^ .JL.

THE ACCOUNTANT'S RESPONSIBILITY IN

MANAGEMENT SERVICES

by

STEVE FOSTER GRIFFITH, B.B.A.

A THESIS

IN

ACCOUNTING

Submitted to the Graduate Faculty of Texas Tech University in

Partial Fulfillment of the Requirements for

the Degree of

MASTER OF SCIENCE IN ACCOUNTING

Approved

-(V: ATUJ

December, 1970

1

1970

ACKNOWLEDGMENT

I am deeply grateful to Dr. Reginald

Rushing for his beneficial guidance and helpful

criticism of this thesis.

11

TABLE OF CONTENTS

ACKNOWLEDGMENT ii

LIST OF TABLES V

I. INTRODUCTION 1

General Problem 1

Purpose 4

Definitions 5

Preview 6

II. HISTORICAL BACKGROUND OF MAl^AGEMENT SERVICES 8

Early Existence of Management Services 8

Post-V7orld War I I Boom of Management Services 11

Development of Management Services Within the Profession . . . 14

III. REASONS WHY CPA FIRI4S OFFER

MANAGEMiENT SERVICES 19

Qualifications of CPAs 19

A Beneficial Service to

the Clients 24

A Benefit to the Profession 26

Types of Services Offered 28

IV. GUIDELINES OF MAtTAGE14ENT ADVISORY SERVICES 34 The Accounting Firms Scope

of Management Services 34 The Accountant's Role in

Management Services 38

iii

IV

Competence in Performing Management Services 41

Specialization Within

Management Services 46

Referral of Management Services . . . 48

Professional Ethics 51

V. THE INDEPENDENCE ISSUE IN r^ANAGEMENT SERVICES 54

Effects of Management Services

on CPA's Independence 54

Phases of a CPA's Independence . . . . 57

Professional Independence . . . . 57

Audit Independence 58

Independence in Fact 60

Independence in Appearance . . . 61

VI. COMPATIBILITY OF I IANAGEMENT ADVISORY SERVICES AND AUDITING 64

Advocates of Combined Consulting and Auditing 64

Opponents of Combined Consulting and Auditing 69

Results of a Survey of

Reasonable Observers 75

VII. SUMMARY AND CONCLUSIONS 79

Summary 79

Conclusions 81

SELECTED BIBLIOGRAPHY 84

LIST OF TABLES

Table Page

1. Firms Indicating Extent to which Performance of Management Services for Audit Clients would tend to Impair Independence 68

2. Respondents' Views of Management Services by CPAs Performing the Independent Audit Function 72

3. Sumjnary of Opinions as to Effect of Management Consulting on Audit Independence of CPA 77

v

CHAPTER I

INTRODUCTION

General Problem

Management advisory services have been performed

by CPA firms approximately since the accounting profession

has been in existence. Although these services have not

always been designated as "management advisory services,"

accountants have been advising on problems pertaining to

management for a great many years.

When t,he phrase "CPA firm" is mentioned, the man on

the street automatically thinks of auditing and tax work,

the profession's two most publicized services. Everyone

knows CPA firms are responsible for the figures in annual

reports prepared by every firm. Again, everyone knows the

most hectic time of the year for CPA firms is the tax

season. Thus, while auditing and tax work perform in the

spotlight, management services are performed unknown and

unnoticed to the man on the street. While they may go

unnoticed, management services play as big if not a bigger

role in the accounting profession than do auditing and tax

work.

In recent years, the scope of management advisory

services has expanded greatly. One of the big reasons for

this remarkable growth has been the growing needs of

management for assistance in this area of accounting.

Managements are no longer primariJ.y concerned with such

time-honored areas as inventory control and personnel.

The recent developments of electronic data processing,

operations research, complex budgeting, and financial

information systems have added a whole new dimension to

the management services field. These developments have

caused the accounting profession to develop a broader range

of management services so as to better cope with manage­

ment ' s more and more complex needs and problems.

Many accountants believe the profession should have

never become involved with management services in the first

place. They contend that CPA firms have more than enough

work in auditing and taxes without adding a third area of

service. Professional management consultants agree v/hole-

heartedly with these accountants as their business is

suffering because of accountants branching out into manage­

ment services.

This same group of accountants, who are against

management services, also fear for the CPA's and profession's

independence.

Some CPA's, and some commentators outside the profession, have expressed a fear that performance of such services may jeopardize the independence

of the firm which also audits the financial statements of the client.

Independence in management services is a highly

controversial subject. Many articles pro and con have

been written on this subject. Some solid agreements must

be reached soon concerning independence or it may eventually

destroy the whole accounting profession.

The AICPA knows where it stands with respect to

management services as the basic policy on management

services was set forth by the organization in April, 1961.

This resolution adopted by the Council of the Institute

stated:

It is an objective of the Institute recognizing that managem.ent services activities are a proper function of CPAs, to encourage all CPAs to perform the entire range of management services consistent with their professional competence, ethical standards, and responsibility.^

This resolution was conceived by the committee on

management services, which was obviously in favor of all

phases of management services and saw no immediate problem

with the independence issue. If there were dissenters on

the committee, they were obviously overwhelmingly overruled.

"Independence and Services to Management," The Journal of Accountancy, CXVI (November, 1963), 44.

AICPA Committee on Management Services, "Statements on Management Advisory Services No. 1: Tentative Descrip­tion of the Nature of Management Advisory Services by Independent Accounting Firms," The Journal of Accountancy, CXXVII (March, lv69), 62.

Management services have made great strides in the

accounting profession, especially so since World War II.

This relatively new service in accounting has cut deeply

into the business of professional consultants, and will

continue to do so at an increasing rate. As one writer

quite eloquently stated: "In their quiet way, . . . the

staid old CPAs have been capturing a major share of the near 3

$900-million management consulting business in the U.S."

If only the independence issue were settled, management

advisory services would truly be a dynamic force in the

accounting profession.

Purpose

Since management services is a relatively new field

of service in accounting, there is no widespread knowledge

among laymen as to v/hat management services entails.

Furthermore, within the accounting profession the inde­

pendence issue pertaining to management services is a topic

of paramount importance and has yet to be settled.

Therefore, the purpose of this thesis is twofold:

(1) to take an overall look into the many aspects of

management services from its early existence to present-day

modern times, and (2) to delve into the pros and cons of

• "Are CPA Firms Taking Over Management Consulting? Forbes, XCVIII (October, 1966), 57.

the independence issue and see what problems the advocates

and opponents of this issue have in understanding one

another. It is hoped that through this thesis a better

understanding of management services in accounting can be

achieved.

Definitions

There are a few terms used in this thesis which

perhaps are not familiar to the average reader. Therefore,

definitions and explanations will be provided at this point

in the thesis.

The topic of the thesis being management services,

the first and main definition would obviously be that of

"management services," or "management advisory services"

as it is often referred to in numerous publications. As

long as "management services" have existed in the profession,

an authoritative definition has not appeared until recently.

The AICPA committee on management services has issued this

definition of "management services":

Management advisory services by independent accounting firms can be described as the function of providing professional advisory (consulting) services, the primary purpose of which is to improve the client's use of its capabilities and resources to achieve the objectives of the organization.^

A

Committee on Management Services, "Statements on Management Advisory Services No. 1 . . . " 63.

This definition of "management services" was long

overdue as the field of management consulting has grown

tremendously in the last fifteen years. A list of services

offered by CPA firms is needed to supplement the definition,

thus making the scope of management services completely

clear.

The term "CPA" is an abbreviation for "Certified

Public Accountant," as opposed to "Public Accountant."

CPAs are individuals who have met certain qualifications

and have received a license so designating their achieve­

ment. "Public Accountants" need no license to practice in

many states.

The term "AICPA" is used as an abbreviation for

"American Institute of Certified Public Accountants."

This national organization is the professional society of

CPAs in the United States. This organization is the

governing body of the profession and includes some 45,000

members.

Preview

This thesis will consist of six more chapters

other than Chapter I which is the introduction. Chapter II

is concerned with the history of management services up to

present times, and the reason for the development of these

services.

Reasons for offering management services and

benefits attained from their usefulness are discussed in

Chapter III. Types of services offered by CPAs are also

discussed here. Chapter IV will get to the heart of

management services as the different aspects of these

services will be discussed. Aspects covered will include

the scope, role, competence, specialization, and referrals

in management services.

Chapter V will explore the independence issue,

covering the effects of management services on CPA' s

independence, and the four phases of independence:

(1) professional, (2) audit, (3) in fact, and (4) in

appearance. Chapter VI will look at the pros and cons of

the compatibility of management services and auditing.

The results of a survey concerning independence will also

be discussed.

Chapter VII will contain the summary and conclusions

of the thesis.

CHAPTER II

HISTORICAL BACKGROUND OF MANAGEMENT SERVICES

Early Existence of Management Services

Management services is thought of by most laymen as

being a relatively new field in accounting. Their beliefs

are supported by the fact that the majority of the litera­

ture published in this field has been v/ritten within the

last twenty years. However, their ideas can not be justified

since the field of m.anagement services has existed practically

as long as has the accounting profession.

Accounting as a practice actually began in the pre-

Christian eras of history. Trading companies brought more

use and advancements to the accounting practice, eventually

leading to double entry bookkeeping. The accounting pro­

fession as it is known today in the United States had its

beginning in Scotland and England.

In 1788, an accountant performed management services

for his client, who obviously placed great importance on

his accountant's advice:

After revolving for a considerable time in my mind a subject to us so momentous and consulting with my friend Mr. Farquharson, the accountant, to whose counsel I had long been accustomed to resort on every emergency, I fixed on Mr. Samuel Anderson,

8

a merchant in Edinburgh, as a gentleman who a Dpeared to be v/ell suited to us.

This was the first recorded evidence of actual

consulting service by accountants. Management services

was one of the major areas of service provided by

accountants in the early 1800's, but was replaced by

auditing in importance in the latter half of the same

century.

In-1896, accounting was recognized as a profession

in New York State, and accountants first received the

title of "CPA." The area of management services was

reappearing on the accounting scene at this same time.

In 1899, equalities of good management services personnel

were already being discussed:

To be a good accountant necessitates your being thoroughly conversant v/ith the recjuirements, if possible, of any and every business; to be able to show a man, if needs be, where he can do better than he is doing; how he can save money; hov/ he can make it. This is the true sphere of the accountant--not that of a semi-commercial policeman seeking whom he may devour by prying into this or that. You have to study the weak points, and there are some in every business.

John W. Buckley, "Management Services and Management Audits by Professional Accountants," California Management Review, IX (Fall, 1966), 44; and James E. Redfield, A Study of Management Services by Certified Public Accountants (Austin: Bureau of Business Research, University of Texas, 1961) , p. 6.

^Ibid., p. 7.

10

Most of the major accounting firms began performing

management services around the turn of the century. One

of the major firms had a consulting job dating back to

1898. Bookkeeping and auditing were still the main areas

of service in accounting, however. Around 1910, CPAs

began installing accounting systems to facilitate the

determination of net income, which was replacing the

balance sheet figures in importance. These installations

of accounting systems were the forerunners of the present

activities of management services.

