Harmonization of Independence Standards for Accountants Around the World
Ethical standards are evolutionary and must change over time. A profession's ethical standards reflect the social, legal, economic, political and cultural norms of a society at a given time. As norms and values and circumstances change, ethics rules must change as well. This comment was made in 1907, but is still relevant nearly 100 years later.
Each of the member bodies in the International Federation of Accountants (IFAC) has its standards, which are based on the circumstances and the social and political environment and shared values of its members. Accountants around the world, however, also share the most basic values of our profession, commitment to the integrity and objectivity which, in the perception of the public, is the cornerstone of our profession. Harmonization of standards would be a major step forward to strengthen the accounting profession and protect the public interest in all countries around the world.
The global business community has changed rapidly over time, and particularly in the last decade. Technology and the growing potential of E-commerce put international business within the reach of small locally based companies as well as larger transnational corporations. Cross-border investments and stock ownership, whether through employee benefit programs or individual investment, are growing at a rapid pace and will likely increase ten-fold within a short period of time. While in the past it was considered unusual for a spouse to be employed in a high-level management role with a client, this is no longer the case. The advent of E-business opportunities, coupled with improvements in telecommunications and increasingly flexible work arrangements, have made the accountant increasingly mobile and able to perform services from a wide variety of places.
The public reliance on the reports of accountants in public practice is a keystone for financial markets. This holds true for publicly traded companies as well as millions of others that are privately held. Government, regulatory and nonprofit organizations also rely on the independence of the auditor as the demonstration of our objectivity and integrity.
The Standard which the IFAC Ethics Committee has recently issued for Exposure defines independence as
- Independence of mind--the state of mind that permits the provision of an opinion without being affected by influences that impair professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional skepticism, and
- Independence in appearance--the avoidance of facts and circumstances that are so significant that a reasonable and informed third party, having knowledge of all relevant information, would reasonably conclude a firm's, or a member of the assurance team's, integrity, objectivity or professional skepticism had been unacceptably impaired.
Both are equally important, but those whose interest lies in protecting the public can measure only independence in appearance. Accordingly, the IFAC Standard proposes to address independence matters with a conceptual approach, which provides broad principles to govern independence. It also provides specific guidance on considering potential threats to independence in particular situations, along with safeguards, which should be considered to minimize the risk that objectivity may be impaired.
The IFAC proposal is compatible with the Common Core of Principles for the Guidance of the European Profession, recommended by the Federation des Experts Compatables Europeans (FEE), in 1998 and Statement of ConceptsóA Conceptual Framework for Auditor Independence exposure draft issued by the Independence Standards Board (ISB) in the U.S. during 2000. This proposal provides a framework, built on strong principles, to identify, evaluate and respond to potential threats to independence.
Five threats are identified:
- A Self-Interest Threat, which occurs when a firm or a member of an assurance team could benefit from a financial interest in or other self-interest conflict with an assurance client.
- A Self-Review Threat, which occurs when (1) any product or judgment of a previous engagement needs to be re-evaluated in reaching conclusions on an assurance engagement or (2) when a member of the assurance team was previously a director or officer of the assurance client or was an employee in a position to affect the subject matter of the assurance engagement.
- An Advocacy Threat, which occurs when a firm, or a member of the assurance team, becomes an advocate for or against an assurance client's position or opinion to the point that objectivity is, or is perceived to be, impaired.
- A Familiarity Threat, which occurs when, by virtue of a close relationship with an assurance client, its directors, officers or employees, a firm or member of the assurance team becomes too sympathetic to the client's interests.
- An Intimidation Threat, which occurs when a member of the assurance team may be deterred from acting objectively and exercising professional skepticism by threats, actual or perceived, from the directors, officers or employees of an assurance client.
The assurance team approach that the Committee has chosen recognizes that the greatest risk to independence comes from the actions and judgment of those who have the most opportunity to influence the engagement. The assurance team includes not only those professionals who directly participate in the engagement, but also all others within a firm who can directly influence the outcome of the assurance engagement. This would include those who have direct management, supervisory or other oversight responsibility for the assurance engagement partner.
The firm must clearly identify and assess the level of risk and put the most stringent safeguards in effect to protect the public interest at the level where it is most likely to cause harm. This approach recognizes the changes in the business and professional environment and structures, which have made arbitrary "across the board" prohibitions throughout a firm and its related entities unworkable and sometimes unenforceable.
