firms. This is, however, in very special cases. Intimidation is the act of the client to delimit the scope of auditors’ actions in evaluating the former FS by pressuring of replacement or reducing fees. When non-audit service is applied, quality is thus compromised.
Unlike US version on remedies of non-audit services that disrupts independence which can be considered as very disciplinary, AU version (as stated above) is lighter. Safeguards are created both at professional, legislation and regulation levels wherein education, inspections and reviews are crucial. There are also disciplinary processes; however, this can be said of extreme cases considering that safeguards are regarded to clients by having competent employees, thus, minimal dependence on non-audit service from auditing accountants. Also, auditing firms are provided with a platform to serve as benchmark to implement and monitor independent and quality. With this forgoing, AU version can be considered as relatively preventive whereas US version is relatively disciplinary.
By examining provisions from the Professional Statement F1, it is observable that audit accountants can perform non-audit services when they have sufficient experience and knowledge to advice, assist and coordinate services in aspects of investments, business recovery, valuation, dispute analysis, investigation, actuarial, and, assurance and business advisory. In addition, as reflected herein, the benefits should accrue to clients and not the accountant or its auditing firm. Also, in the area of tax-related services, there is little restriction or prohibition for accountants to perform.
Should non-audit services be conducted by auditors to their audit clients?
Before answering this question, there is a need to distinguish a developing economy to a developed one and derive implications on the business sector. US and AU are two economic giants of the world unlike Philippines or Mexico who are in developing stages of their economic lives. In effect, informal sector tends to proliferate the latter countries than the former. The formality in the former countries has likely contributed a huge share of their economic affluences. Business actions are coordinated and strategies are policed. As a result, scarce resources are relatively used efficiently, thus, positive externalities (increase in wages, quality of goods, lower interest rates) ensued in the economy. This situation is arguably apparent in micro- and macro-environments.
Such theory can be applied to the relationship of auditing firms and their clients. Formality in their relations will make scarce resources of firms to be used efficiently as well as fulfilling the public task of auditors effectively. This is in consideration that formality connotes professional and ethical standards. Thus, avoiding the dualism role of audit-accountants passes the theory of formality and its advantageous features for both the public, auditing firms and clients. When an accountant exposes itself to economic gains of the profession (including the marginal increase of non-audit service fees), it is also exposing its basic responsibility of creating a risk-free environment to an eager investing public due to manipulated/ distorted FS. As a result, formality is observed when dualism is dropped and singularity is promoted.
This formality theory instantaneously inhibits non-audit service to be conducted. Enron’s financial discrepancies that officially catalyzed into bankruptcy early in the 21st century and stock shock for several investors was a clear evidence that outsider’s role in figuring firm performance and giving a second opinion is very crucial. Considering this, there is no data more vital to outsider analysis than the client’s financial statement. However, even though auditors have full access to FS, unethical or collusion-driven findings would result to the same even more destructive outcomes than having no audit at all. Thus, formality has direct relationship with non-audit service provision since it provides the platform or area by which collusion between the client and auditor may emerge. Professionalism is also cut because in the process of non-audit service the communication between them becomes closer-and-closer up to the point that the interest of the public is blurred by either economic and/or personal gains.
On the other hand, is it also of the public’s advantage when the coordination and systems of firms and auditors are somewhat streamlined to some degree? Efficiency is undoubtedly present when this situation happens. The public may also want not only reliable financial information of a publicly listed firm but also fast findings/ auditors from auditors since the nature of stock market or other capital markets are ambiguous and can change abruptly. The solidified relationship of clients and auditors can make the evaluation faster since auditor can execute in favor of client at times that are really urgent or face substantial loss of opportunity for both the client and auditing firm and public at large. This was considered by both US and AU version.