Management services were truly on the upswing.

The growth of 'management consultants was remarkable as

the whole consulting field mushroomed.

From such very humble and unheralded beginnings these heterogeneous services broke out into the open with some formality, v/hen probably in the early 1930's at least one of the major national firms gave these services some measure of stature and prestige by recognizing them as 'special services' and actually accounting for them separately as a new class of services to clients.

Areas covered by management services expanded at

a tremendous rate.

This increased interest in a wide variety of management assistance continued among pro­fessional accountants until the depression of the 1930' s began."^

3 Robert Beyer, "Management Services—Time for Decision," The Journal of Accountancy, CXIX (March, 1965), 43.

^Redfield, A Study of Management Services . . . , p. 9.

11

Interest reappeared in management services in the late

1930's, but was soon to be shelved again, this time by

World War II.

Post-World War II Boom of Management Services

With the coming of World War II, many thought the

area of management services would be lost in the shuffle.

These people could not have been farther from the truth.

World War II only served as a catalyst to boost management

services on to greater heights. The tremendous expansion

of management services has occurred in the post-World

War II years.

This postwar boom recjuired expanded services by

CPA firms. These expanded services went beyond the

traditional auditing and tax work into services never

before uncovered and/or provided. The war and postwar

eras demanded unheralded assistance from accounting firms

in the area of consulting services. New inventions and

innovations such as data processing, operations research,

and complex budgeting served to challenge accountants as

they struggled to keep clients satisfied with their

assistance in these new areas.

This period made the previously skeptical firms

sit up and take notice. Those accounting firms which had

been against management services had now changed their

attitude. Most of the major CPA firms organized or

12

restructured their management services departments right

after the end of World War II. These departments still

did not have near the personnel the auditing and tax

departments enjoyed. Still, it was a start in the right

direction.

The immediate postwar period was beginning to be recognized as the start of a nev/ era in public accounting, and many of the prejudices which had been long held were battered down by sheer pressure, from both v/ithin and without the profession.^

By the early 1950's, most CPA firms that could

afford them had management services departments. Many

firms did not have enough personnel to spread into a third

area of services performed by CPAs. Most accounting firms

went along with the crowd in adding these services, however.

Up until this time, the AICPA had not concerned

itself a great deal with this relatively new area in

accounting. In 1953, the AICPA established a Committee

on Management Services as a result of the increased interest

shown in the area of management services. Most of the

state societies of CPAs have since formed their ov/n such

committees which work together with the national committee.

The Committee has three objectives as it meets twice a

year:

. . . to (1) improve and increase the services of the CPA to his clients through the development

^Ibid

13

of management services, (2) improve the prestige of the CPA as an adviser to management, and (3) increase the reliance of the business community upon the CPA.^

In 1961, as mentioned in Chapter I, the resolution

on management services was adopted by the Council of the

AICPA. In 1969, three statements on management services

were issued by the Committee on Management Services to serve

as guides in consulting engagements. These resolutions and

statements have come as a result of the grov/th of CPA firm' s

consulting personnel. As a cou]ple of examples in manage­

ment services departments. Peat, Marwick, Mitchell and

Company grev/ from a staff of 12 in 195 2 to a staff of

200 in 1961, v/hile Arthur Young and Company has grown

from 12 staff members in 1954 to over 100 staff members in

1961. In 1966, management services were supposed to have

comprised 15 per cent of the total revenue of the total

CPA work. In ten to twenty years, this percentage is

forecast to jump to between 25 and 50 per cent.

While these figures would have startled a

practitioner twenty years ago, today they seem highly

probable. Nothing that can be said about management

services v/ould seem out of proportion today. Management

services now share the spotlight v/ith auditing and tax

Hov/ard F. Stettler, Systems Based Independent Audits (Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1967), p. 666.

14

work, a feat some said was too distant to perceive, much

less to achieve.

Development of Management Service; Within the Profession

The growth of the field of management consulting

has been spectacular in the last twenty to twenty-five

years. The growth of this field of accounting has even

been more spectacular, however. Hov/ did the profession

get started in this field? How are accounting firms

acquiring more and more of this business every year?

After ,V7orld War II, consulting services really

skyrocketed. Getting most of the business from these

services were professional consulting firms, and rightly

so. These firms provided managements with very useful

advice in numerous problem areas. It was during this

period that accounting firms began getting somewhat serious

about providing management services for their clients.

The new areas of services appearing after the war caused

some firms to be pushed into this field v/ith no idea of

what was to come. By the early 1950's, most of the

medium-sized and large CPA firms had management services

departments, though somewhat limited in personnel.

There are various reasons explaining the develop­

ment of management services within the profession. One

of the main reasons for this development has been the

15

failure of existing cox^sulting firms to handle the increased

demand in this area. Clients were dissatisfied with the

performance these consulting firms were rendering and were

slowly losing faith in the consulting field as a whole.

This was the cue the profession needed as accountants

stepped into the consulting field. It might be added here

that CPAs entered this field very reluctantly. Most CPAs

did not want to change their attention from their tra­

ditional areas of work to the new area of management

services; they did not want to learn new knowledge about

this nev7 area.

Slowly, most CPAs have come to the idea that

management services may not be so bad after all, with the

increased demand for consulting services and the lucrative

fees attached. As a result, management services departments

have mushroomed in personnel within the past twenty years.

The profession has cut deeper and deeper into the

consulting field which was once exclusively occupied by

professional consulting firms. This strong push by CPA

firms has been the result of a combination of various

reasons.

Perhaps most importantly, the auditing firm and the quality of its work are already knov/n to management as a result of an extended period of contract ."7

' Ibid

16

If a CPA firm has been auditing a particular firm for ten

years, then the firm knows the competency and cjuality of

work this particular CPA firm can produce. With a manage­

ment consulting firm, the client knows nothing about the

competency and cjuality of work performed except from a

client who has previously engaged the firm, and from the

consulting firm's own affirmations.

Another reason management has been looking more

and more to CPAs for consulting services is the familiarity

CPAs have with the client's organization and operations.

By virtue of their familiarity with their client's organizations, acquired through auditing and tax work, CPAs are in a position to undertake many management services, within the limits of their professional competence, v/ithout the orientation in the affairs of a business which v/ould be necessary if an outside expert, unfamiliar with p the organization, were brought in for this purpose.

Whereas CPAs are familiar with their client's

organization, and can immediately begin on management

services, consulting firms have to learn a client's

background and organization before they can ever think

about performing services. This "homework" is time-

consuming and very inconvenient to the client.

A consulting firm is hired for a certain job,

performs the services, collects its fee, and leaves the

o John L. Carey and William O. Doherty, Ethical

Standards of the Accounting Profession (New York: American Institute of Certified Public Accountants, Inc., 1966), p. 105.

17

client as its duties are completed. On the other hand, a

CPA firm must return for its annual audit engagement. Its

duties are not completed when the consulting services are.

Therefore, the CPA firm has to provide consulting services

as well as it possibly can because faulty management

services can mean the loss of an audit client. Consulting

firms perform a one-time service; they may return for

future consulting services or they may not. Clients thus

prefer CPA firms who all but guarantee their work to be of

top quality because of the continuing relationship.

Another reason CPA firms are acquiring more

management services engagements than ever before is the

fact that CPAs are members of a professional organization

with rules of conduct. The client knows this and is very

appreciative of the fact that the CPA " . . . perform

services for v/hich he is qualified by aptitude, education, Q

training, and experience." Consulting firms may operate

ethically, but with no professional rules of conduct to

follow, clients never rest easy with consulting firms

performing the services. With CPA's performing management

services, clients assume the work will be of top cjuality;

with consulting firms, they can only hope.

"Enlarging a Practice Through Management Services," Accountant's Encyclopedia, 1964, IV, 1327.

18

Accounting firms may one day take over completely

the area of management services. Until that day, they

will continue to eat away at the large market enjoyed by

professional consulting firms. The profession knows its

position in management services is strengthening daily;

and, sorrowfully, so does the consulting profession.

CHAPTER III

REASONS WHY CPA FIRMS OFFER MANAGEMENT SERVICES

Qualifications of CPAs

Approximately twenty-five years ago, the accounting

profession found itself giving birth to its third area

of service--management services. Today, management services

is indeed the strong, fledgling third area of service in

the profession. What special attributes and qualities

do CPAs possess that allow them to perform management

services? Have these qualities suddenly appeared within

the last twenty-five years?

A CPA should perform only those consulting engage­

ments for which he is well qualified to perform. Becoming

"well qualified" is the objective of every CPA who aspires

to perform engagements in this field. Many qualities are

acquired by years of experience and many are acquired by

years of hard study.

The major quality CPAs must acquire to perform

consulting services is the experience of competence.

Competence entails all the qualifications possible that

CPAs must meet before they can begin performing management

services. Numerous qualities are acquired from experience

alone, with little or no formal education needed.

19

20

These qualities include an objective point of view, the habit of relating each phase of opera­tions to its effect on overall earnings of the company, an analytical approach to complex problems, and a facility and poise in dealing directly with top executives in the client companies.

The CPA has expert knowledge of accounting and

taxes. These aspects of the accounting profession, while

not directly related to management services, are indirectly

connected with consulting services. Advice to management

has to include long-range forecasting as to the accounting

and tax consequences of the advice. Professional con­

sultants do not qualify for assistance to management in

these areas of accounting, whereas CPAs most assuredly

qualify.

CPAs must possess an analytical ability to analyze

problems in the business world. Every firm for which

consulting services are performed have many different

problems. No two firms are the same. Ability to analyze

problems comes from actual experience; ability to analyze

is not taught in universities or read in books. Analytical

ability is an important quality a CPA must possess if he

is to render management services.

Not only is the ability to detect problems of the firm important, but perhaps even more so is the ability to analyze those needs and to

• Walter B. Meigs, Principles of Auditing (3rd ed. ; Homewood, Illinois: Richard D. Irwin, Inc., 1964), p. 791.

21

make constructive proposals. Management con­sultants must have a broad viev/ of the business and be able to analyze the problem in terms of the total operation, as well as of its parts.^

A CPA on a consulting engagement might advise a

solution in a particular problem area of a firm, and soon

learn that another area of the firm had been adversely

affected by this solution. Thus, an overall perspective

of a firm must be kept at all times even though the

integral parts are under close scrutiny.

There are other attributes gained by the CPA only

through experience, such as: problem solving; two-v/ay

communications; choosing among different solutions; knowing

where industrial information is found; distinguishing

between previously tried solutions; and being open-minded,

to name a few. Of course, there are two other attributes

that have been previously mentioned and are most important

qualifications, and they are: (1) the continuing client

relationship the CPA has with his client, and (2) the

familiarity the CPA possesses of his client's organization,

policies, and personnel.

CPA qualifications for management services engage­

ments are also existent solely through the education

process. A college degree is almost essential today for

2 A. W. Patrick and C. L. Quittmeyer, "The CPA and

Management Services," The Accounting Review, XXX\'"III (January, 1963), 110-11.

