GAO limits auditor consulting. (Issues in Accounting).(Brief Article)

The U.S. General Accounting Office recently promulgated important changes to the standards governing auditor independence set forth in its publication Government Auditing Standards, commonly known as the "Yellow Book." The principal impact of these changes will be to limit significantly the extent to which auditors of government financial statements will be able to perform nonaudit (i.e., consulting) services for their audit clients.

Background

In recent years, there has been a marked trend among auditors in both the public and private sectors toward providing ever-increasing levels of nonaudit services to their audit clients. Common examples of these services include determining account balances, developing internal control systems, establishing capitalization criteria, processing payroll, posting transactions, evaluating assets, and performing actuarial studies. In particular, auditors frequently have taken a leading role in developing and implementing accounting systems for their clients.

The types of services just mentioned often are closely related to the financial statement audit. For example, an auditor's assessment of the adequacy of a client's accounting system may be expected to have an effect on the extent of tests performed during the audit. This relationship has led some observers to question whether auditors can truly maintain their independence in such situations. Perhaps the most prominent of these critics has been Arthur Levitt, who served as chair of the Securities and Exchange Commission from 1993 through 2001.

In the private sector, critics of the status quo, led by Mr. Levitt, initially were unsuccessful in their efforts to place limits on consulting by independent auditors. These efforts, however, have taken on new life recently in the wake of the much-publicized bankruptcy of Enron Corp. In contrast, the public sector proved more responsive to critics' early calls for change. Specifically, GAO released an exposure draft on May 4, 2001, well before the Enron bankruptcy, proposing amendments to the Yellow Book's rules on auditor independence that would have the practical effect of severely limiting the type and extent of nonaudit services that auditors could provide to their audit clients.

In late January 2002, the comptroller general of the United States, David M. Walker, announced that a revised version of the proposed amendments to the Yellow Book rules on auditor independence had been adopted and would formally take effect for audits of periods beginning on or after October 1, 2002. (Earlier implementation would be encouraged.)

The balance of this article is devoted to describing the limitations on nonaudit services imposed by the new rule. A complete text of the Yellow Book's new independence standard can be found at GAO's Web site at http://www.gao.gov/govaud/ybk01.htm.