HD8 - The Study of Issues Relating to the Practice of Accountancy

  • Published: 1988
  • Author: Department of Commerce and Board of Commerce
  • Enabling Authority: House Bill 1019 (Regular Session, 1987)

Executive Summary:
Background and Purpose

The 1987 Virginia General Assembly, as part of House Bill 1019, directed the state Board of Commerce to "evaluate (i) the need and desirability for additional regulation of accountants who are not certified public accountants; and (ii) the proper parties to be involved in rendering review reports on financial statements; and (iii) the appropriateness of modifying the limitations on references to accounting principles and standards contained in this act".

To assist it in carrying out the mandates of the legislature, the State Board of Commerce ("Board") retained the consulting firm of Technical Associates, Inc. of Richmond, Virginia ("Consultant"). This report has been prepared by the Consultant to aid the Board in its evaluation.

Methodology and Procedures

To meet the objectives of the study, four avenues of inquiry were undertaken. First, the conceptual basis for the licensing or regulation of professional practices was considered particularly as it relates to the accounting profession. Second, the Consultant conducted a general review of statutes and regulations governing accounting practice in the U.S. including legal summaries of relevant case law.

Third, the Consultant attended the public hearings held by the Board and closely examined the transcripts and written comments flowing from those proceedings. Finally, a major survey was taken regarding opinions in the Commonwealth of the issues at hand, directed at more than 14,000 businesses, 1,000 users of financial statements, and 1,100 accounting professionals.

An assessment and weighing of this considerable amount of information and data forms the basis for the Consultant's conclusions and recommendations.

Regulation Elsewhere

Laws and regulations governing accounting practices vary widely among the 50 states. Some appear to be highly restrictive, literally granting a monopoly to CPA'S in the accounting services market. Others are less restrictive, limiting the exclusive domain of the CPA'S to auditing services. There are still other states who have a minimum of regulation, allowing anyone to do anything except that only CPA's can claim to be licensed. Some 14 of the 50 states have chosen a two-tier system whereby there are licensed CPA's and licensed non-CPA's, each with exclusive rights over particular accounting functions.

Diversity in the regulation of accounting practice is apparent when considering just the systems in Maryland, the District of Columbia, West Virginia, Kentucky, Tennessee, and North Carolina. At one end of the spectrum sits North Carolina, where the only restriction on non-CPA's is that they may not refer to themselves as anything except accountants. Beyond that, unlicensed accountants can perform any accounting function in Virginia's southern neighbor. At the other end of the spectrum sits Tennessee with a two-tiered licensing system, i.e., licensed CPA'S and licensed PA's. Moreover, the regulations in the Commonwealth's southwestern neighbor specifically set forth what each of the classes of licensees can do.

Public Hearings

The Consultant attended public hearings held by the Accountancy study Subcommittee of the Board in Fairfax, Williamsburg, and Roanoke. At these hearings, over which Subcommittee Chairman Michael W. Cannaday presided, representatives of the Virginia Society of CPA's argued forcefully for retaining the present law, while spokesmen for the Virginia Society of Accountants put forward vigorous arguments for reducing present restrictions. Representatives of other organizations, and many individuals, took a variety of positions which were as diverse as, and in many cases were similar to, positions advocated by the respondents to the Consultant's surveys.

For example, representatives of financial institutions, with one exception, took positions in support of the present law, although those who were questioned agreed that they could easily distinguish the work of a CPA from that of an unlicensed accountant and could establish a policy of rejecting reports by non-CPA's if they wished.

The record of the public hearings was kept open until July 31 to permit the submission of written testimony and additional materials. Forty-five exhibits were received and incorporated into the record before the deadline. These exhibits also reflected the same wide variety of opinion expressed in the surveys.

Survey Results

To determine the general views of Virginia businesses regarding the issues posed by the General Assembly, the Consultant conducted three mail surveys of accounting service users and providers in the Commonwealth: (A) a survey directed at 14,360 chief financial officers or chief executive officers of randomly selected businesses; (B) a survey directed at 1,000 third party users of financial statements, such as bank loan officers, executives of investment banking and brokerage firms, and investment company officials; and (C) a survey of 1,146 accounting professionals, divided approximately equally between CPA's and non-CPA's.

Half of the businesses responding (50%) in survey (A) are satisfied with both the cost and quality of accounting services available in their areas. Substantially more firms are concerned over the cost of accounting services (23%) than over its quality (5%). Only 5% are concerned with both the cost and quality of accounting services.

