Auditor independence in the public sector.

• Author: Blann, Stephen W.

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State and local governments serve a variety of stakeholders. Some of these (such as creditors and regulatory agencies) are very similar to the kinds of stakeholders found in the private sector, while others (such as citizens and their elected representatives) are unique to the public sector. To meet the diverse needs of these stakeholders, governments produce and disseminate general purpose financial statements. However, by themselves, such financial statements might not prove as useful to their intended audiences as could be hoped. Questions regarding the reliability and accuracy of the information could make potential users of the financial statements hesitant to base important decisions on data that might be misstated (either intentionally of otherwise). To address those concerns, governments need an objective third party to lend credibility to their financial reporting process, through an unbiased examination of the financial statements and underlying accounting information. The independent auditor serves that role.

UNDERSTANDING GOVERNMENTAL ACCOUNTABILITY

The very nature of state and local governments demands public accountability. The unique elements of the governmental environment--from the power to tax, to the restrictions on the uses of funding sources, to the role of the annual budget as a legal appropriation of public funds--all point to the need for governments to provide the public with detailed information that meets the principles of transparency and accountability. This concept has long been recognized by authoritative accounting standards, which have emphasized that "financial reporting helps fulfill government's duty to be publicly accountable," (1) and "the independent audit of state and local government financial statements is considered an essential element of financial control and accountability." (2)

If transparency and accountability begin with financial reporting, then financial reporting begins with internal control. In its landmark report, Internal Control--Integrated Framework, the Committee of Sponsoring Organizations (COSO) identifies several parties with responsibility for internal control, including management, the board of directors (those charged with governance), internal auditors, and other personnel in an organization. However, the COSO report notes that while external auditors can contribute to achieving an entity's objectives, they are not actually part of an entity's internal control. Instead, external auditors bring an "independent and objective view" that provides information "useful to management and the board in carrying out their responsibilities." (3) The role of independent auditors, then, is to assist state and local governments in demonstrating their accountability, but not to be a part of the internal control structure itself.

DEFINING INDEPENDENCE

Like so many terms in the accounting world, "independence" means different things to different people. To some, it is simply an acknowledgement that someone is not under the control or influence of another party. To others, the concept of independence means being objective and free from bias or prejudice. In the context of financial statement audits, however, independence is governed by authoritative standard setters.

All financial statement audits of state and local governments are subject to...