The Cost of Auditor Independence

The line Sarbanes-Oxley drew between audit firms and their clients may have been a good idea overall, but it increased accounting risk, a new study indicates.

Sarah Johnson - CFO.com | US

Hiring a public accounting firm to provide both internal and external audits, a practice that was banned by the Sarbanes-Oxley Act, actually reduced companies' accounting risk, researchers claim.

The knowledge of a company that an external auditor gained from internal auditing lowered the chances of publishing misleading or fraudulent financial results, according to preliminary findings by professors at Brigham Young and Texas A&M universities.

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"This evidence supports the prediction associated with the knowledge spillover hypothesis — the idea that external auditors are more effective when performing both internal and external audit services," concluded a paper written by Douglas Prawitt, accounting professor at Brigham Young University, Nathan Sharp, assistant accounting professor at Texas A&M University, and David Wood, a visiting instructor at Brigham Young.

The researchers referenced 166 publicly traded companies' financial data between 2000 and 2002, when Sarbox was signed into law. They devised formulas based on several data points, including the Institute of Internal Auditors' database of internal-audit surveys and metrics calculated by risk-analytics firm Audit Integrity for measuring the likelihood of poor financial reporting, such as the risk of class-action lawsuits and restatements.

Nearly seven years ago, Sarbox ended what was once a cozy relationship between companies and their audit firms. Bristled by Arthur Andersen's collapse and strict prohibitions in the law, auditors quickly stepped back from their clients, withholding accounting advice and isolating their consulting services.

Among Sarbox's many auditor-independence restrictions: audit firms could no longer provide internal-audit work to the clients they audit. For some observers of the industry, there was no question that keeping the two audit functions separate was preferable, to avoid any appearance of conflict of interest and, effectively, boost investor confidence that had been violently shaken by Enron and the other corporate debacles earlier this decade. "These were obvious areas to separate," says Ed Nusbaum, CEO of accounting firm Grant Thornton.

Until now, there's been lots of talk about how much Sarbox — in particular, its internal-control provision — has cost companies, but little analysis of what benefits the law truly achieved, says Prawitt.

"Of all the services external auditors provided before the SOX prohibition, we believe internal audit outsourcing represents the greatest possibility for creating knowledge spillover effects," the academics said in their paper.

Their conclusion doesn't sit well with IIA president Richard Chambers, who cautions that the researchers' scope was very narrow and doesn't delve into the many responsibilities of internal auditors. "They're also looking at operational risks, compliance risks, business and strategic risks," Chambers says.

While external auditors are independent of a company and primarily focused on reviewing financial statements and attesting to internal controls, internal auditors are — in the views of the IIA — ideally working in-house, as part of the business, and their work in helping management test and document internal controls is just one of their many tasks. Internal auditors have the best understanding of any function in a company to know where a company's risks lie, Chambers contends.

Chambers doubts any of the large accounting firms would want to revisit this aspect of auditor independence rules, and the researchers themselves aren't advocating that lawmakers reconsider this part of Sarbanes-Oxley. What they do hope is that their research — which is still subject to a peer review process that could take months or longer — will begin a debate about the thought process behind the law, which by all accounts was rushed through Congress. "There was a tsunami that came from the scandals and it didn't matter what the evidence showed," says Prawitt. "We had to shore up public perception and investor confidence in the markets."

Grant Thornton's Nusbaum says he hopes future research will consider the more "absurd" independence restrictions Sarbox has put on firms when it comes to related entities that really have no interaction with each other except that they're owned by the same company.

Another outcome the researchers are hoping for is that communication between internal and external auditors will improve, which in turn, as their paper implies, could lead to better financial reporting by knowledge sharing. Chambers says the two groups' anxiety over being open with each other in the beginning of Sarbox has waned. "It's important for both parties to be open and receptive to each other," he says. External auditors can gain from internal auditors' knowledge by talking more regularly and informally than some do now, he adds.

Helping Students Identify Opportunities in the Accounting Profession

By George Violette and John Sanders

In 2003, PricewaterhouseCoopers published a paper titled Educating for the Public Trust, in which the company outlined its position on accounting education. The paper suggested reforms in the delivery of formal accounting education that are needed to attract and develop “a consistent flow of quality talent” to the profession. It stressed the need for professionals and faculty to work together “to ensure that students understand both the benefits of majoring in accounting and the challenging reality of actually practicing in the profession.”

PricewaterhouseCoopers believes that “faculty should ensure that their students make critical choices with sufficient, reliable information … and create and maintain connections with students who have not yet chosen a major.” Students need help understanding the roles and responsibilities of a practicing accountant and what it means to be a member of the profession. They suggest the need for students to meet frequently with members of the profession, especially those at the senior level, from the beginning of their accounting education experience. Because the first accounting course shapes how prospective majors perceive the profession, it must properly portray the practice of accounting so that students understand the importance of it.