22

a young person aspiring to be a CPA. Furthermore, a college

degree provides a base from which a future CPA' s competence

can be built. The requirements for attainment of a CPA

certificate are becoming more rigid every year.

In many states the requirements for the CPA include a college degree. This, together with the CPA examination, provides assurance that practitioners have met some fundamental intel­lectual standards and have exhibited minimum qualifications in the core management--services area of accounting and related subject matter. This is far more than many consultants, even highly successful consultants, had as a base on which to build their competence.

This tightening of requirements is essential as

the quality and number of candidates are increasing every

year. This minimum standard put forth by many states has

increased the quality of the CPAs within these states.

As important as a formal education is study and

training within the CPA firms. The CPA certificate does

not mean one is competent to immediately begin consulting

engagements. The certificate indicates a basic knowledge

of the management services area as previously explained.

Through long hours of training and study, a CPA can develop

a professional level of quality for performing management

services.

This development will require special study in management problems, participation in advanced

3 John L. Carey, The CPA Plans for the Future

(New York: American Institute of Certified Public Accountants, Inc., 1965), p. 228.

23

management programs, seminars, and conferences, and a shift of thinking from an accounting point of view to a management point of view."

When a CPA is asked to perform a consulting service

for a client, he does not rush right over and begin the

engagement. This would be equivalent to a sprinter running

a race before taking warm.-up exercises. Even though the

CPA may possess a professional level of skill in manage­

ment services, he may be totally uninformed on the particular

industry he is to work with. Thus, the CPA usually has

time before an engagement to study and prepare for a specific

assignment. Professional and trade literature are useful

for acquiring knowledge about a certain industry and the

"language" they use.

The ideal CPA in management services has a careful

blending of experience and education. A combinatipn of

both is needed before a CPA can render management services.

If a combination of both is not attained or cannot be

attained, then the CPA should question his competence to

perform the engagement. A consulting engagement rendered

without the CPA being competent could jeopardize the CPA,

the CPA's firm, and the profession as management consultants.

Meigs, Principles of Auditing, p. 791.

24

A Beneficial Service to the Clients

In a sense, consulting services have always been

performed by CPA firms for its clients. During the course

of an audit, an unexpected problem would develop and the

CPA would naturally offer suggestions for corrective

action. Thus, the CPA was providing services to management

which extended beyond the scope of the normal accounting

services of auditing and tax work.

When a CPA performs a management services engage­

ment for a client, he is providing a very beneficial

service to his, client. It might be added that management

advisory services are provided specifically for the

assistance of management. Whereas, when an audit is

performed and the service is for stockholders and third

parties, a consulting service does not concern itself

with anyone except management.

What would happen if no consulting services existed

for any firm, large or small? One can not even begin to

imagine the catastrophic results which would occur. The

number of dollars saved by businesses each year because

of management services would be a staggering figure. The

fees alone for consulting services in 1966 were nearly

$900 million. Without consulting services, the business

world would most assuredly be in a dire state of affairs.

25

Most firms do not have the time or personnel

necessary to provide their own management services.

Management advisory services exist and have existed because management may not possess the staff or time to do the work, and because management increasingly relies upon its certified public accountant for service and advice over and above that rendered through the medium of auditing, accounting services, and tax services.

Managements are relying more and more on accounting

firms to provide these management services. CPAs are

becoming more important than consulting firms in the con­

sulting field. Numerous surveys have shown that among the

organizations providing special services for the business

world, CPA firms stand at the top of the list as the most

frequently used organization. This distinction is verified

by the number of consulting engagements CPA firms provide,

and the number of these is increasing yearly.

Clients are deeply grateful that CPAs provide

management services. By providing these services the CPA

furnishes numerous benefits to his clients: (1) he saves

the client time which could be used more valuably elsewhere,

(2) he saves the client personnel which may be somewhat

incompetent to perform management services in the first

place, (3) he gives valuable advice which may mean the

difference betv/een sure bankruptcy and unexpected profit.

Arthur W- Holmes, Auditing Principles and Procedures (6th ed.; Homewood, Illinois: Richard D. Irwin, inc., 1964), p. 859.

2b

(4) he gives the best advice he can since his firm v/ill

return for its annual audit, and (5) he gives management

breathing room v/ith respect to management decisions. With

a CPA close-by, management has expert professional help in

making its decisions.

While CPAs can not actually make the decisions,

they can advise management on how to make the right

decisions. Management services by CPAs benefit the entire

business world, from the smallest firm to the large

corporation. Management advisory services are luxury

services above and beyond the routine accounting functions.

A Benefit to the Profession

When management services emerged some tv/enty-five

years ago as the third area of service in the profession,

little did anyone realize what a benefit it v/ould be to

the profession. As the area of m.anagement services

struggled through the 1950's and into the early 1960's,

great strides were being made by the larger CPA firms.

During this period, most of the large CPA firms had increased

their management services personnel between ten and twenty

times their original staffs.

Even though these strides were being made, many

CPAs were still skeptical about the management services

area. They were not willing to learn about this new area

or change their thinking from the traditional functions

27

of accounting. While some CPA firms were performing these

services as a third area of service, most CPA firms v/ere

not engaged in consulting work. However, once these

abstaining firms began realizing the great demand for CPA

consulting services and the lucrative fees that were being

received, their attitudes soon changed.

The share of the consulting services received by

the larger and greater-staffed CPA firms is tremendous.

In 1965, Peat, Marwick, Mitchell and Company, one of the

eight largest national CPA firms, grossed $17.5 million

in consulting services, while Booz, Allen and Hamilton,

the largest general management consultant, grossed $20

million domestically. CPA firms have practically passed

the consulting firms in dollar volume of management services

provided. With respect to the eight largest national CPA

firms, or "Big Eight,"

. . . the dollar volume of management consulting operations is expanding at an average annual rate of 15 per cent, as against 4 per cent for the consulting business in general, and 10 per cent for the 45 general management consultants who belong to the elite Association of Consulting Management Engineers.

These figures show the great surge CPA firms have

made in the management consulting area. This area of

consulting has enabled CPA firms to expand into areas of

"Are CPA Firms Taking Over Management Consulting?" Forbes, XCVIII (October, 1966), 57.

28

business never before thought possible. Consulting services

have added millions of dollars in revenue to many CPA firms.

The area of management services and the accounting profession

could not have been better suited for each other. With

their past knowledge of client's affairs, their competence,

their independence, and their professional standards, CPAs

perform consulting services as good or better than pro­

fessional consultants.

The benefits to the profession will be even greater

as more and more CPA firms expand their management con­

sulting departments. The greatest reward will come when

all CPAs are s'atisfied v/ith and accept management advisory

services as one of the greatest breakthroughs the accounting

profession has ever made.

All certified public accountants should be interested in this area because valuable manage­ment guidance services can be rendered, because this area of professional work is totally compatible with the education and background of certified public accountants, and because management should receive stimulating advice rendered by persons who are not members of a concentrated management team.^

Types of Services Offered

When a CPA firm secures a management services

engagement, the specific problem area can be any one of

a number of possible problem areas. The size of the CPA

7 'Holmes, Auditing, p. 859.

29

firm will determine the extent of the services to be offered

for specific problems. If a small CPA firm with limited

consulting personnel is engaged, the scope of its services

offered will be restricted. On the other hand, if a large

CPA firm with hundreds of consulting personnel is engaged,

the scope of its services will be almost limitless.

Irregardless of the number of management services

offered by CPA firms, the performance of these services v/ill

involve an analytical approach. This analytical approach

typically involves:

Ascertaining the pertinent facts and circumstances Seeking and identifying objectives Defining the problem or opportunity for improvement Evaluating and determining possible solutions, and Presenting findings and recommendations and following the client's decision to proceed, the independent accounting firm may also be involved in: Planning and scheduling actions to achieve the desired results, and Advising and providing technical assistance in

implementing. . . . °

Thus, usually a CPA v/ill remain with his client

from the time the problem is diagnosed until the recommen­

dation is put into effect, if the client desires the

CPA's assistance in this final step.

Q AICPA Committee on Management Services, '^Statements

on Management Advisory Services No. 1: Tentative Description of the Nature of Management Advisory Services by Independent Accounting Firms," The Journal of Accountancy, CXXVII (March, 1969), 63.

30

All areas of business have benefited from management

advisory services provided by CPA firms. The following

examples of management services and their subclassifica-

tions have been offered by most CPA firms; some firms offer

a few of the services, while other firms offer all the

services. The following list includes sixteen types of

services and their subclassifications, if applicable.

1. Finance: working capital requirements study,

receivership services, survey of credit and collection

policies, methods of financing capital acquisitions,

price-level changes, survey of pension and profit sharing

plans, short and long-term financing needs, repurchase

price of shares in close corporations, and return on

investment.

2. Office Management: office layout and space

utilization, office methods and procedures, office equipment,

evaluation of personnel, office organization, review of

paper work, filing system surveys, control of office forms

and records, clerical work standards, feasibility of data

processing systems, and design and installation of these

EDP systems.

3. Sales: marketing research, distribution costs

and statistics, pricing policy studies, organization of

sales department, sales reports, sales training programs,

warehousing methods and space utilization, sales

31

compensation plan, efficiency of delivery methods, and

price establishment for items sold.

4. Personnel: aptitude test studies, advice for

pension and retirement plans, salesmen's compensation

plans, executive compensation programs, training programs,

job classifications, labor relations studies, surveys of

accounting and nonaccounting personnel, incentive-pay

plans, group insurance plans, advice on fringe benefits,

and financial and statistical studies to help with union

negotiations.

5. Accounting: design and installation of

accounting systems, installation and review of internal

controls, installation of accounting machines, SEC reports,

selection and installation of data processing equipment,

statistical sampling techniques, and renegotiation of

contracts.

6. Production: plant location surveys, production

standards, production planning, quality control studies,

material handling surveys, time and motion studies, factory

overhead studies, survey of production records, space-

utilization studies, material control, and waste reduction

studies.

7. Budgeting: developing capital budgets for

acquisition of equipment and plant, developing cash budgets,

flexible budgets for scheduling production and controlling

costs, studies of costs and profit potentials of specific

32

projects, developing income and expense budgets, and

financial forecasting.

8. Costing: cost procedures, cost studies,

development of cost systems, appraisal of cost reports,

government contract costs, incremental cost studies, and

capital expenditure studies.

9. Industrial Engineering: production scheduling,

inventory control, materials handling, factory layout and

automation, studies of work simplification, time and motion

studies, production records and reports, and shop methods.

10. Organization: survey of the organization plan,

preparation of organization charts and flow charts, studies

of employees' effectiveness. Operations Research, assistance

for sources of capital, reorganization of financial structure,

survey of basic policies of company, advice as to form of

business organization, and reports for managerial control.

11. General Management: survey of management

policies and objectives, system of internal reporting,

managerial cost controls establishment, development of

office operating records, advice regarding contraction or

expansion, and purchase or sale of a business.

12. Auditing: rendering an opinion, installation

of internal audit procedures, examining for proposed

acquisitions or mergers, and coordinate programs with

audit staff.

