Examining the integrity of professional accountants

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High profile corporate collapses and fraud, with which accountants have been associated as auditors, executives and directors, have prompted searching questions to be asked as to the integrity of the professional accountants involved (Clarke et al., 2003). These collapses or systemic failures, as the broad range of financial scandals exposed in the early years of the 21st century have been labelled, have brought into sharp focus and over a more concentrated timescale, issues of long-standing debate including: audit and accounting regulation; auditor independence; earnings management; and audit and audit firm quality controls.

Ethics have been shown to have assumed an increased importance in organisations, which are now subject to scrutiny and criticism from the media, regulators, and public interest groups (Axline, 1990).

However, the scandals of the early 21st century provided evidence that the commercial interests of large firms of accountants had overwhelmed the allegiance to professional integrity (Boyd, 2004).

This monopoly is defended by the profession on the rounds of the profession's superior qualities of independence, integrity, and of serving the public interest. The relationship of these characteristics to ethical behaviour is central to much of the criticisms levelled at the profession over the past 25 years.

The strands of the literature reviewed for the current study include: business ethics; professional ethics; financial reporting and auditing; sociology of work and the professions; histories of the accounting profession and professional bodies; examinations of the relationship between institutions of accountancy and the professionals, explorations of the meaning and interrelationships between a profession's authority, its responsibility and its independence; and theories of accounting regulation. These have all contributed to the current body of literature relevant to the topic of 'ethics and professional accounting firms'.

This research often relies on proxies for phenomena that cannot be measured directly and is therefore subject to limitations

Code of ethics:

A profession's code of ethics is perhaps it's most visible and explicit enunciation of its professional norms. A code embodies the collective conscience of a profession and is testimony to the group's recognition of its moral dimension.

Frankel, M S (1989), 'Professional Codes: Why, How and with What impact?', Journal of Business Ethics, Vol.8(2/3), pp.109-115.


As noted by Fischer and Rosenzweig (1995, p.434):

Accountants perform the crucial function of preparing organisational statements which are fair representations of the organisation's financial status; they are in effect gatekeepers of the public trust in our institutions. Therefore, it is crucially important that members of the accounting profession have a reputation of solid integrity, and that this reputation be deserved.

Auditor independence

According to Ponemon and Gabhart (1990, p.228), the characteristic of 'auditor independence' conveys to the general public 'an image of an auditor having professional integrity, honesty and high moral calibre'.

Independence is believed by the APB (APB 2004, ES1, paragraph 12) to underpin objectivity and:

Whereas objectivity is a personal behavioural characteristic concerning the auditors' state of mind, independence relates to the circumstances surrounding the audit, including the financial, employment, business and personal relationships between the auditors and their client.

Antle (1999, p.9) goes on to say:

If auditors' activities create independence problems, economics suggests a cost-benefit test: Do the benefits to society of the auditors' activities outweigh the costs due to impairment of independence? If the benefits outweigh the costs, we are better off with these activities than without them.

A moral framing of independence sees auditors as professionals, with obligations to the public.

Antle goes on to argue that the rewards and obligations of auditing are part of the auditors' incentives and that it is a matter of efficiency, rather than vocation, that society demands an element of professional conduct from auditors.

Historically, the independence of the auditor was one of the cornerstones of the accounting profession's ethos, and certainly today, the profession would claim that its importance has not diminished (APB, 2004).

Beattie et al. (1999) suggest that independence has two distinct dimensions, independence in fact and independence in appearance, and that both are fundamental to public confidence in financial reporting. Independence in fact is the unbiased mental attitude of the auditor. Independence in appearance is the perception by a reasonable observer that the auditor has no relationship to the audit client that suggests a conflict of interest.

Since independence in fact is unobservable, research in the area of auditor independence has focused on identifying factors that influence independence, both positively and negatively, and on assessing their impact upon perceived independence.

The primary economic factor is the provision of NAS to audit clients, and this is complicated by the degree of dependence by the auditor on the audit client and the level of competition in the external audit market.

Auditor independence is perceived to be compromised if the auditor is economically dependent on client companies either because the audit is too valuable to lose in its own right, thereby weakening the auditor's ability to stand up to client management in a significant disagreement, or because it is too valuable to lose because of the lost opportunity to provide other services to the client.