Accounting faculty at the University of Southern Maine also recognized many of the same issues identified by PricewaterhouseCoopers and added a course to the curriculum to try to improve student understanding of the accounting profession. A new freshman-level course, “Introduction to the Accounting Profession,” was designed to inform both declared and potential majors of the diversity of exciting career opportunities available (see the Exhibit).

Overview of the Course

The course, given for one credit, pass/fail, met once a week for about an hour and a half in early evening over seven weeks. No textbook was used, but several handouts were distributed. Students were required to become members of either the AICPA or the Institute of Management Accountants (IMA), though the instructors encouraged membership in both.

In Week 1, the instructor presented an overview of the profession and career opportunities available, along with an overview of the course. In Weeks 2 through 7, a series of panels covered assorted topics, including: accounting career opportunities in public, industry, government, and not-for-profit organizations; the value of membership in professional organizations; discussion of certifications available and how to obtain them; the benefits of internships; and educational opportunities available to learn accounting. The second time the course was offered, the panels were expanded to include representatives from the finance sector, to help support students interested in learning about related career opportunities in finance.

Prior to each class, the students were given background information on the panelists for the coming week. After a brief introduction to the topic, a panel of three to five individuals was introduced. Each panelist presented in turn, with the instructor acting as moderator. Students were encouraged to interrupt with questions, and did so frequently. Generally, each panelist had about 15 to 20 minutes to present materials and answer questions. Informational handouts were usually distributed to supplement the presentations. At the end of the course, all students were required to submit a final “reflection” paper, which summarized their understanding and learning of the topics presented, including an evaluation of the course.

Panels

Each week the panelists discussed career opportunities in their area and were asked to share their unique experience and the story of how each came to be in the profession, and what they were currently doing. It followed the PricewaterhouseCoopers paper’s suggestion of exposing students to senior members of the profession. Panels contained a diverse mix of individuals, and frequently used USM alumni.

The first panel consisted of four senior partners from large and small area firms. The panelists discussed careers and opportunities in public accounting, and compared the differences and opportunities between small and large firms.

The second and third panels discussed careers and opportunities outside public accounting and included: a controller from a local closely held company; the chief accountant at a small corporation; the head of internal audit from a large publicly traded bank; an FBI agent; a senior accountant for a local not-for-profit organization; experienced small business counselors; and the deputy auditor of the State of Maine. The panelists discussed accounting opportunities available in industry, government, and not-for-profits and compared these opportunities to public accounting experiences, from which many had come.

The fourth panel discussed certifications and specializations available in the profession (e.g., CPA, CMA, CIA, ABV, PFS, CFA) and the importance of being involved with national and local professional associations (e.g., the AICPA, the IMA, the Maine Society of CPAs). This panel included professionals such as the chairman of the Maine Board of Accountancy, the executive director of the Maine Society of CPAs (MSCPA), past presidents of the MSCPA, a current Maine representative to AICPA Council, and a past president of a Maine IMA chapter.

The fifth panel, which focused on the value of internship experiences, featured a mix of current and former students that had internship experiences in public, private, or not-for-profit accounting in organizations of assorted sizes, along with a public accounting firm’s recruiting liaison. In the final panel, all the full-time faculty of the department told their own stories and promoted the value of majoring or minoring in accounting. Details of the 150-hour rule and graduate education opportunities were also presented.

Student Reaction

There were 36 students that completed the course the first time it was offered and 88 students the second time. In the first offering, 94% of students indicated that they enjoyed the course and felt the classes were informative and worth attending, with 97% indicating that the stated course objectives were met. In the second offering, the numbers were similarly strong, with 90% of the students enjoying the course and 97% indicating that the classes were informative, worth attending, and met stated objectives.

All students were required to complete a paper that summarized their understanding of the topics presented as well as their general comments on the course. The questions students were asked to consider in the paper were open-ended and allowed them to further explore their reactions to the topics. Many students indicated that the course had significantly changed their perception of accountants’ work. Several were amazed at the breadth of opportunities in accounting. Students liked hearing from panelists with a diversity of experience, and were surprised about the variety of career paths and certifications available. They learned what it meant to be a member of a profession and the value of involvement in the profession.

For many, the course helped reinforce their choice of accounting as a career; for others, it caused them to seriously consider accounting as a career option. For a few students, the course helped them to determine that accounting was not for them. Many expressed that “all majors” should have a course like this, and that they were glad it was offered.