33

13. Taxes: federal tax planning, state and local

taxation services, and estate tax services.

14. Research and Development: records and controls.

15. Purchasing: purchasing procedures, and

inventory control.

16. Miscellaneous: rate regulation surveys, life

insurance programs, advice on general business matters,

assistance in rehabilitating a business, survey for new

ventures, arbitrating disputes, developing fidelity, fire,

and other casualty insurance, and accumulating and reporting

trade statistics.

The foregoing list is by no means complete. It

only serves to show the great variety of management services

performed by CPAs. This list shows why management services

in accounting is growing every year. The many types of

management services performed by CPA firms indicates that

the profession will perform management services as long

as management has problems or needs advice.

CHAPTER IV

GUIDELINES OF MANAGEr4ENT ADVISORY SERVICES

The Accovinting Firm' s Scope of Management Services

When a person receives his CPA certificate, he is

assumed to be competent in accounting, auditing, and tax

matters. The CPA certificate does not mean a CPA is

competent in matters of management services. CPA firms

who perform auditing and tax work can not decide to jump

into management services. "Many CPAs believe that they

have a duty to offer management services to their clients.

Because a firm offers tax work and auditing to a client,

so the argument goes, a CPA firm should offer management

services to a client where its management has problems.

Competency in auditing and tax work does not automatically

qualify a CPA firm as competent in management services.

There are two ways to broaden the scope of manage­

ment services within a firm to build this competence:

to build from within the firm, and to employ outside

specialists. If a CPA firm tries to build gradually from

within, someone must be designated to train the staff in

II 1

John L. Carey and William O. Doherty, Ethical Standards of the Accounting Profession (New York: American Institute of Certified Public Accountants, Inc., 1966), p. 106.

34

35

these consulting services. Usually one or more partners

are assigned to study management services so they can in

turn train the staff. if specialists are employed, partners

once again play an important role. One or more partners

who are competent in management services are assigned to

supervise and evaluate the work of the specialists.

The AICPA committee on management services has its

own ideas as to the scope of management services.

The committee believes that an independent accounting firm in reaching decision as to the scope of its management advisory services should be guided by certain significant criteria established by the profession, such as competence and independence.

If a CPA or CPA firm is not competent to perform a

consulting engagement, a referral should be made to a

specialist or another firm. If a CPA firm is not competent

in certain areas where its assistance is greatly needed,

then its scope is limited. If a CPA firm is fully competent

in numerous consulting areas, then its scope is very broad

indeed. The performance of many management services

challenges a CPA's independence. By declining an engagement

where his independence would be jeopardized, a CPA would

2 AICPA Committee on Management Services, "Statements

on Management Advisory Services No. 1: Tentative Descrip­tion of the Nature of Management Advisory Services by Independent Accounting Firms," The Journal of Accountancy, CXXVII (March, 1969), 63.

36

lose the fees and possibly his client, but would keep his

integrity and pride as a CPA.

Each independent accounting firm has to determine

the scope of the services v/hich it can perform competently

for its clients. One firm may lean toward one area of

management services, say electronic data processing, v/hile

another firm may concentrate in another area, sophisticated

cost analysis, for example. Most small CPA firms, because

of their staff and time, offer management services in only

one or two areas. The medium-size and large CPA firms

offer numerous management services, with most of the "Big

Eight" firms offering management services in practically

all of the types of management services listed in

Chapter III.

Many accountants believe there should be limits

as to the scope of management services performed by

accountants. There are three differing views with regard

to the limitations.

(1) The conservative view is that such services should be limited to matters which are an immediate and natural outgrov/th of the CPA' s basic function as independent auditor.

(2) The middle-of-the-road view is that the CPA may properly undertake any services which he is competent to perform within the scope of the client's information system. This could include a wide area. . . .

(3) The liberal view is that the CPA may properly undertake any work which he is competent to

37

perform in all the areas of management except those restricted to another profession by law.

These views, while largely academic, could only do

harm to the profession. CPAs should not be limited, except

by law, in any way in their performance of management

services. An attempt by the accounting profession to

limit the CPA's scope as to consulting services could only

do more harm than good. CPAs should be allowed and encouraged

to expand their scope of management services. This expansion

would broaden the range of areas where the CPA's advice is

sought.

The scope of management services will be decided by

CPAs; they will decide whether they want to broaden their

services or leave them as they are.

Regardless of the ultimate scope of management services in which CPAs may engage, the most likely point of departure is the client's information system. The CPA's understanding of the internal control and data-producing pro­cedures which he acquires as independent auditor, and his understanding of the operations of the business as reflected in the financial statements, provide the basis on which he can begin to advise and assist management.

As long as the CPA's scope is not limited, his

area of possible management services is boundless. Each

CPA firm has its own scope of management services, as does

3 John L- Carey, The CPA Plans for the Future (New

York: American Institute of Certified Public Accountants, Inc., 1965), p. 217.

^Ibid., pp. 218-19.

38

each CPA. With the new era of computers and the pro­

fession's destiny to spread out into many new areas which

are as yet untapped, the scope of management services

cannot keep from expanding.

The Accountant's Role in Management Services

The accountant's role in management services is

that of an adviser. If the role becomes anything more

than an adviser, then the CPA loses his independence and

usually his job as well.

The role of an independent accounting firm in performing management advisory services is to provide advice and technical assistance, and should provide for client participation in the analytical approach and process. Specifying this as the proper role recognizes both the appropriate place of management advisory services and the realities of practice. This is the only basis on which the work should be done, and it is the only basis on which responsible management should permit it to be done.^

The role assumed in each engagement depends on

the nature and objectives of the management service to be

performed. The role assumed, however, will always be that

of an adviser, and not a decision-maker.

In many management services engagements, the

analytical approach is but the preliminary step of service

^Committee on Management Services, "Management Advisory Services No. 1," p. 62.

39

as the CPA must follow the engagement through to its

implementation.

The objective is to supplement management's capability by providing an objective point of view, a consideration of alternate courses of action, a broader perspective from experience ^ in analogous situations, and technical assistance.

The CPA's role in consulting services is strictly

to assist and give advice to management. The CPA is not

a decision-maker or an employee of the client, but is an

adviser to the client. Because he gives advice, the CPA

hopes his advice is put into action. Gradually, as the

CPA's advice is introduced to the firm, the CPA's partici­

pation lessens' in degree as the client's personnel take

over where the CPA left off. The CPA hopes that when he

eventually leaves his client, the client's personnel will

have the C3[ualifications to proceed on their own.

The CPA/consultant's role is that of an adviser.

Even if he wanted to, the consultant would have a hard

time making decisions. The main reason for this is that

the CPA is a member of an accounting firm, and not a staff

manager with the client. If the CPA were a staff manager

with the client, then he would have the necessary resources

at his command to carry out the decision. Members of

management of the client are the only persons who can

AICPA Conamittee on Management Services, "Statement on Management Advisory Services No. 3: Role in Management Advisory Services," The Journal of Accountancy, CXXVIII (November, 1969), 63.

40

command these resources. If a CPA tries to command the

resources and make the decision, he loses his role as an

impartial and objective consultant; he is in a sense a

member of management. Also, management frequently tries

to relinquish its decision-making role in favor of the

CPA, who must decline the engagement or rearrange the

roles so that he still possesses his impartiality and

objectivity.

Many CPAs are asked to give answers to questions

in an informal, "off-the-cuff" atmosphere. The person

asking the question should understand that no background

research or extensive study has been made to fully

encompass all pertinent facts and alternatives of the

question. In circumstances such as these, the role assumed

by the consultant is to ansv/er as practicable as possible

under the circumstances, explaining that the informal

advice should be accepted at its face value.

As an adviser, the CPA/consultant has only one

thing in mind--success of his advice and assistance.

The measure of ultimate contribution by the consultant is the effectiveness with which management acts on a sound recommendation and the degree to which, at the conclusion of the consultant's participation, the client's personnel have acquired the capability to continue at a higher level of effectiveness in the future.'^

7 Ibid., p. 64.

41

If the consultant leaves the client with the

client's personnel performing at a level higher than when

he arrived, the CPA's work has brought him rewards. If

the consultant leaves the client with the client's

personnel still floundering in the wake of the advice and

assistance rendered by the CPA/consultant, the CPA's work

has been for naught. The role the CPA assumes on each

engagement will go a long way in determining the success

of his assistance and advice. If the CPA maintains his

impartial and objective role as an adviser throughout an

engagement, the client as v/ell as the client's personnel

will benefit from it.

Competence in Performing Management Services

A CPA must be fully competent when performing

management services. A faulty management services engage­

ment can discredit the entire accounting profession.

Competency is a must for every CPA who renders consulting

services.

Competence in management advisory services refers to knowledge, experience, skill, and research capability in applying judgement and finding and implementing solutions via this analytical approach and process.°

o

AICPA Committee on Management Services, "Statements on Management Advisory Services No. 2: Competence in Management Advisory Services," The Journal of Accountancy, CXXVII (April, 1969), 56.

42

Two kinds of competence will be discussed in this

section: staff competence and firm competence. Staff

competence is concerned with every individual who performs

management services for a CPA firm. How does a CPA attain

competence in management services? Does the CPA certificate

render a CPA fully competent?

Foremost, the CPA certificate is the accepted

minimum proof of competence concerning management services.

However, the CPA certificate acknowledges a degree of

proficiency in auditing, tax, and general accounting

services. Management services per se is not included in

the CPA examination. Thus, the CPA who aspires to enter

the management services area must attain more substantial

proof that he is fully competent in this area of service.

This is the key to the performance of management services,

as almost 100 per cent of a CPA's competence in management

services is acquired after he receives the CPA certificate.

CPAs can acquire this competence through education,

training, research, and experience. It takes time to

build up this competence; it does not develop as an instan­

taneous phenomenon. Even when a CPA has been in management

services for ten years and has all the confidence in the

world in his competence, he still may not be fully com­

petent. An engagement may arise in an industry the CPA

has not yet encountered. The CPA must then research the

industry through professional and other literature so

43

as to become familiar with its organization, the industry

"language," and operating techniques applicable to the

particular industry. This research allov/s the CPA to

prepare in advance for an engagement, and to become

competent in a particular industry.

A continuous staff development program is needed

to augment the methods used to acquire competence, or

competence may deteriorate. The reason for this is obvious

New developments in technology and business techniques are

occurring every day, and CPAs must keep pace v/ith this

technical revolution if they are to survive in management

services.

CPAs are individuals, and as individuals they have

their own ideas as to the degree of competence they can

attain for management services engagements. A method of

training and research which works well for one person may

not work at all for another. Tv/o equally competent CPAs

may perform an engagement differently. Only the CPA knows

his limitations and shortcomings in management services.

If a CPA realizes his limitations in a certain area in

which a client needs advice, he should obtain help from

a more competent source rather than attempting the engage­

ment with the risk of losing a fee as well as a client.

Nothing would discredit the accounting profession more rapidly than a general tendency on the part of CPAs to undertake engagements for which they are not qualified. Loss of client's confidence

44

would have adverse effects even on the more familiar areas of accounting practice.

