Understanding the AICPA’s
Yellow Book Independence
Practice Aid for Performing
Nonaudit Services
A Governmental Audit Quality Center (GAQC) Web Event
April 11, 2012
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Administrative Notes
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Presenters
Nancy Miller, CPA
Partner
Miller Foley Group
---
Brian Schebler, CPA
National Director of Public Sector Services
McGladrey & Pullen LLP
---
Lisa Snyder, CPA
Director of Professional Ethics
American Institute of CPAs
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What we will cover
Overview of Independence Requirements
in 2011 Government Auditing Standards
(Yellow Book or YB)
Purpose and Background of Practice Aid
titled, 2011 Yellow Book Independence Nonaudit Services Documentation
Practice Aid (Practice Aid)
Using the Practice Aid – A Case Study
Questions
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Overview of
Independence
Requirements in 2011
Yellow Book
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2011 Yellow Book Independence
Requirements
Today’s presentation focuses on the new GAQC YB
Practice Aid
Archived GAQC Web event, The New 2011 Yellow
Book: What You Need to Know Now, provides a
more in-depth discussion on 2011 Yellow Book
2011 Yellow Book is effective for financial audits and
attestation engagements for periods ending on or
after December 15, 2012; early implementation is not
permitted
However, new independence rules need to be
considered before effective date when auditor
performing a nonaudit service
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Auditor Independence Rules a Key Emphasis
Area
Main area of change in 2011 Yellow Book relates to
its independence rules
Chapter 3 titled, General Standards, of the 2011
Yellow Book critical to understand
• Defines independence of mind and in appearance
• Emphasizes the importance of considering individual
threats to independence both individually and in
aggregate
GAO will be retiring current Government Auditing
Standards: Questions and Answers to Independence
Standard Questions guidance
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Chapter 3 – General Standards: Independence
Introduction of a Conceptual Framework
Allows the auditor to assess unique circumstances
Adaptable
Consistent with AICPA and IFAC frameworks
Significant differences from AICPA Interpretation 101-3
Entry point for use of the framework
Emphasis on services “in aggregate”
Documentation requirements
Preparation of financial statements are nonaudit service
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Applying the Framework
New approach combines a conceptual framework
with certain rules (prohibitions)
• Balances principle and rules based standards
• Serves as a hybrid framework
Certain prohibitions remain
• Generally consistent with Rule 101 AICPA
Beyond a prohibition
• Apply the conceptual framework
• Will be used more often than AICPA
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Chapter 3 – General Standards:
Independence
Threats could impair independence
• Do not necessarily result in an independence
impairment
Safeguards could mitigate threats
• Eliminate or reduce threats to an acceptable level
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Independence Categories of Threats
1.
2.
3.
4.
5.
6.
7.
Management participation threat
Self-review threat
Bias threat
Familiarity threat
Undue influence threat
Self-interest threat
Structural threat
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Documentation Requirements
Threats to independence that require the application
of safeguards, along with the safeguards applied
Assessment of audited entity management’s ability
to effectively oversee nonaudit services, including
whether management possesses suitable skills,
knowledge, or experience (SKE);
The understanding established with the audited
entity regarding the nonaudit services to be
performed.
