Did consulting services increase unethical behavior in accounting firms

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The accounting scandal on Enron led to SOX 2002. A lot of people claim that the arise of this scandal is due to the lack of independence and conflict of interest in Arthur Anderson while providing consulting services to their audit clients. Hence, the question of whether the rise of consulting services in accounting firm will increase unethical behaviour before SOX 2002 has to be examined. In order to study this question, the definition of consulting services and the role of accountants have to be defined. According to Kuttner, Monroe S, "consulting services are defined as professional services that employ the practitioner's technical skills, education, observations, experiences and knowledge of the consulting process." [1] More precisely, "the AICPA issued the first statement of Standard of Consulting Services (SSCS) in 2002 to assist CPAs to identify what kind of functions made up consulting services." [2] It identifies that there are six main functions of consulting services and their purposes, which include consultation, advisory service, implementation services, transaction service, staff and other support services and product service. [3] Accountants that provide consulting services involve in the business operations or management of their clients, which not only lead to lack of independence and conflict of interest, but it might also ruin the reputation of accountants, as "the underlie value of CPA services are based on the accountants' experience and competence. [Furthermore], another principal component of worth, namely, independence, was also identified" in order to build the reputation of accountants. [4] Moreover, "Chairman Arthur Levitt asserts that independence is the core of the accounting profession…the space to think, to speak, and to act on the truth. And truth is the lifeblood of investor confidence." [5] The value of independence ensures that accountants, especially the auditors, will be able to serve the public's interest by providing a free-of-basis audit opinion. However, consulting services in accounting firm might eventually affect the independence and lead to conflict of interest, and therefore it is important to examine the question whether the rise of consulting services in accounting firm will increase unethical behaviour before SOX 2002.

History of the rise in consulting services

According to Stephen A Zeff, he reported that "from the earliest days of profession, accounting firms rendered consulting services. By the 1910s, [accounting firms] included the installation of factory costs systems… But accounting, auditing, and taxation constituted the solid core of the firms' services" [6] However, after the Second World War, many major accounting firms have begun to expand beyond their traditional services to the new lines such as management services, management advisory services or administrative services. [7] This is the time when people started to concern about the independence and ethical behaviour in accounting firm. Later on "in the early 1980s, the Big Five had begun expanding their services in consulting and has exceeded that of most industries, with the possible exception of the software and telecommunications fields." [8] Moreover, in 1991, Lentini, Fern wrote an article on the Journal of Accountancy on "CPAs can improve their clients' business and their own firms by offering business advice." It argued that it is important for CPA firms to develop and attract new business due to the loss of market share and the high competitions and high costs. Furthermore, professional stated that only providing traditional services in accounting firms is not enough to compete in the market. Hence, it is important for "individual practitioners and small to mid-size firms that have not already done so must develop new areas of business consulting while retaining their passion for numbers and financial statements." [9] As a result, more accounting firms started to provide a greater variety of services to their clients including consulting ever since.

Impact of accounting firms

Accounting is viewed as a profession rather than a business. However, due to today's competitive market, accounting firms have been expanding their traditional services into consulting. Since consulting services have a lower cost compare to other accounting services such as auditing, and additional revenues are generated by such expansion. "In 1984, the consulting fees in the Big Eight firms from the mid-1970s had increased a percentage of total gross firm fees from a range of 5% to 19% in 1977, to a range of 11% to 28% in 1984." [10] "Even by 1978, six of the Big Eight firms placed in the top 10US consulting firms in terms of gross billings for consulting services." [11] The high earnings from consulting services lead to increasing concerns about the impact of consulting services in accounting firm. The public and certain professionals argued that the rise of consulting services impaired the value of independence and changed a profession into a business; however, on the other hand, there were professionals argued that consulting services had more benefits to accountants than just increasing the firms' revenues. Firstly, Mednick, Robert, and Previts, Gary John claimed that "the questions of maintaining independence and auditing work for a client who regularly seeks the accountants' advice upon management problems or for whom various other management services are rendered, it is probable that all doubts as to complete independence cannot be avoided." [12] Although an accounting firm cannot be fully independent, they should still try to minimize events that will affect their independence in order to maintain the core values of an accountant. Hence, accounting firms should try to minimize or spin off the consulting services into an independent department in order to maintain the firm's independence. Besides the arguments regarding the impossibility for an accounting firm to maintain independence, "practicing accountants argue that the provision of non-audit services does not impair auditors' independence because they have strong economic and legal incentives to remain independent and preserve their reputations. In addition, they maintain that non-audit services improve the quality of audits as auditors become more knowledgeable and develop greater expertise concerning the clients' businesses and operations." [13] Although there are strong economic and legal incentives for accountants to remain independent and preserve their reputation, the economic bond between the accountants and clients also create incentives for them to participate in unethical behaviours in order to secure their relationship with the clients. Furthermore, as an accountant, it is important for them to continue to develop their knowledge to maintain competence. Even though auditors can become more knowledgeable and develop greater expertise on client's businesses and operations through providing non-audit services such as consulting, it is not the only way for accountants to develop their ability. They are able to gain relevant knowledge by reading, conducting research and implementing professional development while simultaneously maintaining their independent. Furthermore, "previous studies contend that both audit and non-audit services may create the same incentive effects on auditors, and that independence might also be impaired when both audit and non-audit services constitute profitable business for the auditor" This shows that not only non-audit services will impair independence, but so do audit services when there is a fee associated with them. Hence, any type of accounting business will impair independence, and therefore consulting services is not be the only reason that contributes to the rise of unethical behaviour in accounting firm.