Approximately 70% of the respondents in survey (A) distinguish between various types of accounting services such as compilation, bookkeeping, review, tax preparation, and audit. And, of this 70%, 9 out of 10 believe different education and experience levels are required to competently provide such services. Auditing services are ranked highest as requiring the most education and experience.

When the firms in survey (A) were asked if "Virginia law should be changed to permit non-CPA's to use such terms as "generally accepted accounting principles", or GAAP, approximately 40·% answered "yes" and 60% responded "no". Virtually the same distribution of answers resulted when they were asked if the law should be changed to allow non-CPA's to use the term "review", issue review reports, or to call themselves "public accountants". That is, about 60% said "no" and 40% said "yes".

The converse situation arose when the survey (A) businesses were asked if they would "favor regulation of non-CPA's, such as a licensing requirement similar to but not necessarily identical to the licensing of CPA's, as a prerequisite to non-CPA's being able to use such terms as "GAAP." That is, about 60% said "yes" and 40% replied "no". The same converse response distribution emerged when the survey (A) firms were asked about the same form of regulation of non-CPA's being a prerequisite to them being able to use "review", issue review reports, and hold themselves out as public accountants.

In survey (B), it was found that bankers and other users of financial statements use compiled statements, reviewed statements, audited statements, and income tax returns with approximately the same frequency in making financial decisions. About 67% also believe such statements are prepared in accordance with "generally accepted accounting principles".

More than 8 out of 10 of the survey (B) respondents recognize the accounting terms of art distinction between audited and reviewed financial statements. And, about 60% of them believe that preparation by a CPA is the most important factor in determining the reliability of an unaudited financial statement.

The pattern of responses in survey (B) regarding changing present Virginia law to allow non-CPA's greater latitude or favoring regulation of non-CPA's as a prerequisite to such an allowance is similar to that of survey (A), but users of financial statements are more opposed to changing current law than is business generally. At the same time, survey (B) respondents favor regulation of non-CPA's to a greater degree than survey (A) firms.

The views of CPA's and non-CPA's differed sharply in survey (C) regarding the desirability of changing present restrictions on the use of accounting terms and the preparation of review reports. More than 90% of CPA'S favored no changes in present law on both of these issues, while 77% of non-CPA's wanted the law altered. The two groups were somewhat closer in the matter of the need for regulation. Among CPA'S, 47% favored regulation (such as a licensing requirement) as a prerequisite to allowing non-CPA's to use such terms as GAAP. In contrast, 58% of the non-CPA's took this position. The percentage of CPA's favoring regulation as a prerequisite for non-CPA's to perform reviews was 54%, whereas the number of non-CPA's seeking this prerequisite was 67%.

Conclusions and Findings

The justification for the licensing or regulation of professional practice is that the public benefit of economic and other restrictions outweigh the public cost. That net benefit, where it exists, is due to the technical nature of professional practice which makes it difficult for the public to make rational and informed choices.

In the case of medical practice, where life and death decisions abound, it is understandable that significant market restrictions have been imposed. With respect to other professions, the need for regulation is less obvious. As a people, however, we have approached licensing and regulation cautiously--believing that the free market produces the greatest gain for society overall. Perhaps nowhere is this better exemplified than in Virginia, not only with regard to broad public policy measures, but also with respect to professional licensing. To illustrate, section 54-1.26 of the Code of Virginia (1950, as amended) states "that the Board shall regulate only within the minimum degree necessary to protect public health, safety and welfare".

The evidence from both the public hearings and surveys does not indicate an overpowering need for restrictive regulation. The business public is able to distinguish among various types of accounting services and is generally satisfied with the cost and quality of those services. Nothing suggests that a large (or even a small) body of the business consuming public needs a restrictive form of licensing or regulation before they can make rational and informed choices about accounting services.

At the same time, a majority of businesses do not want present Virginia law changed. But given the large minority who do wish to allow non-CPA's greater latitude, one wonders whether the majority's opinion may have been influenced by a natural reluctance to advocate a change in the law or by a lack of experience with the present law. However, the fact that a majority of firms are in favor of regulating non-CPA's as a prerequisite to granting them greater latitude in their practices must also be considered in the interpretation of the apparent preference of a majority of businessmen for retaining the current law.

As for users of financial statements, their views are clearly and understandably governed by self-interest, as are those of CPA's and non-CPA's. Financial statement users seek avenues which will make their jobs easier and less costly. Restricting accounting services to CPA's or licensing non-CPA's fulfills those ends.