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Purpose and
Background
of Practice
Aid
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Purpose of Practice Aid
To assist auditors in:
• Applying the YB independence conceptual framework
• Identifying and evaluating threats to independence for nonaudit
services
• Identifying safeguards where necessary
• Assessing management’s Skills, Knowledge, or Experience
(SKE)
• Complying with YB documentation requirements
Practice Aid highlights nonaudit services frequently
performed for smaller entities:
• Preparing financial statements (F/S)
• Preparing journal entries other than proposed audit entries
• Preparing reconciliations
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Background of Practice Aid
Developed by the AICPA GAQC, Ethics, and Peer
Review teams
Audits performed under 2011 Yellow Book
Federal agency representatives reviewed the
Practice Aid and provided feedback (e.g., GAO,
various agency Inspector General representatives)
• General reaction from federal agencies has been very positive
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Using The Practice Aid
Limited to considerations of potential threats to
independence related to management participation
and self-review
Auditors must also consider other threats and
determine whether the facts and circumstances
warrant use of the YB Conceptual Framework
Auditors are cautioned to reevaluate conclusions
whenever circumstances change
Keep in mind that YB requires evaluation of threats in the
aggregate
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How to Obtain the Practice Aid
Flat PDF Version. Free to AICPA members, including
GAQC members. Access the free pdf version of the
Practice Aid on the GAQC Web site
For Sale Version. Practice Aid Version Designed for
Auditor Documentation Input (Supplement) available
for a small fee to AICPA members, GAQC members,
and non-members; order the for-sale Supplement
• Can be saved and included as part of auditor’s documentation
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Using the Practice Aid –
A Case Study
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Case Study Approach
Presentation will use a case study to assist
participants in understanding how to use the
Practice Aid and what is in the Practice Aid
Next few slides explain facts and circumstances of
case study; see also handouts for a summary of the
case study facts and circumstances and
instructions to Practice Aid that you can refer to
Case study is illustrative to demonstrate how an
auditor, using professional judgment, might reach
conclusions about the situation described
• Not an authoritative example
• Subtle changes in facts and circumstances could lead an auditor
to reach different conclusions
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Case Study – Facts and Circumstances
ABC Firm has audited Small Town USA for the last 3
years
Small Town is governed by a 10-member town
council
3 employees in Finance Department of Small Town
• Brandon, Town Manager, has worked for Small Town for 15
years
• Dave, Finance Director, has 5 years with Small Town and
formerly held a similar role for another small town
• Shelly, Accounting Clerk, has worked for Small Town for 15
years
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Case Study – Facts and Circumstances
(continued)
Small Town provides a trial balance to ABC Firm but
does not make any year-end adjusting entries
Small Town provides a listing of fixed asset
additions and deletions and ABC Firm prepares the
depreciation schedule
ABC Firm prepares the town’s F/S, including the
cash-to-accrual conversion and GASB 34
conversion entries
ABC Firm prepares the town’s property tax roll
reconciliation
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Case Study – Facts and Circumstances
(continued)
Finance Director reviews and approves all adjusting
entries
Capital assets for the 12/31/2012 year-end are not
material to the town’s F/S
Town Manager and Town Council assume all
management responsibilities related to nonaudit
services
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Preconditions to Performing
Nonaudit Services
Management should assume all management responsibilities
and take responsibility for nonaudit services performed by the
auditors
Management should oversee the nonaudit services and
evaluate the adequacy and results of the services
Auditors should establish and document their understanding
with management regarding the nonaudit service
Auditors should assess (AICPA & YB) and document (YB)
whether management possesses suitable SKE to oversee the
nonaudit service
IMPORTANT: Must document the suitability of management’s SKE and
the understanding established with the audited entity for all nonaudit
services performed, regardless of whether threats to independence are
determined to be significant
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Appendix A: Detailed Instructions
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Completing Section I
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Section I: Prohibited Nonaudit ServicesManagement Responsibilities
Step 1 – List in Column 1 the nonaudit services to be
performed and describe them in detail in Column 1a
• See Appendix B, Nonaudit Services, of the Practice Aid for
guidance of determining which services are nonaudit services
• 2011 YB differentiates nonaudit services from routine audit
services
• Routine activities are those services performed by auditors that
relate directly to the performance of an audit
• Auditors should consider that any services that do not meet the
definition of routine audit services (and are not audit or
attestation services) may be nonaudit services
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Routine Audit Services and Nonaudit
Services
Services that are considered nonaudit services include:
• F/S preparation
• Bookkeeping services
• Cash to accrual conversions (a form of bookkeeping)
• Other services not directly related to the audit
• Appendix B of the Practice Aid describes other services
Unless specifically prohibited, nonaudit services MAY be
permissible but should be evaluated
• In relation to the conceptual framework
• In relation to the auditor’s assessment of managements’ SKE
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A Quick Note on Bookkeeping Services
May be performed provided the auditor does not
Determine or change journal entries, account codes or
classifications for transactions, or other accounting
records without obtaining client approval
Authorize or approve transactions
Prepare source documents
Make changes to source documents without client
approval
Consistent with AICPA Interpretation 101-3
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Section I: Continued
What services does ABC firm plan to provide to
Small Town USA?