Recommendations

Based on the success of this course, accounting programs that want students to connect with professionals and understand the opportunities available in the accounting profession could benefit from offering a course like this. Many schools do not offer their first accounting course until the sophomore year. By offering this course in the freshman year, students that expect to major in accounting can confirm that desire and meet professionals and faculty.

Although it is too early to tell, this early exposure to the profession will hopefully result in additional majors and minors, as well as improve retention. Discussing this course with university and college academic counselors would help promote it as a means for undecided students to explore an interest or aptitude for business or accounting. Part of the reason for the increase in students in the second offering was a result of the work with academic counselors. The first two offerings of this course have been a success for students, professionals, and faculty. It reinforced the choice of an accounting major for many students, and encouraged others to look at a possible major or minor in accounting.

The accounting profession needs a consistent flow of quality talent to ensure the continued success of the profession. Early communication about the roles and responsibilities of accountants makes it possible for students to understand the profession more fully and make an informed decision about becoming an accountant, thereby attracting to the profession interested quality students. Such a course enables professionals and educators alike to market the discipline and excite students about the breadth of career opportunities available in the accounting profession.

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George Violette, CPA, PhD, is a professor of accounting at the University of Southern Maine in Portland, Maine, and past president of the Maine Society of CPAs.
John Sanders, CPA, is an associate professor of accounting at the University of Southern Maine.

The Importance of Educators and Coursework in Choosing an Accounting Career

By George Violette and Charlotte Pryor

MARCH 2005 - There is a sentiment among some public accountants that if they could do it all over again, they would not enter the accounting profession. Some say the hours are too long, and the resulting strain on family and personal health is more than they wish to bear.

A survey was conducted to explore job satisfaction in public accounting as perceived by partners and principals in accounting firms, a group that has enjoyed success in accountancy. The goal was to gain insights from these individuals that could be shared in an open discussion with accounting students and faculty about how experienced and successful CPAs rose to partner level, how they initially decided to enter the profession, why they have chosen to remain in it, and whether or not they would “do it all again.”

More than 25 public accounting firms in Maine, ranging from sole proprietorships to firms with more than 100 professionals, contributed partners and principals to respond to a series of questions, presented in Exhibit 1. Respondents included 28 partner and principal respondents, nearly half of whom were managing partners or principals. They averaged 27 (median 28) years of experience in public accounting, with a range from 9 to 42 years (see Exhibit 2).

Survey Responses

The responses to the first question were quite varied. When choosing to become a CPA, many took the advice of mentors, including parents, teachers, and friends. Some were good with numbers or math, while a couple took aptitude tests. Several others took accounting classes that they greatly enjoyed, and some respondents had successful internships in college.

When asked if a career as a CPA was their “first choice,” 50% indicated that it was. The other half started out in, or expected to be in, such diverse careers as banking, nursing, management, teaching, medicine, and the military.

Responses to questions three and four tended to overlap. Almost half of the respondents were motivated to join the profession by a high school teacher or college professor, while several others pointed to a particular course. A few were inspired by family and friends working in the profession.

When asked why they “remain in the profession,” several responses were similar. The two most frequent replies were enjoyment of the challenges of the work, and the opportunity of working with and helping clients. Several indicated that their work was “never boring,” and was financially rewarding. Many also expressed a joy of working with intelligent and talented coworkers.

In response to the sixth question, 72% of respondents said yes, they would go into the profession again, 14 % said maybe, and 14% said no (see Exhibit 3). Those who said they would not do it again indicated that they would likely pursue careers in teaching, law, medicine, or finance.

Finally, an overwhelming 86% of respondents indicated that they would recommend the profession to undecided students because the profession is challenging yet rewarding, and a great place to start to learn about business in general, even if they decide not to remain in accounting.

Implications

The majority of respondents cited inspirational faculty and interesting courses as key reasons why they decided to enter the accounting profession. Perhaps the most important course in establishing accounting as an interesting subject, and a possible career choice, is the first accounting course taken by students. Accounting programs should use their “best” teachers in the first accounting course, those that can make the course interesting, challenging, and stimulating for the students. Furthermore, it is imperative that students in their first course meet and interact with dynamic and successful members of the profession. Students should be encouraged to learn from current professionals, ranging from recent hires to senior partners. They should also hear directly from CPAs that are challenged and energized by their work. In addition, internships should be developed and promoted, so students can experience the work firsthand.

While this survey is limited in scope, the results reinforce the importance of inspirational faculty and intriguing accounting courses in persuading students to enter public accounting careers. By involving highly motivated members of the profession in each accounting class, students can understand more clearly the opportunities and diversity of the profession. This will allow students to make informed career choices and lead to increased interest in the profession.

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George Violette, CPA, PhD, is a professor of accounting, and Charlotte Pryor, CPA, PhD, is an assistant professor of accounting, both at the University of Southern Maine in Portland, Maine.

