Events that led to the separation of consulting firms from auditing firms
The widespread concerns over the practice of providing auditing and consulting services by a firm to the same client are largely due to the need to curb conflict of interest among other reasons. Audit independence is apparently a necessity that defines the integrity of financial reporting. This and other factors have led to the split of consulting firms from auditing firms into two independent businesses operating in separate business environments. This is evidenced by the Enron case, and the general trend being experienced in the industry as observed in recent practices by the major players (Matthews, 2002). The separation of consulting firms from auditing firms is perfect in timing and presents opportunities that will help in redefining the auditing and consulting services globally.
The Enron case is quite complex as regards the separation trend identified above, but the fundamental reasons for the event are almost universal for the industry. In order to achieve higher performance, a separate consulting division that operated independent of Arthur Anderson was established in 1989 (Matthews, 2002). This was accompanied by a cross financing agreement between Accenture and Arthur Andersen based on performance, which saw large resources being allocated from Andersen Consulting to Arthur Anderson annually. The formation of a new small-scale consulting firm by Arthur Andersen led to the separation of Andersen Consulting from Arthur Andersen in order to compete with the latter. Andersen Consulting changed its name to Accenture in 2001 (Matthews, 2002). Accenture had to restructure and reorganize its business and lean it towards a technologically focused perspective that would adapt it to the more specific and completely different global business environment. The nature of the consulting business has seen Accenture grow into a successful, highly networked and open business. Had it been part of the combined force under AA as both an audit and consulting services provider, Accenture would not have been open to the degree that has earned it a successful run in the consulting business.
Disney Corporation also favored the idea of separating audit and consulting services back in 2002 (Accounting Web, 2002). This followed a shareholder voting process ordered by the Securities and Exchange Commission concerning a proposal that would prohibit the company from using the same firm to provide both audit and consulting services. Although a majority of Disney’s shareholders were against the proposal, the company’s Chairman and Chief Executive noted that the company had plans to separate audit and consulting services among outside providers in a bid to the public remained confident in its financial reporting.
Elsewhere in Europe, the economic crisis that occurred in the later part of the past decade prompted the European Commission to draft a proposal that sought to compel the major players in the industry to split auditing and consulting arms into separate independent businesses. According to Taylor (2011), this move targeted the dominant companies in the region, which are also the world’s four largest firms in the industry namely: Deloitte, Ernst & Young, KPMG and PwC. The Commission’s top personnel observed that the initiative would yield lasting positive results for the industry. First, the practice is expected to inhibit conflict of interest and therefore improve public confidence in financial reporting. Two, it will enhance competition among firms in the industry, which is very beneficial to the region.
A personal perspective on the pros and cons of a firm providing both auditing and consulting services
The controversy surrounding the practice by firms providing both auditing and consulting services is perhaps complicated by the ethical dilemma associated with this problem. A number of pros and cons can be observed from this state of affairs. These are explored below from a personnel perspective.
Accounting firms that offer both services enjoy a diversified revenue mix, which is very necessary for any healthy business. Goldwasser (2002) argued that consulting services are highly placed among accounting firms due to their higher profitability compared to purely auditing services. This diversification has maintained the viability of the accounting profession. Purely audit-based firms are likely to demeanor the profession by narrowing competitive dimensions to price if unchecked. Clients may be attracted to audit firms that offer cheap prices. The profession is therefore maintained up-scale thanks to the non-audit services’ contribution.
The provision of non-audit services present audit firms with a wider pool of expertise that better understands the client’s business. This may be through experience or hiring qualified personnel in this area. Additional costs would be incurred if the firms are limited to auditing services because they would be compelled to add additional expertise to the independent unit without guaranteed increases in revenue.
However, a firm offering both auditing and consulting services has more incentives to indulge in practices that encourage conflict of interest. The external auditor bridges the information gap between a firm’s managers and its shareholders, or the larger general public. This role is critical and ought to be the principle objective of auditors. However, situations involving conflict of interest pose serious threats to the auditor’s role of promoting information symmetry. An accounting firm that provides both services to clients stands to gain a big deal. The gain may at times occur in a trade off with providing objective financial information to external users. First, the particular client that receives consulting services in addition to audits from the accounting firm is likely to have more influence on the auditor. This can easily be affected through threats of withdrawing from the consumption of the extra services, which may be an important part of the accounting firm’s revenue. Second, auditors are less likely to criticize client systems in cases where they were consulted in developing them. Consequently, substandard information is delivered to investors under such a scenario. In a bid to retain clients, auditors may provide an unduly favored report.
Another concern is that in an environment where these firms offer both services, growth of both units is hindered. Consulting services need to be approached from a very different perspective from the auditing one as witnessed by the Accenture case (Mathews, 2002). If these units are permanently synchronized with audit services, there will be few opportunities and even fewer incentives to develop innovative approaches that are essential for success in the consulting business environment. In this case, a consulting unit would be better off as an independent and separate business from the auditing services business.
The trend observed in public accounting firms as regards the separation of consulting firms from auditing firms defines the future of the industry. The practice has both positive and negative consequences. However, the ever increasing pressure on firms in this business to separate the two units into two separate businesses is already materializing as the largest four firms in the industry embrace the practice. This will bring competition and reduce conflict of interest in auditing. The trend therefore represents an important aspect of the future of accountancy and should be affected objectively.
References
Accounting Web. (2002). Disney To Split Audit and Consulting Firms, Despite Shareholder Ok. Retrieved from http://www.accountingweb.com/topic/disney-split-audit-and-consulting-firms-despite-shareholder-ok
Goldwasser, L. D. (2002) The Accounting Profession’s Regulatory Dilemma. The CPA Journal. Retrieved from http://www.nysscpa.org/cpajournal/2002/0502/nv/nv1.htm
Matthews, G. (2002). Future of Consultancy: After Enron the Next Turn Must Be Right. Accountancy Age. Retrieved from http://www.accountancyage.com/aa/feature/1782960/future-consultancy-after-enron
Taylor, A. (2011). Here’s What You Need to Know about Europe’s Plan to Split Up the big Four Auditing Firms. Retrieved from http://www.businessinsider.com/europe-auditing-firms-accounting-2011-12