In direct attack to question, it depends on the structure of the economy and efficiency that can arise in adapting a certain system like absolute or relative limitation to non-audit services. Viewing the US and AU versions, they have allowed non-audit services to auditors as long as the final decision-maker is the client especially on financial matters (US version) and/ or the there are established safeguards for public welfare/ audit independence to be protected (AU version). This disciplinary and preventive approaches of the two countries can be suspected the formality theory where its application rises when an economy is more advanced (US) than the latter (AU). It is a resolution that is designed to be relative to every countries condition particularly its business sector structures.
Personal Resolution and Findings
Auditing profession is so vital for the efficient transfer of public funds to the hands of the business for the former purpose of increasing future wealth, quality improvement of products/ services, among others. Their submission to invest in a publicly listed firm based on bias and unreliable FS evaluation could have micro- and macro-adverse effects. This can range from ineffective saving that would affect households spending that in turn result to impairment of their welfare. Other businesses that are acting in good faith might also loose the opportunity of getting enough capital that would in turn make their products more competitive. In the part of the government, such adverse effects will serve additional funding for public utilities and pump-priming activities as household and business sectors are worse-off at the moment.
Although such scenarios would arguably an exaggeration due to imperfect information between firms, the existence of several professional organizations aggravated by closed operations of firms (except of course to external auditor’s scrutiny) contributes to band wagon effect that would not be monitored by overseeing bodies. Grated that the government and professional bodies are aware of the existence of threat to audit independence in the business sector; can they mitigate the already crippled non-audit services on both legal and professional curtailment? In effect, the tight policies of US are more appropriate to control the excessiveness of independence decline (excessive since isolated cases cannot be easily reprimanded unless through scandal).
This recognition is strengthened by the fact that US-SEC designed the stricter policy for both situations of small and large firms where the former is more vulnerable to indulging in non-audit service to cut costs. Such allowance is conceived to adhere to both justice and order (a very rare combination in a modern society). Although US authorities are very sensitive due to the status of their economy, they do not compromise the rights of small to medium enterprises including other contingent situations (for the part of big companies) that would make non-audit service a very lucrative alternative to internal or outsourcing methodologies.
For the part of AU version, the monitoring of authorities and reporting of clients and auditors make their framework tedious and self-defeating (relative). Non-audit services can be allowed as long as it adheres to efficiency and the winner of such act is the general public. There is also the provision of prohibited acts in order for the discipline to find itself in the minds of auditors and clients. This will then offset the economic/ personal gains from collusion unlike the AU model wherein policies have multi-layered stages to be able to enforce. As a result, it provides the den for independent auditors to act as they are dependent to their “same-kind” firms and collusive clients rather the general public.
Conclusion
Limiting non-audit services to same audit clients is a debate by policy-makers, companies, auditing firms and the public at large. The criticality of audit independence can be suspected as more important in the US than AU considering differences in their regulations. Nonetheless, it is acknowledged that US has an active public investing in capital markets and has relatively bigger economy. Formality theory, thus, took place and dearer to US. Overall, policies should be formed within the framework of the present economic structure including PEST analysis. These are public policies for public welfare and therefore should be externally-stimulated rather than internally-contemplated through bargaining of self-vested large firms and auditing companies.
Bibliography
Electronic Sources
ACSI Newsletter; 2003; Accounting Council of Super Investors; viewed on 11 May 2006; http://acsi.org.au/documents/Newsletter_3.pdf
Auditor Independence and Other Services; 2003; Auditing & Assurance Standards Board; viewed on 11 May 2006; http://www.aarf.asn.au/docs/NewGuidanceNoteMarch2003.pdf
Inform Magazine; 2003; Queensland; Queensland Audit Office; viewed on 11 May 2006; http://www.qao.qld.gov.au/publications/document/Inform10.pdf
Tempone, I & Richardson, A; 2006; Teaching Business Ethics; viewed on 11 May 2006; http://www.gu.edu.au/school/gbs/afe/symposium/proceedings/tempone_richardson.pdf
US Securities and Exchange Commission; 2001; Washington DC; viewed on 11 May 2006; http://www.sec.gov/rules/final/33-7919.htm
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