•
•
•
•
Preparing F/S
Preparing journal entries
Preparing property tax roll reconciliation
Preparing depreciation schedule
Are these nonaudit services under AICPA and YB?
Yes….by reviewing Appendix B you will find that all
are nonaudit services
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Section I: Continued
Step 2 – Determine whether the 2011 Yellow Book
specifically prohibits the nonaudit services being
considered.
See Appendix C, Prohibited Nonaudit Services, of
the Practice Aid for guidance
If nonaudit services are prohibited, no safeguards
are sufficient to mitigate the threats and
independence would be impaired
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Appendix C: Prohibited Nonaudit Services
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Section I: Continued
Step 3 – Determine if the nonaudit service will
involve assuming management responsibilities
Management responsibilities involve:
• Leading and directing an entity, including making decision
regarding the acquisition, deployment, and control of human,
physical, and intangible resources.
If an auditor assumes management responsibilities
for an audited entity, the management participation
threats created would be so significant that no
safeguards could eliminate or reduce such threats
to an acceptable level.
Assuming management responsibilities will impair
independence
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Section I: Example Documentation
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Completing Section II
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Section II: Nonaudit Services-Evaluation of
Threats to Independence and the Application
of Safeguards
Step 4 – Evaluate threats, which are circumstances
that could impair independence, and determine if
they are significant
See Appendix D, Threat Indicators, of the Practice
Aid for assistance
Practice Aid focuses on management participation
and self-review threats. Remember that other
threats may exist and will need to be evaluated if
relationships exist beyond nonaudit services
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Section II: Step 4 – Evaluating Threats and
Identifying Significant Threats
When evaluating threats, the following threat
indicators may suggest an increase in the
significance of threats:
• The cumulative effect of aggregate threats (e.g.
performing multiple nonaudit services)
• The significance of nonaudit services to the subject matter
of the audit
• The degree of assumptions and judgments by the auditor
• Increasing the degree of subjectivity related to nonaudit
services
• The cumulative effects of the indicators
• Other threats to independence
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Section II: Step 4 – Other Factors to Consider
When Evaluating the Significance of Threats
Auditors should evaluate threats both individually
and in the aggregate because threats can have a
cumulative effect on independence
Whenever relevant new information about a threat
comes to the attention of the auditor, the auditor
should evaluate the significance of the threat
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Need Help? Let’s Run Through Example 2 in
Appendix D
Auditor has been requested to prepare the F/S for an
audited entity. The auditor considered the following in
evaluating whether a significant threat to
independence existed:
a) The audited entity’s books and records are
substantially complete and accurate. Few, if any
correcting entries are expected to be proposed.
b) The individual designated by the audited entity who
oversees the preparation of the F/S possesses SKE
sufficient to oversee the service but is not capable
of reperformance.
c) This is the only nonaudit service that the auditor
has been requested to perform.
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Need Help? Let’s Run Through Example 2 in
Appendix D
Conclusion:
• The auditor reached the conclusion that preparation
of the F/S would result in a significant threat to
independence; therefore
• It would be necessary to apply safeguards.