Firm competence, the second type of competence, is

not limited to any one individual, since all the personnel

in a firm's management services department are included

under this second type.

There has seemed to be substantial agreement within the accounting profession that the com­petence of a firm of certified public accountants is as broad as, but no broader than, the combined competence of the individual members of the firm.

With respect to small CPA firms, they are at a

distinct disadvantage in firm competency. A small CPA

firm may only have two or three CPAs performing management

services in only one or two areas. If an engagement occurs

that requires competency in a completely different area

and one in which this small firm is not competent, outside

competency will have to be found. With a larger firm,

however, the consulting personnel are stronger in number,

are better developed in management services, and are more

competent to perform consulting services in a larger

number of areas. Thus, the trend for larger and larger

CPA firms is understandable—the more a firm expands, the

Carey and Doherty, Ethical Standards, p. 109.

James E. Redfield, A Study of Management Services by Certified Public Accountants (Austin: Bureau of Business Research, University of Texas, 1961), p. 26.

45

broader its competency becomes and the more specialized

its staff becomes.

If a CPA firm has a good development program as

well as a good training program, it will not encounter

any problems in broadening its competency. A CPA firm

can also broaden its competence through the use of

specialists. A specialist is not permanently employed by

the CPA firm employing his services, but is temporarily

employed to render help in a certain area. If members of

the CPA firm work with the specialist they might acquire

competence in this particular area. In general, hov/ever,

the competency of the firm is not broadened by a

specialist's engagement.

A CPA firm should perform only those services that

its partners can supervise or evaluate competently.

Supervision and evaluation recjuire a thorough training

program for the participating partners as their duties

call for performances above and beyond those of the staff.

On the one hand, competent supervision may not be essential for the performance of management services by employees who are nonaccounting specialists and who do possess sufficient competence. On the other hand, it is imperative that such services be completely evaluated.^

The larger a firm's staff becomes, the broader

its competency becomes. These larger staffs are becoming

^^Ibid., p. 27

46

more and more specailized every year. However, a con­

sulting department staffed only with specialists would

be in the same position as a consulting firm.

A wide range of management advisory services can normally be performed only by a firm v/hich includes both general!sts and individuals who have acquired specialized qualifications in the subject matters or techniques involved.-'•

Specialists and generalists are both needed in a

CPA firm. A firm's competence depends on the number and

quality of its specialists and generalists. The combined

competence of these two groups is the sum total of the

competence of the firm.

Specialization Within Management Services

No one person can accjuire specialized knowledge

in all areas of management services. The field of manage­

ment services covers too many areas for anyone to specialize

in them all. That is why generalists and specialists are

needed in the profession.

Specialization makes possible a great deal of

competence as the CPA's entire study is concentrated in

one area of management services. In a sense, the CPA

becomes an expert in the particular field in v/hich he

1 2 Committee on Management Services, "Statement No. 2," 57.

47

specializes. Thus, specialists can command and usually

receive higher fees than do the generalists.

The scope of management services performed by

CPA firms depends on the amount of specialization within

each firm.

Accordingly, the requirements for specialization in certain areas may limit the scope of manage­ment advisory services offered by any given independent accounting firm.

If a firm has five men in the consulting department

and three of them are specialists, the scope of management

services offered by that particular firm will not be too

big. As there is competition among the firms to perform

client's management services, many firms develop specialties

of their own. These firms may decide on areas of service

not yet offered by other CPA firms. Firms developing such

specialties will be assured of engagements in their own

areas with no competition.

Specialization is the order of the day. In medicine

and law, for example, specialization is the rule rather

than the exception. The same is beginning to materialize

rapidly in the accounting profession. Practically all of

the major firms have specialists in every area of consulting,

while the smaller firms are becoming more and more of

13 Committee on Management Services, "Statement No. 1/" 64.

48

specialists, whether in areas such as budgeting, production,

or cost accounting.

As the profession extends its activities farther into the field of management services, individuals and firms will of necessity specialize to a greater degree. -^

Specialists within the profession are equally as

competent, if not more so, than outside specialists.

Specialists within the profession are performing more and

more engagements every day. If such keen competition

within the profession did not exist, and if more CPAs

swallov/ed their pride a little more regularly, engagements

for CPA specialists would come much more rapidly through

referrals from their fellow CPAs.

Referral of Management Services

The area of management services is growing rapidly

day by day. The larger CPA firms, with their large staffs

of consulting personnel and their development programs,

are keeping pace with this ever-growing third service of

the profession. The smaller firms, while attempting to

expand their personnel rapidly so as to broaden their

consulting competence, do not have the competence to cope

with many consulting services. Thus, the smaller CPA

14 Carey and Doherty, Ethical Standards, p. Ill

49

firms are more apt to refer clients to other CPAs or

outside specialists than are the larger firms.

One v/ould tend to think that CPA firms not competent

to perform certain consulting services would refer clients

to other CPAs. Up to now, this has not been true. CPA

firms have referred clients more to outside specialists,

such as engineers, than they have to other CPAs. V7hether

these firms believe technical experts from outside the

profession are more competent, or whether the firms do not

want to refer to competing firms, the profession is

suffering from the consequences.

The clients are caught in the middle of this

referral controversy. If specialists within the profession

are not referred to by their fellov/ practitioners, clients

will be forced to seek outside specialists for assistance.

If outside specialists are brought in, the client may be

without the extra services of CPAs working in conjunction

with the specialists. CPA/consultants are usually more

competent than outside consultants to perform management

services--what a shame to have all that expertise "sitting

on the shelf."

The fields of auditing and tax work have been in

existence as long as the accounting profession. CPAs have

been able to keep up with the developments in these two

fields without much inequity in knowledge. In management

services, however, the big expansion has come v/ithin the

50

last twenty-five years. Some CPAs have had the time to

devote concentrated study to this field, and have thus

become specialists. Many other CPAs have not had the

opportunity to study this relatively new field of services,

much less specialize in any certain area. Therefore,

referrals are needed more in management services than in

the fields of auditing and tax work.

A major reason for reluctance to refer clients to

other CPAs has been the fear that the other CPA might

take over the regular accounting work from the original

CPA. This fear has caused many a CPA to call on outside

specialists for client assistance, as outside specialists

can not take over the accounting work. As a result.

Rule 5.02 of the Code of Professional Ethics was adopted,

which states:

A member or associate who receives an engagement for services by referral from another member or associate shall not discuss or accept an extension of his services beyond the specific engagement without first consulting with the referring member or associate.15

Whether a CPA refers to another CPA or an outside

specialist, the CPA can often times work with the specialist

on the engagement. Participation in an engagement with a

CPA specialist rather than an outside specialist is looked

upon much more favorably by the profession.

Ibid.

51

In any event, to the extent that the independent accounting firm finds an effective way to co­operate with others, it may thereby expand its own knowledge and extend its own scope of service toward providing the full range of management advisory services.

The better the cooperation betv/een CPAs and referral

engagements, the better the cooperation between CPA firms.

Cooperation will further the development of the entire

profession.

Professional Ethics

The field of management services is unique in that

no specific standards have been designed primarily for

management services. Both auditing and tax work have

much authoritative literature and accepted practices which

serve as guides for CPAs. Development of standards for

management services might be difficult because of the

erratic nature of management services.

The applicability of the Code of Professional

Ethics to management services was clarified by Opinion No. 14

of the AICPA committee on professional ethics. They stated

in part:

. . . It is the opinion of the committee that all provisions of the Code of Professional Ethics apply to management advisory services, except

•^^Committee on Management Services, "Statement No. 1/" 64-65.

52

those rules soley applicable to the expression of an opinion on financial statements.17

With the jurisdiction of the Code of Professional

Ethics now extending to management services, many ethical

questions concerning CPAs and management services can be

answered. For example, according to Rule 3.04, a non-CPA

management expert can be made a partner of a CPA firm.

Other areas clarified by the Code are: contingent fees,

forecasts, use of a CPA's name by another, incompatible

occupations, advertising, solicitation, division of fees

with nonpractitioners, encroachment, and referrals.

The ethical problem of advertising has been a big

issue lately. Since management services is a new field,

CPAs, as well as professional consultants, want to inform

their clients of this extra field of service. Non-CPA

consultants can advertise in any means they so desire,

and thus have the CPAs at a disadvantage since they must

follow the Code. CPAs do have various means of informing

clients of their management services, such as brochures,

monographs, slide films and motion pictures. Restrictions

on the material should be set so it will be received by

the proper professional people. "In general, a CPA may

17 Ibid., p. 65.

53

send his clients any information which he believes would

.- n. .,18 interest them."

Professional ethics are a must for all CPAs

performing management services. Whether or not professional

consultants have rules of ethics is of no concern to CPAs.

Clients realize the strict rules of professional conduct

with which CPAs must comply, and are showing their admira­

tion and appreciation by engaging more CPAs yearly.

18 Carey and Doherty, Ethical Standards, p. 113.

CHAPTER V

THE INDEPENDENCE ISSUE IN MANAGR^IENT SERVICES

Effects of Management Services on CPA's Independence

The professional reputation enjoyed by the

accounting profession is second to none in the business

world. One of the main reasons for this reputation has

been the distinct independent relationship which the CPAs

have maintained with their clients. The new field of

management services has brought a challenge to the strict

independent attitude employed by CPAs.

To be independent, a CPA can not be influenced

by others concerning his opinion.

One must agree that true independence is a state of mind, but it is impossible to get inside a person's head at the time of the audit to discover his attitude. True independence is thus a very subjective concept, even in acccpunting where we pride ourselves on objectivity.

This independent relationship employed by CPAs has

existed from the day the first audit or tax engagement

was undertaken for a client. With the tremendous growth

of management services since World War II, CPAs have been

R. W. Schattke and Alan Smith, '^Management Services and Auditing - Ethical Problems," Accountancy, LXXVII (August, 1966), 550.

54

55

faced with newer and more demanding problems concerning

independence in this new field.

One of the main problems concerning independence

centers around the CPA/consultant and decision-making.

In performing a consulting engagement, the CPA's only

concern is to give advice and assistance to management.

In performing his services, the CPA is to maintain an

independence in attitude at all times. When all the

alternatives have been presented, management should decide

on the course of action it will follov/, not the CPA. If

the independent accountant ever makes a decision for

management, no- matter what the circumstances, he auto­

matically loses his independence. The role of the CPA is

to advise; management's role is to make the decision. If

these two roles are not altered in any v/ay, the CPA's

independence will not be endangered.

There are two other major problems concerning

management services and a CPA's independence. One of these

problems deals with the performance of auditing and manage­

ment services for the same client. This problem will be

the topic of the next chapter. Pros and cons of compati­

bility of auditing and management services for the same

client will be presented, as well as the results of a sur­

vey concerning the impairment of a CPA's independence by

performing both these services.

56

The second of these problems deals with a CPA' s

audit independence and a possible conflict of interest

with his performance of management services. On this issue.

Opinion No. 12 from the AICPA's Committee on Professional

Ethics represents the profession's position.