Bridging the Gap Between Professors and Practitioners: ‘Quasi-’Case Studies

By Michael J. Krause


NOVEMBER 2005 - While the accounting cycle and FASB’s conceptual framework are a dominant part of the initial instructional unit in an intermediate accounting course, these two topics should also serve as a pervasive reference point for all subsequent financial accounting discussions. Successful accounting education depends upon students knowing why professional practice calls for a particular accounting treatment. Background lessons (or work experience) also give accounting students insights into why financial accounting authoritative pronouncements mandate what they do. Delving into details without context will lead to disaster in accounting education or practice. The professional literature supports this position. For example, SSARS 1 requires that a CPA who performs a compilation or review must have a general understanding about the industry in which the client or business functions before implementing the specific required tasks that fulfill the engagement.


Quasi-cases

Young students can begin to develop an accounting experiential background with what the author calls “quasi-cases,” which have definite solutions. A “classic” case, as defined by Clarke and Gardner (Journal of Accounting Education, Vol. 8, No. 1, 2004), requires students to make decisions that should result in diverse conclusions standardized only by their professional presentation. The “classic” case format is effective in undergraduate capstone courses and graduate courses. In functional courses, such as intermediate accounting, students start the transition from basic-principles knowledge to professional-context knowledge. This author believes that because quasi-cases dramatically narrow data-sorting choices, a junior-level accounting student (60 college credit hours) has a greater chance within a quasi-case format for intellectual growth via the actual experiences of accounting practitioners. An analogous situation exists when a service business trains its staff.


Accounting firm managers know that a staff accountant’s first-year experiences are the foundation for greater insights and responsibilities in the second and third years. If initial work assignments are more limited in scope, then wouldn’t logic call for initial college case assignments to be more limited in scope? While the scope should be limited, the context of a case assigned in intermediate accounting can be enriched by input from working professionals. Hoping to add to that enrichment and to promote an ethical business world view, the author assigns a Wall Street Journal project where students follow SEC investigations. Ethical perspectives, like lessons about the accounting cycle and FASB’s conceptual framework, should shadow every accounting-course assignment at every level.


Quasi-cases can include reviewing basic lessons on the accounting cycle and showing how other more-advanced lessons (like multinational issues) fit within that fundamental framework. For example, once initial adjustments for receivables and payables are covered, when the topics of depreciation and prepaid expenses were broached, discussions can turn to new issues of accrued interest, premium amortization, investments’ fair value adjustments, and cash dividends. Quasi-cases can also explore the benefits of using reversing entries for accounts payable and accrued interest payable. Introducing correcting entries will emphasize that the accountants’ responsibilities go beyond the scope of bookkeeping. The author has found that a single case study, classic or quasi-, does not completely fill in a student’s experience gap. Yet the quasi-case study experience also allowed the author to start class with a review or context for a new lesson with: “Remember in the case study when you had to….” This lesson-reinforcement tool using recent quasi-case experience promotes long-term learning.


Feedback

The author administered a diagnostic exam to an intermediate accounting class that had used a quasi-case. Of the 29 students, 16 strongly agreed, or agreed, that the case study helped when they took the diagnostic test. (Eight students were neutral, and only five disagreed or strongly disagreed that the case study helped.) Twenty-eight students also strongly agreed, or agreed, that the diagnostic test was a good experience. Additionally, all 29 students strongly agreed, or agreed, that the diagnostic test helped them understand accounting basics.


The results of the exam indicated that the quasi-case assignment helped the students understand the accounting cycle. The median score on the diagnostic exam was 28 out of 40 correct. The top three incorrect questions dealt with topics that had not been covered in the quasi-case. To the author’s delight, the one perfectly answered question (on the purpose behind closing entries) contained a perspective that reflects his views on accounting education: Concentrate on reasons, and the details will eventually be understood in later applications.


Cases based on practitioner input can generate benefits by applying contextual experience to theory in a way that promotes more than “for the exam” learning. Long-term learning generates an awareness that leads to more-complex professional and ethical issues. Without the initial input from accounting practitioners, whether in the form of cases or other personal interventions, such professional awareness will not happen in the college environment. Most important, the early initial input from accounting practitioners to today’s students will lead to an improved start in the long-term development of tomorrow’s staff accountants.


Editor’s Note: This article is a follow-up to “Bridging the Gap Between Professors and Practitioners” (February 2005), which discussed how case studies establish a connection between accounting professors and practitioners. It continues the author’s perspective on the use of case studies in intermediate accounting courses and the need for collaboration between educators and practitioners.

Michael J. Krause, CPA, is an associate professor of accounting at Le Moyne College, Syracuse, N.Y.