Magazine article The CPA Journal

Advocacy and Independence

Magazine article The CPA Journal

Advocacy and Independence

Article excerpt

I have followed with some interest first the SEC'S 2002 attempt to restrict tax services that auditors provide their clients and, more recently, the deliberations of the PCAOB and its Standing Advisory Group (SAG). This is an interesting problem because, on the one hand, CPAs have for a long time demonstrated their value as tax preparers and advisors, and, on the other hand, the advocacy relationship at the heart of tax services runs counter to the independence expectations for auditors. This problem persists in part because the basic advocacy approach of CPAs to tax services was formed before the securities acts of 1933 and 1934, which changed the fundamental nature of accounting and auditing but did not affect taxation.

The Proprietary Perspective

Before the securities acts, the proprietary theory of accounting guided financial accounting. The job of the accountant was to value the ownership interests of the proprietor, usually for distribution or settling-up purposes. Under this approach, the accounting was performed from the perspective of the proprietor, which was effective and efficient until the dramatic expansion of the American domestic capital markets in the first quarter of the twentieth century rendered the identification of the proprietor essentially impossible. Accountants were independent of management and accounted objectively for the proprietary interests, from whom they were not independent.

The separation of management and ownership in the American public company, coupled with the diffusion of ownership and the ready transferability of ownership interests, created fundamental problems with the accounting model. The changes to the model in the late 1930s involved focusing on accounting for the transactions of the entity rather than the ownership interests of the proprietors. Without a defined perspective to guide the accountant, there arose a demand for standardizing the accounting for transactions by different entities.

Changing Meaning of Independance

In this new environment, the meaning of independence also changed because accountants no longer could point to a proprietary interest for which they were the agent. Instead, they began to adopt a neutral position, still reflected in the Code of Professional Conduct, in which serving the public interest means that they take no one party's interest. Although some of these ideas about entity accounting and independence as complete neutrality existed before the securities acts, they were not necessarily generally accepted.

The Sixteenth Amendment passed in 1913, 20 years before the securities acts of 1933 and 1934. Because the amendment gave the federal government power to tax incomes, it was natural for the relatively new profession of accountancy, whose primary purpose was to account for income to be distributed to owners, to become involved in the preparation of tax returns and in the rendering of tax advice. …

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