Small Firms and the Independence Standards Board

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Small Firms and the Independence Standards Board

In recent years, the SEC has expressed concern about the rapid expansion of consulting services offered by accounting firms. SEC Chairman Arthur Levitt Jr. warned accounting firms against using audits as "loss leaders retained as a foot in the door for higher-fee consulting services" and stated that independence may be impaired if accountants provide management advisory services (MAS) to the companies they audit.

The SEC has good reason to be concerned about the rapid growth of MAS practices within accounting firms. Large consulting engagements increase the client's financial power over the accountant. An accounting firm receiving hundreds of thousands of dollars in consulting fees may be reluctant to enforce a strict accounting interpretation that would anger the client. Providing MAS and audit services to the same client also potentially puts the accountant in the position of auditing the firm's own work. This is especially true when accounting firms are hired to design information systems that they will then audit. Performing consulting services for a client can also impair the mental objectivity and professional skepticism required to perform an audit. Abraham Briloff states, "It should be patently self evident . . . that a firm undertaking the management consulting responsibility has, in effect, allied itself with management and has become an integral part of such management. To presume such a firm could then don the robes of an independent auditor for that enterprise would be to perpetrate a hoax."(1)

In partial response to SEC concerns, the AICPA recently formed the Independence Standards Board (ISB) to establish independence guidelines for accounting firms that audit public companies. The ISB, chaired by William T. Allen, formerly of the Delaware Court of Chancery, has eight members. Four of the members represent the public while the other four members represent "practicing accountants." Unfortunately, it doesn't appear that any of the ISB members represent accountants in small practices.

Accounting firms vary greatly in the mix of services they provide to clients. A recent study published in the July 1997 issue of the National Public Accountant revealed that the average accounting firm earns less than 10% of its revenue from MAS.(2) Many accountants in small firms share the SEC's concern about the propriety of accounting firms providing MAS services to audit clients. The views of practitioners in average firms are not represented on the ISB, however. All four practicing accountants on the ISB are current, or former, top officials with "Big Six" accounting firms. Collectively, the Big Six accounting firms now earn more than 40% of their revenue, and a larger percentage of their profits, from MAS engagements. The accountants on the ISB are obviously committed to maintaining and expanding their firms' consulting practices. …