According to the AICPA's Professional Standards, CPA is required "to retain their integrity and objectivity in all phases of their practice and, when expressing, opinions on financial statements, avoid involvement in situations that would impair the creditability of their independence" [14] However, consulting services create economic bonds between auditors and the clients which impair the value of accountants. In auditing, accountants have the responsibility to serve the public interest and perform their work on behalf of the public. On the other hand, in consulting services, accountants perform their work to serve best interest of their clients where they provide opinion and advices based on their knowledge and according to the clients interest. If the accountants provide advices and audit for the client at the same time, it will lead to conflict of interest. Consulting services also affect independence in that the interaction between the accountants and clients by providing services out of their scope created tight relationship between the two parties.

In 1984, before the well-known accounting scandal, Simunic, Dan A wrote a research paper on "Auditing, Consulting, and Auditor Independence. It indicated that there is "one research team [which] examined the association between level of non-audit and both the magnitude of discretionary accruals and the company's tendency to just meet or beat analysts' forecasts, concluding that high levels of non-audit fees significantly impair auditor independence and reduce the quality of earnings." [15] Furthermore, it also provided evidence that clients who purchase non-audit services from their accountants paid significantly higher non-audit fees than audit fees. Since non-audit fees are higher than the auditing fees, there is an intention for the accounting firm to focus more on non-audit services such as consulting and maintain an significant relationship with the clients in order to capture the non-audit business. Hence, the significant profit to the accounting firm that gain by consulting services will eventually impair the accountants' independence with the clients. This will also increase the risk of unethical behaviour.

Accounting case

Enron, one of the high-profile scandals in accounting industry, which happened in 2002 has led to the great concern about the independence of consulting services and audit. The bankruptcy on Enron is mainly due to two reasons: 1) the failure to disclose related-party transaction, 2) Arthur Anderson, Enron's auditor "received more than half of its Enron revenue from consulting services which gives an appearance of lack of independence." [16] In Enron, they used off-balance sheet partnerships to hide losses. Enron used 3,500 special purposes entities (SPE) to try to cover up their losses. These SPEs were managed by Enron employees and funded by Enron stock which should be reported and disclosed as related-party transactions. Furthermore, the SPEs have no legitimate business purpose and were used simply to improve the appearance of the health of Enron. Since these SPEs are connected with the stock of Enron, hence the stock price determined whether the debt can be covered. If the stock price increases, the debt will be covered, however, on the other hand, if the stock price drops, the debt will be uncovered which leads to the failure of the company. Besides the inappropriate accounting treatment on the SPEs, another important reason for Enron's failure was the lack of independence of the auditor. Arthur Anderson had received $27 million from Enron as consulting fees while earning $25 million from auditing Enron. [17] The amount that they received from consulting was more than auditing fees. Although "the company claimed that the consulting revenue did not affect any of their audit decisions, ..., to the public, the independence in appearance is impaired when one firm provides both audit and consulting services." [18] As a professional accountant, they should have maintained their independence both in appearance and in fact. In Enron, Arthur Anderson that generated such large amount of revenues from both auditing and consulting from Enron made the public think that they were not independence, hence, this lead the company to be treated as not independence in appearance and should not perform audit services to Enron. This well-known accounting scandal led to SOX 2002 to address public's concern over independence issue arise from consulting services in accounting firm.

SOX 2002

The Sarbanes-Oxley Act of 2002 (SOX 2002) became effective after the famous Enron accounting scandal. In one of the titles in SOX, it provides specific requirements and standards for auditor independence. It limits conflict of interest and address on auditor rotation, auditor reporting requirements and it also restricts accounting firm that provide auditing to provide non-audit services for the same clients similar the Enron case. In Section 201, it provides a descriptive list that consisted prohibited non-audit services such as "bookkeeping or other services related to accounting records or financial statements of audit client, financial information systems design and implementation, legal services and expert services unrelated to audit [etc.]". [19] This rules clearly identify that accounting firm with auditing services cannot provide other accounting services to the same client in order to maintain independent and avoid conflict of interest. Furthermore, "the Commission's principles of independence with respect to services provided by auditors are largely predicated on three basic principles, violations of which would impair the auditor's independence: (1) an auditor cannot function in the role of management, (2) an auditor cannot audit his or her own work, and (3) an auditor cannot serve in an advocacy role for his or her client." [20] These principles lay out the basic events that will impair auditor's independence and provide a guideline for the auditor to be as independent as possible. The SOX 2002 and the Commission's principles regulates the relationship between consulting services and accounting firm which address the public awareness on accounting firm's independence.


In today's competitive business environment, accounting firms will try their best to maintain and expand their client base in order to stay competitive in the industry. Hence, this leads to the rise of consulting services. This expansion raises concerns regarding whether unethical behaviours will arise as a consequence. Due to the fact that accounting firms can gain more revenue from non-audit services, it creates a trend for firms to focus on maintaining the client's interest instead of the public's interest. This leads to conflict of interest and breach the Code of Professional Conduct. Furthermore, consulting services impair independence which is one of the most important values of accountants. The more connection and the stronger the economic bond between the clients and accounting firm, the more likely the firm will be lacking independence. Although consulting services might not directly lead to unethical behaviour, however, it increases the risk of unethical behaviour. Hence, SOX 2002 comes into place to prevent any other similar accounting scandal like Enron.

Beside SOX 2002, in November 2002, "the SEC adopted new rules that prohibit accounting firms from providing certain non-audit "consulting" services to their audit clients. The rule also requires public companies to disclose in their proxy statements the fees paid to their independent auditors for audit and non-audit services." [21] Furthermore, according to Codes of Professional Conduct, it also clearly indicates that accountants have to be maintaining independence in fact and in appearance. Since consulting services bring up huge concerns and lead to accounting scandals, rules and regulations are gradually created to limit non-audit services that accounting firm can provide and decrease the risk of unethical behaviour that will potentially arise from consulting services.