The audit profession has a long and distinguished history of guarding the integrity of our companies' financial statements. They must live up to their history ... I fear that the audit process, long rooted in independence and professionalism, may be diminished in the name of these increasingly lucrative and commercial opportunities.--Arthur Levitt (1999)
Independence has long been recognized as the most important defining characteristic of the public accounting profession. Yet in recent decades, it has become increasingly questionable whether the profession is able to maintain its independence not only in fact but also in appearance. The doubt arose from one of the phenomenon that public accounting firms in this country had become more and more involved in management consulting and other non-audit services. Facing the doubt of the public, the SEC and the profession including the big accounting firms engaged in an unprecedented debate about the merit and demerits of non-audit services provided by the public accounting firms. In spite of the arguments for and against it, the trend of public accounting firms expanding scope of services into other areas continued unabated until the Enron-Anderson events of 2001-2002 where, it is stunning to see, financial information was misrepresented in unqualifiedly signed statements and the highly respected accounting firm was dissolved.
In retrospect, it seems clear that a gradual deterioration in maintaining independence in the accounting profession brought us the Enron/Andersen debacle. This paper places the issue in a historical perspective and tries to reach an understanding of the development. The first section provides a brief historical overview of auditing in this country. The second section illustrates the expansion of public accounting firms into non-audit services, especially management consulting service, in recent decades. The final section discusses the implications of the development for the future of the public accounting profession.
THE BIRTH AND GROWTH OF AUDITING
To understand the importance of the concept of independence in auditing, it is necessary to trace the history of the profession. A brief review of the development of auditing in the United States will illustrate the constant characteristics as well as some important changes in the theory and practice of auditing over the centuries.
The exact origin of audits of financial reports is not clear, but it is known that as early as the fifteenth century auditors were called upon to ensure the absence of fraud in the record kept by stewards of wealthy household estates in England (Carmicheal and Willingham 1989). The early audits were detailed and the objective of auditing was to detect fraud (Brown 1962). Independence was obtained through appointment by the nobleman and prevention of any private contact between the auditor and the auditee. There was no third party interest in the process at that early date (Mautz and Sharaf 1961).
The origin of the audit in the United States is decidedly British. As Moyer (1951) indicated that the first independent audits in this country were patterned after the British audit and were performed largely by British auditors. Almost all of the auditor's staff was devoted to checking footings and postings in detail, looking for bookkeeping errors, and comparing the balances in the ledger with the trial balance and with the statements. All of these procedures served the objective of the audit at the time, which was to detect or prevent fraud and errors (Montgomery 1912). Independence was implied by the fact that the audits were performed by the visiting British auditors. Britain had found it desirable to require statutory audits. The United States was a new, expanding country with little industrial history behind it, and with no such requirements. In this country, it was necessary that the benefits derived from an audit be apparent to clients so that they would be willing to incur the cost of such an engagement. The detailed procedures followed in Britain soon were found to be too costly to clients (Moyer 1951). Consequently, testing methods for checking footings and postings were introduced, but the purpose of the audit remained the same. These audits were intended to provide an independent review of the accounting records and reports and of the work of those subjected to audit (Mautz and Sharaf 1961).
By 1900, the industrial revolution was approximately 50 years old and industrial companies had expanded greatly in size. There were many more absentee stockholders, many of whom began to receive auditors' reports and thus the audits were viewed as a way to make managers and directors accountable to absentee stockholders for the stewardship of assets (Carmicheal and Willingham 1989). Since the public interest came into existence, the concept of auditor independence began to develop. In 1907, the bylaws of the American Association of Public Accountants were amended to recognize the importance of accountants avoiding occupations inconsistent or incompatible with their public-serving functions (Younkins 1983). The following year Sells (1908, p.236) pointed out that "the position of the public accountant in respect to corporations and their management is always an independent one. Unlike the attorney, he is not expected to make out a case. The character of the service he renders is impersonal."
Gradually, American audits evolved into more test audits as procedures were adapted to rapidly expanding American businesses. In addition to increased use of testing methods, auditors began to obtain evidence from outside clients' records as a means of examining transactions. Because of investors' concerns, auditors began to pay closer attention to the valuations of assets and liabilities (Moyer 1951). The first U.S. authoritative auditing pronouncement, prepared by the American Institute of Accountants (now the AICPA) at the request of the Federal Trade Commission, was published in 1917 and referred to as "balance-sheet audit." A revised pamphlet was published in 1929, under the title "Verification of Financial Statements" (O'Reilly et al., 1990).
The 1936 edition of the pamphlet was entitled "Examination of Financial Statements by Independent Public Accountants." The use of the word "examination" instead of "verification" signaled an important change in the concept and practice of auditing. In 1936 it was generally acknowledged that the independent auditor's function was more accurately described as an examination, which means an audit by testing selected items, rather than a verification, which means a detailed audit of all data (O'Reilly et al., 1990). However, these changes, no matter how important they were, only reflected the changes in auditing methodology and not in auditing purpose. For auditors, independence remained their "most precious asset" (Montgomery 1927, pp. 245) in thought and action.
The 1936 revision was influenced by a number of significant events of the previous few years. These included, most notably, the AICPA's collaboration with the New York Stock Exchange in an effort to improve reporting standards and the enactment of the Securities Act of 1933 and the Securities Exchange Act of 1934, which required listed companies to file audited financial statements. With the...