The Reliability Framework Project: A New War for Independence?

Donít grab your musket yet, but a new war for independence may indeed be breaking out in the accounting profession.

November 3, 2008
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According to the Code of Professional Conduct of the American Institute of Certified Public Accountants (AICPA), in order for a CPA to perform an audit, review or compilation of a client’s financial statements, the CPA is required to be independent in both fact and appearance of that client. Independence means that the CPA holds no direct or indirect financial interest in the client and has not performed services for the client that would be construed as making management decisions or functioning as part of the client’s system of internal control. Inherent in this definition is the concept that it could not be construed that the CPA would be biased or lack objectivity in favor of the client due either to potential financial incentives or due to services provided.

The Issue

Since their introduction in December 1978, compilation and review services have been important to small, privately held businesses whose limited resources often prevent them from being fully self-sufficient in terms of having the in-house expertise to prepare financial statements that are fully compliant with generally accepted accounting principles (GAAP). These companies frequently seek out the assistance of their independent CPA to assist them with this endeavor. Therein lies the problem. Under current ethics rules that bind CPAs, the CPA is not permitted to serve in a capacity that would result in that CPA being considered part of the client’s system of internal control over its financial reporting.

The Proposal — The Declaration of Non-Independence

In September 2003, an article was published in Accounting Horizons, a quarterly journal, in which the authors made a number of interesting, though somewhat controversial, assertions regarding independence. The authors concluded that CPAs can never truly be independent as long as the client pays their fees. They further asserted that, while independence is an important consideration, the profession has placed undue emphasis on it and that a better alternative would be to place greater emphasis on reliability. Thus, the customer/consumer of financial information should be asking the question, “How reliable is the CPA who is reporting on these financial statements?” The authors believe that reliability is a function of objectivity, expertise, integrity and independence and that a CPA can provide reliable services even if that CPA is not entirely independent.

The AICPA’s Audit and Attest Standards Team asked the Accounting and Review Services Committee (ARSC) if it would be interested in pursuing this framework as being viable for compilation and review engagements. ARSC responded by forming a “Reliability Task Force” comprised of a cross-section of practitioners, financial statement preparers and third-party users of financial statements. Notably, two of the members of the Task Force were co-authors of the Accounting Horizons article. The Task Force was charged with considering the viability of this framework and making recommendations to ARSC regarding its potential applicability to compilation and review engagements.

The Warning Shot

The original article and subsequent deliberations did not go unheeded by the National Association of State Boards of Accountancy (NASBA). On June 9th, 2006, the Chair and the President/CEO of NASBA wrote a letter to the then-Chair of ARSC, firing a regulatory warning shot. In that letter, NASBA unequivocally stated that its committee that examined this issue “…believes that concluding that independence is not needed for reporting on a compilation is not in the public interest.” The letter went on to suggest that ARSC consider the possibility that individual state boards of accountancy might not concur with the new framework and thus would subject non-independent CPAs that compiled (or reviewed) financial statements to disciplinary action under their state accountancy laws and regulations.

The Battle Lines

In March 2008, the Task Force issued its Recommendations of the Reliability Task Force, Consideration of an Alternative Framework for Compilation and Review Engagements. The recommendations include categorizing current independence requirements into different types.

Type of Independence Threats to Achievement
Relationship Family member of CPA serves in a key management position at client
Financial CPA holds a direct or indirect financial interest in the client
Control Services CPA performs services as part of the clientís internal control system

The Task Force believes that, even if the CPA’s independence were to be impaired due to the performance of certain nonattest control services, the accountant should still be able to express limited assurance with respect to the client’s financial statements provided that it could be demonstrated that the CPA maintained objectivity and provided reliable services.

At its August 6 – 7, 2008 meeting, ARSC requested that the Task Force draft a document that would propose to operationalize the new framework in the context of compilation and review services. The first draft of the proposal is expected to be discussed by ARSC at its November 5 – 7, 2008 meeting in Miami, Florida. It will be interesting to see what happens as this discussion continues. All interested CPAs should be following these developments closely as they could have a substantial impact on their ability to legally and ethically provide services that up until now had been prohibited.

— From the accounting and auditing specialists at AuditWatch, part of the CPE & Training Solutions available from the Tax & Accounting business of Thomson Reuters. Copyright © October 2008. To learn more about AuditWatch, visit trainingcpe.thomson.com/AuditWatch.