Over the last several years, the accounting profession as well as the business community and regulators have developed additional and stronger safeguards to protect and maintain the independence of the firm. These can be broadly grouped into three categories:
- Safeguards created by the profession, legislation or regulation.
- Safeguards created and maintained within the assurance client.
- Safeguards within the assurance practitioner's own systems and procedures.
Safeguards include education and training requirements for entry into the profession, professional standards and disciplinary processes, external reviews of quality control systems, corporate governance structures which include communications with strong independent audit committees, "tone at the top" where firm leadership stresses the importance of independence and the expectation that members of the assurance team recognize public reliance on their work, policies and procedures which prevent individuals who are not part of the assurance team from influencing the engagement as well as many others.
Firms and assurance team members have an obligation, under the principles-based approach, to identify and evaluate circumstances and relationships that may create threats to independence, and to take appropriate action to eliminate these threats or to reduce them to an acceptable level by the application of safeguards. The nature of assurance engagements may differ and consequently different threats may exist, requiring the application of different safeguards. This focus on a thoughtful identification of threats relevant in a particular situation and the development of a tailored plan to safeguard independence for each individual circumstance is likely to provide better protection of the public interest than merely complying with a set of detailed rules. Rules are often arbitrary, may be interpreted differently by various users, and can never address all of the different combinations of circumstances which can occur as the profession continues to evolve rapidly in the years to come.
It is important to recognize that in some situations there will be no safeguard that is adequate to mitigate the risk. For example, it would never be acceptable for an individual on the assurance team to have a direct financial interest in the client or to serve as a director, officer or employee of the client. Likewise, if the firm or a member of the assurance team makes management decisions on behalf of the client, they would not be independent and thus could not perform the assurance service.
In addition to the broad principles, the Code would include guidance on the application of the available safeguards to certain specific situations that commonly occur in practice. These include various types of financial interests, close business relationships with an assurance client, family and personal relationships, long association of senior personnel with clients, issues related to fees and pricing, gifts and hospitality and litigation.
Firms have traditionally provided a range of non-assurance services for which they are well qualified with strong skills and experience to assurance clients as well as others. As the nature of accounting practices and the services we provide have expanded, some have raised concerns regarding whether the provision of non-assurance services to assurance clients could impair independence. The conceptual approach provides guidance for assurance providers to evaluate the circumstances when such services are provided and be sure that appropriate safeguards are applied in order to be sure independence is maintained. The level of threat may differ depending upon the nature of the engagement, whether it is a publicly traded or privately owned company and the extent and nature of the other services performed.
Applications of the principles to specific situations are discussed in relation to specific services including preparing accounting records and financial statements, providing valuation services, internal audit services, IT systems services, temporary staff assignments, acting for or assisting a client in the resolution of disputes or litigation, legal services, recruiting senior management, and corporate finance activities. It is anticipated that as new services develop or as questions arise relating to the application of principles to other specific situations are raised that additional information about specific situations would be considered by the Ethics Committee.
The conceptual or principles approach to independence offers significant advantages to the public, to clients and to assurance providers. The users of assurance reports, and audits of financial statements, including investors, regulators, and creditors, will benefit because principles are straight-forward and more understandable to the public than a maze of different, complex and sometimes unenforceable rules. Audit committees and Boards of Directors will have a logical baseline to frankly discuss independence concerns with their companies' auditors.
Clients will also benefit from a better understanding of how their auditors apply safeguards to mitigate risks. Simplification of the rules will also reduce the costs of identifying potential independence risks and provide for appropriate safeguards specifically designed for the client and the services, which are being performed by the firm, rather than by interpretation of rules, which may not directly apply.
When the public interest and the client interest are benefited, assurance providers benefit also, with less confusion about what independence means and increased public confidence in our objectivity.
Independence for accountants performing assurance engagements is the foundation for the public trust. It is time to recognize the need to harmonize independence standards throughout the world in order to be responsive to the changes in society and business that have evolved since these standards were first established. We are all different, but as a worldwide profession we acknowledge and embrace strong ethical values. The public interest is best served by one set of standards which they can be confident are accepted and enforced on a consistent basis in every country throughout the world.
by Marilyn A. Pendergast, CPA Partner, Urbach, Kahn & Werlin, LLP Chair, IFAC Ethics Committee ,May 2001