Fees to audit firms from NAS have been rising more rapidly over time than audit fees (Beattie and Fearnley, 2002). Consequently, concerns are widely expressed that economic dependence leads to compromised auditor objectivity, backbone and integrity.

The flaw in the triangular system of corporate governance (management, auditor and shareholders) that mitigates against a primary focus on providing valid, balanced and honest information to shareholders.

Abdel-khalik (2002) argues that the threat to auditor independence comes from the institutional arrangements that effectively give management and the Board of Directors control over the appointment and terms of appointment of external auditors, rather than from the same professional firm providing both auditing and consulting services. Abdel-khalik (2002, p.98) state:

… [T]hat shareholders elect and appoint the auditor … is the biggest fallacy in corporate governance today. In today's global economy, corporate ownership is widely dispersed and shareholders, through proxy votes or sheer indifference, have effectively handed over the control of auditor-related decisions (hiring, retention and compensation) to corporate management. The same management will also decide on consulting engagements.'

Citron (2003, p.250):

The growth in multidisciplinary practices, for example, has enabled firms to provide an ever widening range of other services for clients, leading some to argue that their dependency on audit clients is increasing to unsustainable levels … In addition, some of the other activities undertaken by accounting firms raise specific independence problems. Thus it has been questioned whether firms' relations with their clients cast doubt over their ability to act as expert witness in court …, and whether their relationships with banks are compatible with their activities as receivers.

The provision of NAS by incumbent auditors is a phenomenon which has been intensively debated in recent years by policy-makers, the accountancy profession, practitioners, and academics. The benefits and drawbacks have been contentiously argued. Audit firms make the following arguments in favour of the provision of NAS, as cited by Canning and Gwilliam (1999):

• NAS allow audit firms to diversify, making them less reliant on a single client;

• use of NAS can increase client reliance on the audit firm, lessening the weight and efficacy of the client management threat to change audit firms; and

• NAS give rise to increased auditor knowledge of the client, its systems, and their weaknesses, thereby facilitating a better audit.

The integrity of the audit may be compromised because audit firms are reluctant to confront and antagonise management when contentious audit issues arise. Financial reporting principles developed for US public companies in the wake of the Enron and other financial scandals reflect these concerns.

Independence is perceived to be compromised, even if it is not actually compromised, when the relationship between auditor and client management is too close. In the context of impaired independence of non-executive directors, an American shareholder activist is quoted in Gray (2004, p.M4) as follows: 'There's a natural human impulse to dance with the one who invited you to the party'.

This is sometimes labelled the familiarity threat (Hussey, 1999) and is only one of the six principal threats to auditors' objectivity.

Whilst rotation of auditors is sometimes suggested as a safeguard against the familiarity threat, there is no evidence that such a policy is widespread in market economies.

Empirical evidence of link between Non Audit Services and impaired independence

Indirect research on NAS and independence involves using phenomena such as earnings management, financial statement restatements, and qualified audit opinions as proxies for impaired auditor independence.

Frankel et al. (2002) investigated whether auditor independence affected the quality of reported earnings. They conducted an empirical analysis of discretionary accruals and fee ratios (audit fees, non-audit fees, and total fees) and found significant association between the level of non- audit fees and the level of discretionary accruals (suggesting impaired earnings quality).

DeFond et al. (2002) suggested that using the audit report, and the opinion contained therein, in independence studies would be more effective because the audit opinion was controlled by the auditor, and measuring the audit opinion was relatively straightforward. They then tested whether the provision of NAS impaired auditor independence by using auditors' tendency to issue a going concern audit opinion as a proxy for auditor independence. Their results suggested that the provision of NAS did not impair auditor independence.

From studies that have been consulted, even if it cannot be proved conclusively that the provision of non audit services actually impairs auditor independence, there is certainly a strong perception that it does, and that appears to be sufficient justification for some practitioners and companies to avoid the practice, and for policy-makers and regulators to condemn the practice.

Principles vs rules based approach

The IFAC Code generally adopts a principles-based approach. That is, underlying the detailed

guidance in the IFAC Code is a core requirement that all professional accountants should behave in accordance with five fundamental ethical principles in their professional and business activities.