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Need Help? Let’s Run Through Example 3 in
Appendix D
Auditor has been requested to prepare the F/S, cashto-accrual conversion entries, bank reconciliations,
and depreciation schedules. The auditor considered
the following:
a) A significant number of correcting journal entries
are expected to be proposed to the F/S in order to
make the books and records complete and accurate
b) The individual designated by the audited entity who
oversees the preparation of the F/S and the other
nonaudit services possesses SKE sufficient to
oversee the service but is not capable of
reperformance
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Need Help? Let’s Run Through Example 3 in
Appendix D
Conclusion
• The auditor concluded that the nonaudit services
performed would result in a significant threat to
independence
• It would be necessary to apply safeguards
• The auditor would likely determine that the
safeguards to be applied in this situation would
need to be inherently stronger, or more safeguards
would need to be applied, than those in the
preceding example 2 in order to sufficiently
eliminate or reduce threats to an acceptable level
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Section II: Step 4 (continued)
Back to the Case Study
Are threats identified for the nonaudit services to be
performed by ABC Firm and are the threats
significant?
•
•
•
•
Preparing F/S? Yes
Preparing journal entries? Yes
Preparing property tax roll reconciliation? Yes
Preparing depreciation schedule? No
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Section II: Step 5 - Safeguards
For the significant threats identified in step 4, in
column 5 the auditor must evaluate potential
safeguards and document those that will be applied
As noted on previous slide, ABC Firm identified 3
nonaudit services with significant threats of
management participation and self-review
What safeguards can they apply that will eliminate
or reduce the significant threat(s) to an acceptable
level?
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Section II: Safeguards
The 2011 YB requires the application of safeguards
whenever threats are significant
See Appendix E, Application of Safeguards, of the
Practice Aid for help
Keep in mind:
• Some safeguards have a higher level of mitigation of threats
than others
• Auditor may place limited reliance on safeguards the audited
entity has implemented but may not rely solely on such
safeguards
• When determining the type and number of safeguards to be
applied, the auditor should consider the significance of the
threat(s), both individually and in the aggregate
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Section II: Application of Safeguards
Keep in mind (continued):
• Safeguards that involve personnel who are independent of the
audit process are generally more effective than those who are
not independent.
• Determining which safeguards to apply involves professional
judgment and is dependent on the facts and circumstances of
each specific situation.
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Example Safeguards in Appendix E
Consulting another auditor
Discussing independence issues with those
charged with governance of the entity
Assigning separate engagement personnel for
the audit and nonaudit service
Educating management on the nonaudit
services performed so that management is in
a position to determine or approve all
assumptions and judgments and take
responsibility for the nonaudit services
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Example Safeguards in Appendix E
Obtaining secondary reviews of the nonaudit
services by professional personnel who were
not involved in planning or supervising the
audit engagement
Obtaining secondary reviews of the nonaudit
services by professional personnel who were
not members of the audit engagement team
Discussing the significance of the threats to
management participation or self-review with
the engagement team and emphasizing the
risks associated with such threats
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Example Safeguards in Appendix E
When F/S preparation is the nonaudit service being
performed determining that there has been review of
the F/S and successful completion of a disclosure
checklist by the audited entity
• This is a safeguard within the audited entity’s systems
and procedures so an auditor should not rely solely on
such safeguards
• Including the audit engagement as a required
engagement quality control review (EQCR) under the
audit firm’s system of quality control
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Need Help? Let’s Run Through Example 1 in
Appendix E
• The auditor has been requested to prepare the F/S
• The auditor has determined that the preparation of
F/S represents a significant threat.
• The auditor determined the following safeguard
would be applied:
• Have someone not involved in planning or supervising the audit
engagement review the F/S before releasing the statements
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Need Help? Let’s Run Through Example 1 in
Appendix E (continued)
• Other Alternative Safeguards:
• Educate management on the nonaudit services to be performed
by reviewing and explaining the basis for preparing the F/S, so
that management is in a position to determine or approve all
assumptions and judgments and take responsibility for the F/S
• Request that the audited entity complete a disclosure checklist
as part of the overall review of the F/S
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Need Help? Let’s Run Through Example 2 in
Appendix E
• The auditor has been requested to prepare the F/S
• The auditor has determined that the preparation of
the F/S represents a significant threat.