. . . For example, in the areas of management advisory services, . . . so long as the CPA's services consist of advice and technical assistance, the committee can discern no likelihood of a con­flict of interest arising from such service. In summary, it is the opinion of the committee that there is no ethical reason why a member or associate may not properly perform professional services for clients in the areas of . . . management advisory services, and at the same time serve the same client as independent auditor, so long as he does not make management decisions or take positions which might impair that objectivity.2

The committee thus sees no challenge to the CPA's

independence from management services. There are third

parties, however, who feel the audit independence is

impaired by the same CPA performing management services.

Whether this problem will be settled will depend on the

attitude of third parties; only time will tell.

2 Arthur A. Schulte, Jr., "Management Services:

A Challenge to Audit Independence?" The Accounting Review, XLI (October, 1966), 721.

57

Phases of a CPA's Independence

Professional Independence

Professional independence is essential to any

member of any profession. Without professional independence

where would the business v/orld be today? Self-reliance is

the key to professional independence. In accounting, the

CPA must be free from control or influence of management.

This independence is the same v/ith professional consultants

and other professions as well. "To attain professional

independence, the auditor must possess an approach and

attitude which makes him self-reliant and not subordinate

3 to his client."

Professional independence is based on how members

of a profession perform and how they evaluate each other.

In psychological terms, it is more of a peer-group rating

system. If a CPA becomes too good a friend of a client,

the profession as well as his peers might well question

his independence. If a CPA, or member of any other pro­

fession, realizes that his performance is under the careful

scrutiny of hundreds of fellow practitioners, he will make

an added effort to uphold his professional independence.

3 D. R. Carmichael and R. J. Swieringa, "The Com­

patibility of Auditing Independence and Management Services--An Identification of Issues," The Accounting Review, XLIII (October, 1968), 698.

58

One encroachment of his independence could cause a CPA

to lose his job.

This type of independence enables professional

men to accept responsibility without hesitation. The

accounting profession is proud of its independence, and

the profession's clients are grateful for it. As pro­

fessional independence is an important ingredient in

accounting, so it is equally important to any other

profession.

Audit Independence

Audit independence, like independence in general,

is a state of mind. One can not knov/ what an auditor's

attitude is at the time of an audit. Audit independence

is concerned with two roles the auditor must play to

protect his independence:

Not only must the auditor refrain from intentionally favoring the client's interests in planning his examination, gathering evidence, and preparing his report, he must also avoid any unintentional . feelings which might cause him to take such actions.

The CPA should never become subordinate to his

client. Third parties would question the independence of

a CPA who followed every wish of his client. The CPA has

the experience in auditing. He should be self-reliant

and depend on or listen to his client as little as possible

"^Ibid.

59

The more self-reliant the auditor, the stronger the audit

independence appears. All professions practice self-

reliance; it is not peculiar only to the accounting

profession.

The CPA should not let biases or unintentional

feelings sv/ay his judgement. In other words, the CPA has

to be alert at all times v/hen performing auditing services

for a client in order to guard against his self-interests

becoming involved. This aspect of audit independence is

a unique requirement among professions in the business

world. Most professions generally have "professional

independence" and self-reliance as their guides, and

nothing else. In accounting, hov/ever, auditors have an

obligation to third parties who rely on the financial

statements. "Members of other professional groups do not

have such a v/ell defined professional obligation to any 5

unseen audience."

Thus, CPAs require audit independence as well as

professional independence. Audit independence is an added

safety precaution used to strengthen a CPA's independence.

An auditor has to be independent, since a large number of

people rely on his financial statements.

^Ibid., p. 723

60

Independence in Fact

Thomas G. Higgins, chairman of the Institute's

Committee on Professional Ethics in 1962, proposed the

distinction between independence in fact and in appearance.

There are actually two kinds of independence which a CPA must have--independence in fact and inde­pendence in appearance. The former refers to a CPA's objectivity, to the quality of not being influenced by regard to personal advantage. The latter means his freedom from potential conflicts of interest which might tend to shake public confidence in his independence in fact.^

Independence in fact refers to the actual inde­

pendence of a CPA. If a CPA loses his integrity or becomes

subordinate to'his client, then his independence in fact

disappears. Independence in fact is not concerned with

the results of income of the client affected by the con­

sulting services, but is concerned v/ith the procedures

and principles applied by the CPA. If the principles and

procedures applied by the CPA are not affected, then

independence in fact remains intact.

If a CPA performs a management services engagement

objectively and v/ith an open frame of mind, his independence

in fact will not be jeopardized. However, if the CPA

performs his services under undue pressure and with a

closed frame of mind, his independence in fact will

Thomas G. Higgins, "Professional Ethics: A Time For Reappraisal," The Journal of Accountancy, CXIII (March, 1962), 31.

61

disappear. This whole area of independence depends almost

solely on the CPA's state of mind. A CPA's state of mind

determines whether a CPA will continue as an auditor or

find work elsewhere.

Independence in fact does not appear to be jeop­

ardized when an auditor performs management services

engagements. The CPA has to continue his role of con­

sultant, and consultant only. When he attempts to under­

take the responsibilities and duties of management, hov/ever,

the CPA's independence in fact is likely to be lost.

Independence in fact is essential to every CPA who performs

management services and also performs audits for the same

client.

Independence in Appearance

The CPA may know he is independent, and his company

may also know he is independent. But what about third

parties, bankers, and the clients? Even though a CPA

knows he is in fact independent, he must appear independent

to reasonable observers who have knov/ledge of all the facts.

Also, the profession as a whole must appear independent

to the general public. The previous two statements refer

to the two phases of the appearance of independence.

The first phase is concerned with a reasonable and

knowledgeable observer's perception of a CPA's independence.

The second phase is concerned with the general public's

62

perception of the profession's image. Both of these phases,

if closely observed, will be seen to rely solely on percep­

tion for their existence. Perception, or an observer's

opinion, is based on the meaning a particular situation

has for the observer. A reasonable observer might observe

a CPA two times--one time might show no impairment of

independence and the other might show numerous instances

of impairment.

Taken in the strict sense there is probably no CPA in practice today who can honestly say that he has avoided all relationships which to a third party might appear capable of subconsciously impairing the CPA's objectivity.'^

One of the many necessary conditions for inde­

pendence in appearance is that a CPA should have no economic

interest in a client. Every client, at least up until now,

has provided fees to CPAs for their services. Realistically

speaking, a CPA can never actually be completely independent

because of this economic interest.

However, he can try to be intellectually honest--given the nature of his work--and observe certain restraints so that others will justifiably regard him as independent.

7 C. E. Graese, "Management Services and the

Independence Issue," The New York Certified Public Accountant, XXXVII (June, 1967), 430.

p

James Wesley Deskins, "Management Services and Management Decisions,'^ The Journal of Accountancy, CXIX (January, 1965), 53.

63

Appearing independent to reasonable observers is

an objective of all CPAs. Independence in fact does not

satisfy observers, as they have to perceive independence

for themselves. The observer bases his opinion on v/hat

he perceives, not what the CPA would like him to perceive.

V

CHAPTER VI

COMPATIBILITY OF MANAGEMENT ADVISORY

SERVICES AND AUDITING

Advocates of Combined Consulting and Auditing

Can, in fact, a CPA perform management consulting

and auditing for the same client v/ithout impairing his

independence? This question has grown from mere specula­

tion on the part of some CPAs to one of the most hotly-

debated controversies in the profession today.

In his capacity as consultant to management, the independent CPA will offer advice v/hich he con­siders beneficial to his client's interest. In the role of independent auditor, the same CPA ventures an opinion on the periodic income statement.

This chapter will be concerned with the tv/o sides

of this compatibility controversy. The advocates' side

will be explored first, with the opponents' side being

presented second.

The CPA has to be independent in performing

auditing and management services, so performing both

services for the same client cannot be incompatible. This

is not independence in fact or appearance, however, but

Hugo Nurnberg, "Management Services: Effects on Independence," The Accounting Forum, XXXIV (December, 1963), 16-

64

65

professional independence. Thus, independence in this

sense is concerned with the professional integrity of the

CPA, and not the actual performance of both services.

Advocates v/ill admit that pressures exist when

performing management services for a client. However,

they also will argue that the auditor is already subject

to numerous real and apparent pressures. "Providing

management advice to a client need not create greater

threats to audit independence than these that already exist

2

m any CPA's practice."

Pressure exists regardless of whether management

services are performed by CPAs or not. The CPA must resist

this pressure if he wants to maintain his independence.

Auditors, by the very nature of their business,

are in a better position than anyone else to provide

management services to their clients. The client-auditor

relationship, the familiarity with the client's organiza­

tion, and the profession's ethical conduct are a few of

the reasons why consulting work is a "natural" for CPAs.

The disallowance of CPAs to perform management services

would have far-reaching effects in the business world.

Two CPA firms would be involved with auditing and consulting

one firm. If different firms perform consulting services

2 Kenneth S. Axelson, "Are Consulting and Auditing

compatible?" The Journal of Accountancy, CXV (April, 1963), 54.

66

for one firm, time, money, and effort would be lost as the

new firm tried to acquaint itself with the client. A CPA,

performing both services for the same client, would not

only save time, money, and worry, but also the additional

costs which would be required to engage another CPA.

It is difficult to understand the ill-defined fear that if management adopts a CPA's advice, for example, on systems and procedures, the CPA will somehov/ become less independent or impartial in making his audit report.-

Many employees give advice, but just because a CPA

gives advice does not mean he is an employee. A CPA does

not depend on one client as an employee does—if an

employee is fired, he has no job, while a CPA has many

other clients should he lose one. The advice given by

CPAs is not law, nor is it management's thoughts. The

CPA's advice is evaluated along with that of the company's

staff and other outside experts before a decision is

reached. As stated earlier, the CPA advises while manage­

ment makes the decisions.

Thus, while the consultant can be held responsible for the quality of his advice, without the authority to act he cannot be held responsible for its execution and hence for the eventual outcome. V^en as a CPA he audits a financial statement, therefore, he is not auditing his own

3 "Independence and Services to Management," The

Journal of Accountancy, CXVI (November, 1963), 44.

67

decisions but the financial results of management decisions that may not reflect his recommendations.

Advocates of compatibility point out that no

evidence exists showing that performance of auditing and

management services for the same client has impaired a

CPA's independence. CPAs have been performing management

services for over twenty-five years without impairing

their independence, and that adds up to quite a few con­

sulting engagements. Just because litigation does not

exist concerning the impairment of independence does not

mean it cannot happen. Past performances do not dictate

future events. A well-publicized case involving a CPA's

impaired independence could definitely alter the pro­

fession' s position on this controversy.

In Table 1, the results of a survey concerning

management services and impairment of independence are

presented. Participating in the survey were national

CPA firms with separate consulting departments, and local

firms with two or more CPAs. The inclusion of "the

installation of an accounting system" was to show how CPA

firms reacted to one specific type of management service.