The Consultant also concluded that the development of the system in which financial information is couched in a uniform language has been of enormous importance to the economic growth of Virginia and the nation as a whole. This is due largely to the efforts of CPA'S who have achieved similar qualifications and whose work is widely accepted by persons who do not know them. The Consultant has further found that reviews, as defined by the American Institute of Certified Public Accountants ("AICPA") have become an integral part of that uniform language system since their use was suggested by the AICPA in 1978 as an alternative to a full audit.

The evidence also indicated that the work of unlicensed practitioners (non-CPA's) has been indispensable to the Commonwealth and that the growth and development of non-CPA practice normally involves learning about GAAP and other aspects of accounting which are codified primarily through the efforts of CPA'S. The great majority of persons who have received training in GAAP and related subjects are not, and never will be, CPA's. Some non-CPA's were even found to have Ph.D.'s in accounting and related subjects and to teach accounting principles at the college level based on GAAP.

An essential difference was found between the work of CPA's and that of unlicensed accountants. That is, the work of the latter is not part of the nationwide licensing system which gives the work of CPA's credibility. As a result, the reports of unlicensed accountants can only be relied upon by persons who are in a position to make their own judgment as to the accountant's independence, qualifications, and skill.

In addition, the Consultant concluded that third parties who rely on financial statements are normally quite sophisticated and can easily distinguish the work of a CPA from that of a non-CPA. Such users can, and sometimes do, adopt policies of never accepting the work of a non-CPA as evidence of the reliability of a financial statement. As a consequence, the Consultant believes that users of financial statements do not normally need protection from the work of non-CPA's. A majority of such users wish to retain the restrictions in the present law because they would prefer not to be subject to customer pressure to deal with review reports and other assurances prepared by accountants who are not CPA's.

Recommended Approach

Absent the sentiments expressed in the surveys and in the public hearings, the Consultant's recommendation would be the licensing/regulatory system presently in existence in North Carolina. However, because of these views, the Consultant has chosen a system which retains certain major restrictions on unlicensed accountants while eliminating others.

The Consultant recommends that the current broad prohibition against the expression of any kind of opinion on a financial statement (an "assurance" in the language of the current statute) by unlicensed persons be reduced. Practitioners calling themselves accountants, however, or offering services to the public in the fields of bookkeeping or accounting, or claiming special qualifications in these fields should be required to add a disclaimer if they make any kind of assurance which would encourage reliance on a financial statement. The recommended disclaimer consists either of the language:

"The undersigned is not a licensed Certified Public Accountant under Virginia law. Persons relying on this opinion [these opinions] must do so on the basis of their own judgment of the writer's qualifications, ability, and independence." or (at the option of the accountant) "The Undersigned is not a licensed Certified Public Accountant under Virginia Law. This opinion [these opinions or statements] is [are] intended for the client's use only."

The disclaimer should not be required on an assurance which is clearly given by an employee to his employer, or which is given by a government employee in the course of his duties.

In addition, persons who do not claim to be accountants and who neither offer accounting or bookkeeping services to the public nor claim special qualifications in this field should be able to write anything they wish about a financial statement without a disclaimer, whether or not their statements are directed to their employers.

Although the Consultant recommends that the prohibitions against the offering of assurances by accountants and bookkeepers be reduced, they should not be removed. Two important kinds of assurance, an "audit" and a "review", should continue to be restricted to licensed persons and the use of the related terms "audit", "audited" "auditing standards", "review" and "reviewed" should be similarly restricted. All other previously prohibited terms, including "examination" and "opinion" should be available to unlicensed accountants.

No additional class of licensee should be created. The Consultant believes that the disclaimer and the restrictions which should be retained will provide sufficient protection to the public.

In designing these recommendations, the Consultant intends to give to unlicensed persons nearly complete freedom to examine and analyze financial statements, to use or misuse accounting terminology, and to make the results available to anyone who might want to look at them, provided that it is made clear that the responsibility of judging the reliability of that work rests with the user.

The word "review" is reserved to CPA's because it has been restricted in Virginia and is so restricted in many other states. It could be taken, therefore, to mean the type of analysis which is performed by a CPA and which is widely acceptable as a result. A loan officer might request a "review" of a financial statement, for example, when he means a "review by a CPA". The Consultant's recommendations should have the effect of restricting only the word "review", not the review function as long as the function is given another name.