Professional accountants may need to assess potential actions in terms of threats to adherence to those principles and, where necessary, to apply safeguards or refrain from the activity.

FEE believes it is the most appropriate approach for professional accountants and others to use throughout the profession and in other business activities, as it offers numerous advantages over

a detailed rules-based approach.

(Paterson, 2004, p.35) describes the rules based system as :

A rules-based system reduces financial reporting to a mechanical exercise, within which devious people are sometimes tempted to cheat the spirit of the standards through the exploitation of loopholes. Standard-setters are then drawn into a downward spiral of avoidance and anti-avoidance, and before long, we all get bogged down in a quagmire of complexity and risk, losing sight of the overall view given by the accounts

A principles based approach allows for the almost infinite variations in circumstances that arise in practice and prevents the use of legalistic devices to avoid adhering to the spirit of the guidance. The combination of rigour and flexibility of this approach is the most satisfactory way of ensuring that ethical requirements are fully observed in the rapidly evolving modern global economy.


Paterson, R (2004), 'Back to Basics: Summer School perspectives', CA Magazine, July p.35.

DeFond M L, K Raghunandan and K R Subramanyam (2002), 'Do Non- audit Service Fees Impair Auditor Independence? Evidence from Going Concern Audit Opinions', Journal of Accounting Research, Vol. 40(4), pp.1247-1274.

Frankel, R, M Johnson and K Nelson (2002), 'The relationship between auditor's fees for non-audit services and earnings management', The Accounting Review, Vol.77(Supplement), pp.71-105.

Hussey, R (1999), 'The familiarity threat and auditor independence', Corporate Governance, Vol.7(2), pp.190-197.

Gray, S (2004), 'Companies try New Mix on Boards', Wall Street Journal Europe, January 8.

Canning, M and D Gwilliam (1999), 'Non-audit services and auditor independence: Some evidence from Ireland', The European Accounting Review, Vol.8(3), pp.401-419.

Citron, D B (2003), 'The UK's framework approach to auditor independence and the commercialization of the accounting profession', Accounting, Auditing & Accountability Journal, February, Vol.16(2), pp.244-274.

Abdel-khalik, A R (2002), 'Reforming corporate governance post Enron: Shareholders' Board of Trustees and the auditor', Journal of Accounting and Public Policy, Vol.21(2), pp.97-103.

Beattie, V and S Fearnley (2002), Auditor Independence and Non-Audit Services: A Literature Review ,ICAEW, London, available at: http://www.icaew.co.uk/viewer/index.cfm?AUB=TB2I_63270.

Beattie, V, R Brandt and S Fearnley (1999), 'Perceptions of auditor independence', Journal of International Accounting, Auditing & Taxation, Vol.8(1), pp.67-107.

APB (Auditing Practices Board) (2004), Ethical Standards for Auditors (ES1-5), APB, London.

Antle, R (1999), 'Accounting firms, the accounting industry, and accounting research', British Accounting Review, Vol.31(1), pp.1-13.

Ponemon, L A and D R L Gabhart (1990), 'Auditor independence judgements: A cognitive-developmental model and experimental evidence', Contemporary Accounting Research, Vol.7(1), pp.227-251.

Fischer, M and K Rosenzweig (1995), 'Attitudes of Students and Accounting Practitioners Concerning the Ethical Acceptability of Earnings Management', Journal of Business Ethics, Vol.14(6), pp.433-444.

Brinkmann, J and K Ims (2003), 'Good intentions aside: drafting a functionalist look at codes of ethics', Business Ethics: A European Review, Vol.12(3), pp.265-274.

Frankel, M S (1989), 'Professional Codes: Why, How and with What impact?', Journal of Business Ethics, Vol.8(2/3), pp.109-115.

Boyd, C (2004), 'The structural origins of conflicts of interest in the accounting profession', Business Ethics Quarterly, Vol.14(3), pp.377-398.

Axline L L (1990), 'The bottom line on ethics: A fresh perspective on a worthwhile subject', Journal of Accountancy, December, pp.87-91.

Clarke, F, G Dean and K Oliver (2003) Corporate Collapse: Accounting Regulatory and Ethical Failure, Cambridge University Press.