• The auditor has concluded that, although the
audited entity did possess suitable SKE, due to the
poor condition of the books and records the
following safeguard would be applied:
• Have a manager or partner not involved with the audit
engagement team review the F/S before releasing the
statements.
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Need Help? Let’s Run Through Example 2 in
Appendix E (continued)
In this case, the auditor increased the strength of
the safeguard by requiring the review of the F/S by
someone not involved in the audit engagement
The audited entity must always accept responsibility
for the F/S and must approve them
The auditor may have considered the following
alternative safeguard:
• Include the audit engagement as a required Engagement
Quality Control Review (EQCR) under the audit firm’s system of
quality control.
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Section II: Application of Safeguards
Back to the Case Study
Potential safeguards for Preparation of F/S
• Review of the F/S by someone not involved in the audit
engagement
• Discussing the nature and extent of entries and adjustments
with the chair of the audit committee (Note that this safeguard
must be used in combination with other safeguards)
• Finance director reviews the F/S and completes a disclosure
checklist (Note that this safeguard must be used in combination
with other safeguards)
Remember that regardless of safeguards applied,
management must always accept responsibility for the
F/S
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Section II: Step 6
Once the safeguards to be applied are determined,
the auditor needs to evaluate those safeguards and
determine if the safeguards are sufficient to
eliminate or reduce the significant threat to an
acceptable level
If the facts and circumstances change during the
period of the engagement, the auditor should
reevaluate the sufficiency of the safeguards
If the safeguards don’t eliminate or reduce the
significant threat to an acceptable level,
independence is impaired
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Section II – Step 6 (continued)
Threats are not at acceptable level if they either:
• Could affect the auditor’s ability to perform an audit without
being affected by influences that compromise professional
judgment; or
• Could expose the audit organization to circumstances that would
cause a reasonable and informed third party to conclude that the
integrity, objectivity, or professional skepticism of the audit
organization or member of the audit team had been
compromised
In making the determination that safeguards are both available and
have been applied, the auditor should use professional judgment and
should take into account whether both independence of mind and
independence in appearance are maintained. Both qualitative and
quantitative factors should be considered.
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Section II: Example Documentation
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Completing Section III
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Section III: Documentation of SKE of the
Individual(s) Designated by the Audited
Entity
Step 7: Identify the individual(s) designated to
oversee the nonaudit service
Step 8: Document SKE – See Appendix F,
Evaluation of SKE, of the Practice Aid for guidance
If no one at the audited entity is willing and able to
oversee the nonaudit service, independence will be
impaired and no safeguards would be sufficient to
overcome the impairment.
Documentation of SKE is required for all nonaudit
services regardless of the significance of the threats
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Need Help? Let’s Run Through Example 1
and 2 in Appendix F
A small nonprofit executive director understands their
organization’s operations and financial position; also
understands services needed from the auditor and
what those services intended to accomplish; and
regularly carries out important decisions about all
matters affecting their organization. The nonprofit also
has a CPA on its board of directors who can assist the
non-CPA executive director.
• Auditor might conclude that executive director possesses sufficient
SKE alone
• Alternatively, auditor might conclude that the executive director, with
the assistance of the board member, would possess the necessary
SKE
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Need Help? Let’s Run Through Example 4 in
Appendix F
• Auditor is asked to install an off-the-shelf
accounting package and set up the chart of
accounts and F/S format for a small client
• Finance director who is out of town has designated
the office manager to oversee the installation
• The office manager performs routine clerical duties,
has a limited understanding of the finance
department, and has never used accounting
software. She has no understanding of the town’s
books or records and F/S
• Conclusion: Unlikely that the office manager
possesses sufficient SKE to oversee the installation
and accept responsibility
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Need Help? Let’s Run Through Example 7 in
Appendix F
Auditor preparation of F/S
• Audited entity need not have the understanding and ability to
prepare the F/S and disclosures based on GAAP
• Auditor may assist the designated individual in obtaining the
necessary understanding so that he or she is in position to
review and accept responsibility
- For example, explain certain accounting principles and
disclosure requirements that were applied in preparing the
F/S so that the individual has the necessary SKE
• Bottom line – designated individual should be able to review the
F/S, with an emphasis on significant issues and disclosures
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Section III: Step 8 – SKE Documentation
Documentation requirement can’t be met simply by
obtaining management representations or other
actions performed solely by the audited entity.