Advocates believe separation of consulting and

auditing would do more harm than good. If the two services

were not so mutually beneficial, separation would be

4 Axelson, "Compatible?" 56.

68

TABLE 1

FIRMS INDICATING EXTENT TO WHICH PERFORKiANCE OF MANAGEMENT SERVICES FOR AUDIT CLIENTS WOULD

TEND TO IMPAIR INDEPENDENCE

Replies

Offices of National Firms v/ith a Separate Management Service Local

Question Department Firms

Generally, to v/hat degree do you feel that the CPA's "independence" in auditing tends to be impaired by:

Management services for an audit client?

Number of replies 14 314

Per cent of total Definitely impairs indep. - 3 Possibly impairs indep. - 28 Does not impair indep. 100 69

Total 100 100

Installation of accounting system for audit client?

Number of replies 14 313

Per cent of total Definitely impairs indep Possibly impairs indep. Does not impair indep.

Total

•

4 100 96

100 100

Source: Redfield, James E. , A Study of Management Services by Certified Public Accountants ( Austin, Texas: Bureau of Business Research, University of Texas, 1961), p. 29.

69

logical and would not hurt either's performance in any way

Advocates feel the performance of management services does

not pose a real threat to audit independence; there is

no basic incompatibility between the two services. As far

as the advocates are concerned, no tv/o services could be

better-suited to each other than auditing and consulting

by a CPA for the same client.

Opponents of Combined Consulting and Auditing

While a majority of the profession feel consulting

and auditing are compatible, there are many CPAs who

believe these tv/o services are not compatible. The main

issue on this side of the controversy involves the con­

sultant as a decision-maker. When the consultant makes

decisions, he is no longer independent.

The AICPA, as stated in Chapter I, has encouraged

all CPAs to perform any and all management services in

which they have attained full competence. However,

Opinion No. 12 from the AICPA Ethics Committee states that

a CPA who makes decisions impairs his independence.

It is a rare instance for management to surrender its responsibility to make management decisions. However, should a member make such decisions on matters affecting the company's financial position or results of operations, it would appear that his objectivity as independent auditor of the company's

70

financial statements might well be impaired. Con­sequently, such situations should be avoided.^

The Securities and Exchange Commission (SEC) has

essentially expressed the same vie\ point. The Commission

also holds that a CPA impairs his independence when he

makes decisions. When a CPA gives advice, he is performing

his duties as a consultant.

Decision-making is for management, and not CPAs.

The opponents of compatibility contend that management

invites the consultant's advice, and when it is forthcoming,

it is accepted.

Management wants the advice and intends to use it; advice is sought and paid for to be follov/ed, not to be ignored. It seems folly indeed to separate advising and judgement making.

Management should not feel obligated to follow a

consultant's advice simply because the consultant was

employed to give advice. There are usually other experts

as well as staff employees who also give advice toward a

decision. As the advocates of compatibility contend, the

consultant has influence and not authority in decision­

making. Hence, with no authority, the consultant has no

responsibility.

"independence and Management," 44.

R. K. Mautz and Huessin A. Sharaf, The Philosophy of Auditing (Menasha, Wisconsin: George Banta Co., Inc., I961), p. 221.

71

However, management might surrender its authority

and responsibility to the consultant to make the final

decision. Management may feel the CPA is the only person

sufficiently qualified to make the decision. No matter

what the reason for accepting this responsibility, the

CPA immediately jeopardizes his independence. Once he

makes the decision, the CPA becomes a decision-maker v/hich

automatically forfeits his independence.

In Table 2, it can be seen that the financial

community views consulting and auditing as definite

incompatible services. Understandably so, the accounting

profession did not significantly believe the two services

would impair the auditor's independence. The financial

community, as noted in the statistics, are thoroughly

disenchanted with the profession's attempt to make these

two services compatible.

Even if the CPA does not make the decision, his

position in the decision process impairs his independence

in other areas. Opponents of compatibility point out that

when a CPA renders management services he becomes, in

effect, an employee of his client. If a CPA is used in

place of developing a staff for consulting, he also could

become, in effect, an employee. In both cases, the CPA

would respect the wishes of his new employer, his client,

and thus would impair his independence.

72

TABLE 2

RESPONDENTS' VIEWS OF MANAGEMENT SERVICES BY CPAs PERFORMING THE INDEPENDENT AUDIT FUNCTION

Percentage Distribution of Responses

Accounting Profession Category

Financial Community Category

A. In your opinion, the rendering of management services by CPAs in situations v/here they v/ill also be fulfilling the inde­pendent audit function will: (a) Enhance the auditor's

opinion (b) Detracts from this opinion (c) Does not effect this

opinion

B. In your opinion, the rendering of management services by CPAs in situations where they will also be fulfilling the inde­pendent audit function is: (a) Compatible with

auditor's traditions (b) Incompatible with

auditor's traditions (c) Compatible with

independence (d) Incompatible with

independence (e) To be encouraged (f) To be discouraged

8% 22

69

66%

22

72

22 59 22

17% 53

18

22%

49

22

58 18 54

Source: Briloff, Abraham J- "Old Myths and Nev/ Realities in Accountancy." The Accounting Rev lev/, XLI (July, 1966), 492.

73

Another area of concern over compatibility involves

the consultant and client developing a relationship so

close as to possess mutual interests. Opponents argue

that after so long a time in a consulting relationship,

the client and the auditor have practically the same

interests. "The consulting role, by its very nature,

generally leads the consultant to empathize with management."

In the closeness of the relationship, the CPA may uncon­

sciously lose his objectivity, which makes this area rather

touchy.

The CPA may become an advocate for his client

during the course of the engagement. The CPA usually tries

to persuade management to pursue the best alternative to

the problem, thus his persistent advocacy. "First, the Q

CPA, as a consultant, is an advocate towards his client."

The CPA helps his client solve problems. "Second, the

CPA, as a consultant, may act as an advocate for his 9

client." The CPA may need to persuade some group that his client's actions are the best possible, thus his client

becomes of the utmost importance in this situation.

7

Arthur A. Schulte, Jr., "Management Services: A Challenge to Audit Independence?" The Accounting Review, XLI (October, 1966), 725.

Ibid., p. 726.

^Ibid.

74

A final area of possible impairment of independence

involves the financial stake the CPA has in his client's

company. The reputation and financial success of a con­

sultant depends upon the success of his engagement. If

good results come from his engagement, the consultant is

freed of his v/orries. If sub-par results are the outcome

of the engagement, the CPA's reputation and financial

success are in jeopardy. The consultant's interest is not

too different from that of a full-time employee.

Opponents believe that consulting and auditing

ought to be separated. Separation would solidify the

CPA's independence and impairment of independence would

be all but impossible. The CPA should avoid relationships

which endanger his independence, such as close client

relations. The consultant must appear independent to the

public, or his professional position is jeopardized.

Opponents believe the profession v/ill suffer if these two

services are not separated.

To the outsider, the CPA who v/orks one day for management and then audits management's repre­sentations another day hardly presents an appearance of independence, even though he may in fact be independent . . . independence in fact is futile if one gives others reason to doubt -that independence because of objective factors.

10 Delmer P. Hylton, "Are Consulting and Auditing

Compatible - A Contrary View, " The Accounting Review, XXXIX (July, 1964), 669.

lb

Results of a Survey of Reasonable Observers

In 1965, Arthur A. Schulte, Jr., an Associate

Professor of Accounting at the University of Portland,

conducted a survey concerning the appearance of independ.in

to a "reasonable observer" mentioned in Opinion No. 12

of the AICPA's Ethics Committee. A "reasonable observer"

is a third party who relies on a CPA's audit report to

make investment and credit decisions.

The survey included four groups: (1) research and

financial analysts of brokerage firms, (2) commercial Icsr

and trust officers of banks, (3) investment officers of

insurance companies (both life and fire and casualty),

and (4) investment officers of domestic mutual funds.

Financial executives from the largest financial institutic

and smaller financial institutions were chosen to assure

a cross-section of the financial community's "reasonable

observers." In total, 76 per cent of the financial insti

tutions studied were in the survey, and 53 per cent, or

665 of the financial executives responded to the survey.

Because of qualifications, only 635 of the surveyed

executives participated in the survey.

The results were divided into financial executive:

from institutional investors, and those executives from

the banks and brokerage houses. With respect to the

institutional investors, 43 per cent believed that audit_

—I r I O

and consulting were compatible and did not impair a CPA's

independence. On the other hand, 33 per cent believed

auditing and consulting were incompatible and impaired a

CPA's independence. The other 24 per cent were indefinite

about the issue, and thus v/ere not sure of the compati­

bility. Thus, 67 per cent believed auditing and consulting

were compatible and did not impair independence, v/hile

33 per cent believed independence v/as impaired.

The results of the financial executives from the

banks and brokerage houses were somev/hat different than

those of the institutional investors. Table 3 shows

the surprising summary of opinions of these executives.

Reasonable observers from the largest banks and brokerage

houses oveirvvhelmingly saw no conflict of interest impairing

audit independence, while the randomly selected reasonable

observers were less in favor of the compatibility than were

the institutional investors.

This apparent difference between the largest and the randomly selected bankers and financial analysts is probably due to the fact that the former tend to deal with the larger CPA firms where auditing and management services are performed by separate staffs. The implication for the accounting profession may be that specialization of services provides a protection for the professional image of independence of the CPA.11

Arthur A. Schulte, Jr., "Compatibility of Management Consulting and Auditing," The Accounting Review, XL (July, 1965), 591.

77

TABLE 3

SUMlviARY OF OPINIONS AS TO EFFECT OF IvlAimGEIlENT CONSULTING ON AUDIT INDEPENDENCE OF CPA

No May Serious Seriously Effect Effect Undecided

Commercial loan officers

of largest banks 60% 17% 23%

Randomly selected banks 39P/O 39% 22%

Financial analysts of largest brokerage houses 50% 22% 28%

Randomly selected brokerage houses 37if/o 37if/o 25%

Source: Arthur A. Schulte, Jr., "Compatibility of Management Consulting and Auditing," The Accounting Review, XL (July, 1965), 591.

This survey does not support the AICPA's contention

of no conflict of interest to reasonable observers. Maybe

the AICPA Ethics Committee should not have acted hastily

on the matter, and should have conducted their ov/n survey.

In any rate. Opinion No. 12 should be re-evaluated and

supported by substantial evidence upholding the contentions

To 33 per cent of the financial executives from across the

country, the CPA's management services engagement show

a definite conflict of interest with a CPA's audit inde­

pendence. The profession should concern itself with

these 33 per cent who see a conflict of interest, as

78

independence is the backbone of the profession. Confidence

in a CPA's independence must not be broken.

CFIAPTER V I I

SUMMARY AND CONCLUSIOIIS

Summary

The grov/th in management advisory services within

the accounting profession in the past tv/enty-five years

has been phenomenal. This tremendous grov. th has stemmed

from the increasing importance management is placing on

outside resources. Of course, very simply, if management

had not needed outside assistance in proiDlem areas in the

first place, consulting services would m.ore than likely

be non-existent in the profession today.

Management advisory services caught on slov/ly in

the profession, and there are still some skeptics wno

feel these services should not ne performed by CPAs.

