What are the current auditor independence issues surrounding the provision of external auditing services, internal auditing services, and management consulting services for the same client? Develop arguments for why auditors should be allowed to perform these services for the same client. Develop separate arguments for why auditors should not be allowed to perform non-audit services for their

Question

audit clients. What is your view of the arguments on both sides, which side do you take, and why?

What will be an ideal response?

Answer 1

External auditors are required to be independent of the companies they audit. When auditors begin
to perform internal audit and management consulting services for the same companies they audit, the
following questions arise: Can auditors be independent in appearance when providing both services?
Can auditors be independent in fact when providing both services? How does providing both services
affect the judgment of auditors?
Congress enacted legislation known as the Sarbanes-Oxley Act of 2002 in order to enhance
the independence of public auditors. Section 201 of the Sarbanes-Oxley Act specifically gives guidance
relating to independence:
“It shall be ‘unlawful’ for a registered public accounting firm to provide any non-audit service to an
issuer contemporaneously with the audit, including: (1) bookkeeping or other services related to the
accounting records or financial statements of the audit client; (2) financial information systems design
and implementation; (3) appraisal or valuation services, fairness opinions, or contribution-in-kind
reports; (4) actuarial services; (5) internal audit outsourcing services; (6) management functions or
human resources; (7) broker or dealer, investment adviser, or investment banking services; (8) legal services
and expert services unrelated to the audit; (9) any other service that the Board determines, by regulation,
is impermissible. The Board may, on a case-by-case basis, exempt from these prohibitions any person,
issuer, public accounting firm, or transaction, subject to review by the Commission. “It will not be unlawful
to provide other non-audit services if they are pre-approved by the audit committee in the following
manner. The bill allows an accounting firm to ‘engage in any non-audit service, including tax services,’
that is not listed above, only if the activity is pre-approved by the audit committee of the issuer. The audit
committee will disclose to investors in periodic reports its decision to pre-approve non-audit services.
Statutory insurance company regulatory audits are treated as an audit service, and thus do not require
pre-approval.
“The pre-approval requirement is waived with respect to the provision of non-audit services for an issuer
if the aggregate amount of all such non-audit services provided to the issuer constitutes less than 5% of
the total amount of revenues paid by the issuer to its auditor (calculated on the basis of revenues paid
by the issuer during the fiscal year when the non-audit services are performed), such services were not
recognized by the issuer at the time of the engagement to be non-audit services; and such services are
promptly brought to the attention of the audit committee and approved prior to completion of the audit.
The authority to pre-approve services can be delegated to 1 or more members of the audit committee,
but any decision by the delegate must be presented to the full audit committee.”3
Arguments for allowing auditors to perform external audit and other services at the same time include:
• Auditors realize efficiencies by completing both external audit and internal audit services. They
reduce the number of hours required to complete both audits by eliminating overlapping work.
• Auditors discover inefficiencies and other weaknesses while performing audit work. They use
their expertise and knowledge in providing consulting services to management to improve these
weaknesses.
• Auditors already have a relationship established with management. By providing other services,
they save the company time and money that would be spent in obtaining the services of another
organization unfamiliar with company policies and procedures.
• Auditors can act independently in the external audit when they are performing other services.
• Legislation should not impede the freedom to pursue growth and revenues in different lines of
business in a free enterprise system.
Arguments for not allowing auditors to perform external audit and other services at the same time
include:
• Auditors may not act independently in the external audit when they perform other services. The
incentives to perform consulting and/or audit services may lead to impaired judgment.
• Internal audit services are best performed by in-house personnel who understand the company’s
culture and practices. Internal auditors are an important part of corporate governance and should
not be replaced by external auditors acting as internal auditors.
• The company benefits from multiple viewpoints. This includes viewpoints from consultants and
internal auditors who do not also serve as the company’s external auditors.