SKE is not a safeguard but it may be a mitigating
factor in determining the strength of the safeguards
to be applied
The nature of the nonaudit service will affect the
weight and applicability of factors to consider when
determining suitable SKE
The designated individual must possess the SKE
and be willing to oversee the nonaudit service
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Section III: Step 8 – SKE Documentation
Factors to consider when evaluating and
documenting the SKE of an individual
•
•
•
•
•
Understanding the nature of the service
Knowledge of the audited entity’s business
Knowledge of the audited entity’s industry
General business knowledge
Education, license, accreditations, and membership in
professional organizations
• Position at the audited entity
The individual responsible for overseeing the
service needs to understand the service sufficiently
to oversee it but does not need to possess the
technical qualifications to perform or reperform the
service.
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Section III: Example Documentation
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Completing Section IV
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Section IV: Establish and Document the
Understanding With the Audited Entity
Regarding Nonaudit Services
Step 9 – Management has to agree to each of the
management responsibilities described below in
connection with the nonaudit service(s)
• Assume all management responsibilities
• Evaluate the adequacy and results of the service(s) performed
• Accept responsibility for the results of the service(s)
If management does not agree to assume all of the
above functions, independence is impaired
Remember the YB independence requirements must be
met before nonaudit services are performed
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Section IV: Establish and Document the
Understanding With the Audited Entity
Regarding Nonaudit Services
Step 10 – Document the understanding established
with the audited entity regarding the objectives of
the nonaudit service(s)
Step 11 – Document the understanding established
with the audited entity regarding the auditor’s
responsibilities
Step 12 – Document the understanding established
with the audited entity regarding the limitations, if
any, on the nonaudit services to be provided
Typically, this understanding may be documented through
the use of an engagement letter
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Section IV: Example Documentation
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Completing Section V
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Section V: Conclusion
Document the date and signature of the preparer
and supervisory reviewer
If subsequent to reaching a conclusion, relevant
new facts and circumstances come to the attention
of the auditor regarding the threats to
independence, the auditor should evaluate the
significance of the threats, in accordance with the
Yellow Book Conceptual Framework, and update the
Practice Aid documentation and conclusion as
necessary
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Section V – Example Documentation
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Where do you look for guidance?
Become familiar with the Practice Aid and its
Appendixes:
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GAGAS Independence Decision Flowchart
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Where do you look for more guidance?
Encourage staff to listen to the May 2nd CPE
rebroadcast of this Web event (from 1:00PM
– 3:00PM Eastern Time) or the no-CPE
archive to be posted to GAQC Web site
Become familiar with 2011 Yellow Book
http://www.gao.gov/yellowbook
Listen to an archived member Web event
titled, 2011 Yellow Book: What You Need to
Know Now
Check out the new Yellow Book Tools and
Aids section of the GAQC Web site
GAO technical hotline yellowbook@gao.gov
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Questions ?????
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How do I get my CPE certificate?
Just follow these steps:
1. Log on to CPA2Biz.com
2. Click on “My Account” at the top of the page and enter your
CPA2Biz/AICPA username and password
3. Click on “My Web Events” tab
4. Click on “AICPA Learning Center Transcripts and Certificates”
link (a new window or tab will open)
5. On the AICPA Learning Center, click on “My Transcript” in
the left-hand menu
6. Locate your completed course and click on “Go” to retrieve
your certificate.
If you need assistance with locating your certificate, please contact
the AICPA Service Center at 888.777.7077 or service@aicpa.org.
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