V^ile these skeptics still ponder this new area of service,

the rest of the profession is making millions of dollars

from these engagements. As one can readily perceive, the

skeptics are overv/helmingly in the minority.

CPAs are by far the best-qualified professional

organization to perform managerp.ent services. Professional

consultants also provide consulting services, but they do

not have the accounting background necessary fci ac:sistance

in many management problems. It is only ratural for CPAs

79

80

to perform management services because of their implied

professional responsibilities, which the consulting pro­

fession does not possess.

Management advisory services performed by CPAs

serve a dual purpose. These services serve as a benefit

for the clients as the consultants give advice and

assistance in the many different types of services offered.

Consulting services also serves as a benefit to the pro­

fession, in terms of greater revenues and more clients.

Six guidelines are essential in the performance

of management services. Each CPA firm and each CPA must

decide the scope of their service before they can actually

begin performing consulting services. The CPA's role in

consulting is that of an advisor, and not that of a

decision-maker. Competence, which is obtained through

experience and/or education, is a prerequisite for every

consulting engagement. Specialists are needed and found

in all areas of management services. CPAs are reluctant

to refer clients to other, better qualified CPAs, but this

practice is necessary to the continuation of consulting

by CPAs. CPAs operate under strict rules of professional

conduct, whereas the consulting profession does not.

Independence plays a major role in the performance

of management services by CPAs. There are four phases

of independence to which CPAs must adhere: (1) professional

independence, (2) audit independence, (3) independence

81

in fact, and (4) independence in appearance. A CPA has

to maintain all these phases, especially the last one

which involves the public, if he is to keep his inde­

pendence intact. Compatibility of consulting and auditing

is a controversial area with each side supporting its

valid contentions. Surveys have shov/n that numerous

third parties have their doubts as to the compatibility

of auditing and consulting and the effect on audit inde­

pendence. This issue is a major one and needs to be

settled as soon as possible.

Conclusions

The public's acceptance of management services

performed by CPAs has been unbelievable. The public has

aided immeasurably to put management services by the

profession into the respected position it enjoys today.

Without the public's acceptance, management services would

have disappeared long ago within the profession.

. . . the substantial growth which the CPA firms have experienced in management consulting services is a demonstration of the growing acceptance and need for the combination of skills which the CPA can provide in the . . . management services field.1

C. E. Graese, "Management Services and the Independence Issue," The New York Certified Public Accountant, XXXVII (June, 1967), 437.

82

More and more medium-sized and smaller accounting

firms are installing management services branches as a

third field of service. These firms, other than the

"Big Eight" firms, seek to participate in this fast growing

field and in the tremendous profits generated by these

engagements. The largest firms cannot begin to handle

all the demands by clients for consulting engagements.

The smaller CPA firms are needed, by the clients and by

the profession.

The controversy of compatibility between auditing

and consulting must end soon before it literally splits

the profession in half.

Advocates of "incompatibility" have been satisfied to demonstrate that combined consulting and auditing has the potentiality for damaging the auditor's independence, while the advocates of "compatibility" have demanded absolute proof that independence has been lost.

No evidence exists to show the incompatibility

between these services. Thus, there is no basic incom­

patibility between auditing and consulting until evidence

is brought forth to the contrary. Even though there is

nothing basically wrong with performing both services for

the same client, one slight miscue by a CPA might send the

2 D. R. Carmichael and R. J. Swieringa, "The

Compatibility of Auditing Independence and Management Services—An Identification of Issues," The Accounting Review, XLIII (October, 1968), 705.

83

entire profession reeling. Where audit independence is

involved, there is no margin for error.

The CPA, with the introduction of management

advisory services, has greatly expanded his scope of

service. Where once limited primarily to audit and tax

work, the CPA now has a new and challenging field in which

to extend his services. This new field of accounting is

fast-grov/ing and ever-changing, a truly dynamic area.

Management services have played an important part

in adding stature to the role of the CPA in society. If

utilized wisely, management services can help the accounting

profession attain even greater heights. CPAs are limitless

as to the possibilities available in the management services

field.

There are no apparent limits to the opportunities of certified public accountants to expand their services.

The only limitations on his future opportunities are his own intelligence, competence, and venture-someness. Assuming that the CPAs of today and tomorrow have these cjualities in abundance, it is time to go to work in earnest to convert the possibilities into reality.^

3 -._ John L. Carey, Th^ CPA Plans for the Future, New York: American Institute.of Certified'Public Accountants, Inc, 1905), pp. 249-50.

SELECTED BIBLIOGRAPI-IY

Books

American Institute of Certified Public Accountants, Inc. Accounting and The Computer. New York: American Institute of Certified Public Accountants, 1966.

Carey, John L. The CPA Plans for the Future. Nev/ York: American Institute of Certified Public Accountants, 1965.

Carey, John L., and Doherty, William O. Ethical Standards of the Accounting Profession. New York: American Institute of Certified Public Accountants, 1966.

Cashin, James A., and Owens, Garland C. Auditing. 2nd ed. New York: The Ronald Press Company, 1963.

Holmes, Arthur W. Auditing Principles and Procedures. 6th ed. Homewood, 111.: Richard D. Ir //in, Inc., 1964.

Meigs, Walter B. Principles of Auditing. 3rd ed. Homewood, 111.: Richard D. IriNrin, Inc., 1964.

Murphy, Mary E. Auditing and Theory; A CPA Review. Homewood, 111.: Richard D. Invin, Inc., 1963.

Redfield, James E. A Study of Management Services by Certified Public Accountants. Austin, Texas: Bureau of Business Research, University of Texas, 1961.

Stettler, Howard F. System.s Based Independent Audits. Englewood Cliffs, N.J.: Prentice-Hall, Inc., 1967.

The Editorial Board of Prentice-Hall Professional Accounting Publications. Accountant's Encyclopedia Vol, IV, Englewood Cliffs, N.J. : Prentice-Hall, Inc., 1962.

c4

85

Monograph

Mautz, R. K. , and Sharaf, Hussein A. The Philosophy of Auditing. Menasha, Wisconsin: George Banta Co., Inc., 1961.

Periodicals

AICPA Committee on Management Services. "Statements on Management Advisory Services No. 1." The Journal of Accountancy, CXXVII (March, 1969), 62-65.

. "Statements on Management Advisory Services No. 2." The Journal of Accountancy, CXXVII (April, 1969), 56-58.

. "Statements on Management Advisory Services No. 3." The Journal of Accountancy, CXXVIII (November, 1969), 62-65.

"Are CPA Firms Taking Over Management Consulting?" Forbes, XCVIII (October, 1966), 57-61.

Axelson, Kenneth S. "Are Consulting and Auditing Compatible?" The Journal of Accountancy, CXV (April, 1963), 54-58.

Belda, Bertrand J. "Committee report on referrals." The Journal of Accountancy, CX 7 (January, 1963) , 84-86.

Beyer, Robert. "Management Services--Time for Decision." The Journal of Accountancy, CXIX (March, 1965), 43-52.

Briloff, Abraham J. "Old Myths and New Realities in Accountancy." The Accounting Review, XLI (July, 1966), 484-495.

Buckley, John W- "Management Services and Management Audits by Professional Accountants." California Management Review, IX (Fall, 1966), 43-49.

Carey, John L., and Doherty, William O. "The Concept of Independence--Review and Restatement." The Journal of Accountancy, CXXI (January, 1966), 38-48.

86

Carmichael, D. R., and Sv/ieringa, R. J. "The Compati­bility of Auditing Independence and Management Services—An Identification of Issues." The Accounting Review, XLIII (October, 1968), 697-705.

Cony, Ed. "Accounting Firms Push Deeper Into General Management Consulting." Wall Street Journal, October 30, 1961.

Deskins, James Wesley. "Management Services and Management Decisions." The Journal of Accountancy, CXIX (January, 1965), 50-54.

Elliott, Austin M. "Should Accountants Perform Management Services?" The Office, LXIX (February, 1969), 64,68,83.

Elliott, Norman J. "Is Independence Affected by Rendering Management Services?" The Journal of Accountancy, CXV (January, 1963), 84.

. ".Organizing And Staffing For Management Advisory Services." The Accounting Forum, XXXVII (May, 1966), 4-6, 41.

Engel, Lee. "The CPA as a Management Advisor." The Office, LXX (July, 1969), 14-16, 20.

Firmin, Peter A. "Compatibility of Management Services and Auditing." Louisiana CPA, XXVI (October, 1966), 6-17.

Golding, Jordan L. "Recognizing Management Services Opportunities." Management Services, VI (September, 1969), 38-45.

Graese, C. E. "Management Services and the Independence Issue." The New York Certified Public Accountant, XXXVII (June, 1967), 429-37.

Higgins, Thomas G. "Professional Ethics: A Time for Reappraisal." The Journal of Accountancy, CXII (March, 1962), 29-35.

Hylton, Delmer P. "Are Consulting And Auditing Compatible?-A Contrary View." The Accounting Review, XXXIX (July, 1964), 667-70.

"Independence and Services to Management." The Journal of Accountancy, CXVI (November, 1963), 44.

87

Kaufman, Felix. "Professional Consulting by CPAs." The Accounting Review, XLII (October, 1967) , 713-20.

Kell, Walter G. "Public Accounting's Irresistible Force and Immovable Object." The Accounting Review, XLIII (April, 1968), 266-73.

Kesselman, Jerome J. "The Public Accountant's Role in Management Advisory Services." The National Public Accountant, VI (December, 1961), 4-7, 11-12.

Mautz, R. K. "Challenges to the Accounting Profession." The Accounting Review, XL (April, 1965), 299-311.

Nurnberg, Hugo. "Management Services: Effects On Independence." The Accounting Forum, XXXIV (December, 1963), 16-17, 50.

Patrick, A. W., and Quittmeyer, C. L. "The CPA And Management Services." The Accounting Rev lev/, XXXVIII (January, 1963), 109-17.

Rapp, John. "Management Services Should 'Hold No Terror' For CPAs." The New York Certified Public Accountant, XXXVI (July, 1966), 492-93.

Schattke, R. W-, and Smith, Alan. "Management Services and Auditing--Ethical Problems." Accountancy, LXXVII (August, 1966), 547-51.

. "Management Services and Auditing--The Am.erican Experience." Accountancy, LXXVII (June, 1966), 386-90.

Schulte, Arthur A., Jr. "Compatibility of Auditing and Management Services." The Journal of Accountancy, CXXIV (December, 1967), 29-32.

. "Compatibility of Management Consulting and Auditing." The Accounting Review, XL (July, 1965), 587-93.

. "Management Services: A Challenge to Audit Independence?" The Accounting Review, XLI (October, 1966), 721-27.

Tedesco, Patrick E. "Accountants' Opportunities in Management Advisory Services." The National Public Accountant, VIII (May, 1963), 8-9.

88

"To Be or Not To Be--Consultants or Accountants." The Controller, XXIX (December, 1961), 611.

Trueblood, Robert M. "The Management Service Function in Public Accounting." The Journal of Accountancy, CXII (July, 1961), 37-44.