The recommended disclaimer is intended to remind both the person who pays the accountant and any third party, such as a loan officer, of something that should be obvious in any case--that the work he is paying for or examining is outside of the system which makes the work of CPA'S credible to persons who have no knowledge of their individual reputations. It is designed to encourage persons who need to use this system to demand the work of a CPA, but to let persons who are comfortable with the work of a non-CPA to use the work of that accountant.

Alternative Approaches

1. North Carolina Model. North Carolina has put no restrictions on unlicensed accountants accept that they cannot call themselves anything except "accountants". The North Carolina system is one of open competition in which the market alone determines who hires CPA'S, who hires non-CPA's, and for what work each is hired. Third parties are free to use or reject audits and reviews by both types of accountants depending on their needs. Presumably, businesses who hire accountants to perform reviews and audits are (or soon become) sensitive to the requirements of third parties who may use the resulting reports. Similarly, there are economic incentives to encourage banks and bonding companies to communicate their requirements for the preparation of reviews and audits to potential customers, either to avoid turning away customers who submit unwanted types of assurances or to attract customers by having minimum requirements for the preparation of such assurances.

This regulatory approach has been successful enough in North Carolina so that there is no evident movement to change it. The Consultant recognizes, however, that this approach is likely to be contrary to the views of the majority of the respondents to the surveys who do not wish to remove current restrictions on non-CPA's. Otherwise, the Consultant believes that this is a desirable regulatory system.

2. Kentucky Model. If the two approaches presented thus far are felt to give too much freedom to unlicensed accountants, the Consultant recommends a law like that of Kentucky which prohibits unlicensed accountants (or persons claiming expertise in accounting) from giving any opinion as to the reliability of a financial statement. Such a law clearly prohibits both reviews and audits by unlicensed persons. It does not, however, try to regulate persons such as security analysts if they do not claim expertise in accounting, nor does it contain explicit restrictions on the use of accounting terms such as GAAP. This and comparable terms would have to be used carefully by unlicensed accountants, however, if they were to avoid violating the restriction on opinions.

The Consultant believes that this simpler law would avoid some of the awkwardness of the present Virginia statute. It would be less subject to legal challenge on the grounds that it infringed the freedom of speech of non-CPA's, and it would remove much of the problem of accidental violations which may occur under the present Virginia statute. Otherwise, the effect of such a simpler statute on the business of licensed and unlicensed accountants would probably be much the same as that of House Bill 1019.

3. Modified North Carolina Model. This alternative lies between the North Carolina model and the Consultant's recommended approach, as it removes the restrictions on the performance of reviews by non-CPA's. This approach shares with the North Carolina system the disadvantage that it disregards the wishes of respondents to the surveys, especially the survey of users of financial statements. It would restrict only audits to CPA's. Given a choice, the Consultant would prefer the North Carolina approach in total.

4. Retain Present Law. The Consultant does not believe that the status quo is a desirable alternative. In particular, prohibition on the use of terms such as GAAP which are important to many professions, not only accounting, is of questionable legality and does not appear to be necessary to protect the public. The latter is especially true for third party users of financial statements as they are ordinarily very knowledgeable about the requirements for reliable statements. A burdensome regulation which is not strictly necessary is contrary to the Virginia tradition of regulating as little as possible, so that the public can choose for itself whatever level of services and qualifications it wishes to pay for. Alternative approach 2 accomplishes most of the goals of Virginia's current law, but avoids many of its worst problems.

If the current statute is retained, the Consultant recommends that minor modifications be made to: (1) clarify the freedom of employees to make assurances to their employers; and, (2) to avoid incidental violations of the law by persons whose assurances are of an essentially casual nature (as an official of a charity indicating the results of a fund drive).

5. Tennessee Model. If the Commonwealth were to embrace regulation of an additional class of accountant, the Consultant would expect the regulatory framework to be similar to that of Tennessee. There, a licensed "Public Accountant" can perform reviews of financial statements and do anything else a licensed CPA can do except an audit. Persons who are completely unlicensed may not claim to have skills in accounting and may not offer their services to the public. Licensing as a "Public Accountant" in Tennessee requires passing a state test in addition to experience and educational requirements. The educational requirement is an Associate Degree with 24 quarter hours in accounting.

This is the Consultant's least preferred approach, as it exemplifies regulation requiring more regulation. It would prevent many persons who can now pursue a career in accounting from doing so, either because they could not pass the licensing test or did not have the educational qualifications. As a consequence of restricted entry to the occupation, the cost of accounting services could well rise. Qualifications would have to be reasonably strict or reviews performed by "Public Accountants" would have no credibility.