Independence with Respect to Review Engagements

California CPA magazine: December 2008

by Chuck Landes, CPA

Bankers, lenders and other third-party financial statement users count on CPAs to help small businesses get it right with respect to financial reporting. The AICPA Accounting and Review Services Committee has begun the Reliability Project to explore permitting CPAs to perform certain control activities for their clients, while also expressing limited assurance on the financial statements.

Independence has been a performance requirement for review engagements and a reporting requirement for compilation engagements since issuance of Statement on Standards for Accounting and Review Services No. 1 in December 1978. However, many users of compiled and reviewed financial statements have asserted that the integrity, expertise and objectivity of CPAs are more important than whether they have maintained their independence with respect to a client.

This point was buoyed by “A Proposed Framework Emphasizing Auditor Reliability over Auditor Independence,” an article that appeared in the September 2003 issue of Accounting Horizons. The article contended that independence is a means to an end. The ultimate goal, the authors point out, is reliability. In their view, reliability comes from objectivity, which in turn comes from independence and integrity and expertise.

For more than three decades, the Accounting and Review Services Committee’s (ARSC) compilation and review standards have treated the impairment of independence in the same way. If independence has been impaired for any reason, CPAs may perform a compilation, but are required to report their lack of independence in the report. CPAs are prohibited from performing a review if independence is impaired.

Recently, financial statement users and other stakeholder groups have suggested that the AICPA’s independence rules are, in some cases, an obstacle to helping smaller entities provide reliable financial statements. This happens because CPAs engaged in certain control activities for a company are precluded from performing limited assurance engagements—meaning reviews—for that company.

These independence rules could prove costly to businesses, as they require those businesses to hire two different accounting firms: one to perform the control services and the other to review the financial statements.

The aforementioned suggestions were expressed in many different ways.

First, users have been expressing this directly to CPAs, who then have advised the AICPA. The AICPA also heard this in the responses that were received from the third-party users who responded to the AICPA’s 2005 Need for Independence in Compilations survey.

Also, representatives of organizations that represent third-party users (ABA and RMA) expressly stated this concern to AICPA staff.

Yet the CPA serves as a trusted adviser to many small businesses. Frequently, CPAs compiling or reviewing the financial statements of small- and medium-size businesses also perform other services, such as bookkeeping, payroll or internal control projects.

The ARSC recognizes that third-party users view this as a positive relationship, and has started a project that would permit CPAs to perform certain control activities for their clients and express limited assurance on the financial statements—even in those cases where the performance of the control activities impairs the CPA’s independence.

The Details
This project is not about eliminating the need for independence in a compilation or a review. It’s about repositioning the independence requirement with respect to a review engagement. The concept is simple: Reliable financial statements should be the end game, not independence.

Because of increasing accounting complexities, some smaller entities cannot reasonably be expected to prepare reliable financial statements without their CPA playing an important role in certain internal control activities.

However, CPAs cannot establish or maintain their clients’ system of internal control without it impairing their independence. Once they cross that threshold of control activities, CPAs cannot review their clients’ financial statements. Some smaller entities that need a review of their financial statements for bank financing or for other reasons need to hire a second CPA to review their financial statements, even though their long-time CPA is better suited for the job.
The ARSC has just begun to study and debate the issues involved in revising Statements on Standards for Accounting and Review Services to permit the expression of limited assurance when the accountant’s independence is impaired.

The committee has preliminarily determined that independence impairments caused by relationships or financial interests would continue to preclude the expression of limited assurance. But if independence is impaired because a CPA performs control activities that add reliability to the financial statements, the CPA could perform a review—provided that the CPA has appropriate evidence to support the review report and discloses the services performed in the report.

Any revised compilation and review standards still will treat independence as an important consideration. But for certain impairments (those that are caused by the performance of services or activities that improve the reliability of the client’s financial statements), the standards would no longer preclude a review engagement, but rather require CPAs to report the impairment in their report.  

The ARSC is working toward exposing a new standard in spring 2009 for public comment. 

Chuck Landes, CPA, is the AICPA’s vice president of professional standards. You can reach him at clandes@aicpa.org.

Want More?

All ARSC meetings are open to the public and the materials discussed at those meetings are posted online.
Any questions on this project may be directed to the author or Mike Glynn, AICPA Technical Manager.