Auditing 1 Update – 2008 and 2009 Editions
Item 1
Auditor's Independence
The following material, excerpted from our Regulation course, should be reviewed by all Auditing students who have not yet taken the Regulation course.
1. Rule 101: Independence
I
NDEPENDENCE a. A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council.
(1) Independence required for nonattestation services (e.g., tax services, consulting services, or compilations).
(2) Independence must be maintained by “covered members”: all partners in the office connected with the attest engagement, partners or managers who provide nonattest services to the attest client, all members of the attest engagement team, the firm itself, and any parties who can influence the attest engagement.
(3) A covered member's spouse and dependents are also generally subject to
Rule 101.
(4) A member must have independence of mind and in appearance.
(5) A risk-based approach is used to evaluate potential threats to independence. b. Independence Impaired By Financial Interests
(1) Independence will be impaired if a covered member has a direct financial interest (regardless of materiality) or a material indirect financial interest in an attestation client.
Direct financial interests are ownership interests held directly in a client. Examples would include:
• Stock ownership, even if owned in a blind trust.
• Financial interest in a client through a partnership and the member is a general partner.
• Financial interest in a trust when the member is the trustee.
An indirect financial interest involves a removed relationship. Examples would include:
• Member owns shares in a mutual fund that invests in the attestation client.
• Member owns a direct financial interest in Company A and Company A has a direct financial interest in the attestation client.
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Auditing 1 Update – 2008 and 2009 Editions
(2) Independence will be impaired if a covered member or his immediate family (spouse or dependents) has a loan to or from a client.
(3) Independence is impaired by acceptance of more than a token gift.
(4) Independence not impaired in a financial institution client by:
(a) Fully collateralized car loans with a financial institution client.
(b) Cash advance or credit card balances not exceeding $10,000.
(c) A bank account that is fully insured by the government.
(d) A passbook loan. c. Independence Impaired By Business Relationships
A TTESTATION
Independence is impaired if a member is an employee of or makes management decisions for an attest client. Independence may also be impaired if a member was previously employed by the attest client, or if a member leaves the audit firm for a position with the client.
Examples of business relationships with an attestation client that impair independence would include:
Director, officer, employee, or a position where the member acts in a management capacity.
• Promoter, underwriter or voting trustee.
• Stock transfer or escrow agent.
• General
• Trustee for a client's pension or profit-sharing trust.
(1) Independence not impaired by an immediate family member's employment with a client provided that (s)he is not in a key position (e.g., independence would be impaired if the spouse was the client's internal auditor).
(2) A firm may perform nonattest services for clients and still be independent as long as the firm does not serve or appear to
N ONATTEST
S ERVICES serve as a member of a client's management (e.g., the firm may not make operational or financial decisions for clients, perform management functions, or report to the board on behalf of management).
Examples of activities with an attestation client that impair independence would include:
• Authorizing, executing or consummating a transaction on behalf of a client.
• Preparing source documents or originating data (e.g., purchase orders).
• Having custody of clients' assets.
• Supervising client employees in the performance of normal recurring activities.
(a) Independence is impaired if a member manages the internal audit activities of a client.
(b) Independence is impaired if valuation and appraisal services are performed, the results are material to the financial statements, and the appraisal or valuation is subject to a significant degree of subjectivity.
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Auditing 1 Update – 2008 and 2009 Editions
(3) Independence is not impaired by being a member of or an honorary trustee for a nonprofit charitable, civic or religious group if the position is purely honorary and the member does not participate in any management functions.
(4) Membership in the same trade association as a client does not impair independence unless the member serves in a management capacity. d. A member's independence is impaired with respect to a client who is more than one year overdue in the payment of professional fees. Usually, fees from one year must be paid before the issuance of a report on the following year's work. e. Actual or threatened litigation may impair independence, regardless of who is the plaintiff and who is the defendant.
(1) For example, independence is impaired if an auditor sues management for fraud or if the client sues the auditor for audit deficiencies. Even the threat of a suit for audit deficiencies would impair independence if it is likely the suit will be brought.
(2) Independence not impaired by a suit for an immaterial dollar amount for work unrelated to an attestation service.
PASS KEY
The most heavily tested area of the Code of Conduct and professional responsibilities is Rule 101: Independence.
Candidates should be very familiar with the rules covered above.
2. Independence Rules for Government Audits and for SEC Clients a. The General Accounting Office (GAO) sets independence rules for companies audited under governmental auditing standards. b. The PCAOB and the SEC also set rules for independence for firms auditing issuers.
3. Rule 102: Integrity and Objectivity
"In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others." a. A conflict of interest may occur if a member has a significant relationship with a client that could be viewed as impairing the member's objectivity.
(1) The service may still be performed if the relationship is disclosed and the consent of the client is obtained.
(2) Disclosure and consent cannot eliminate the necessity for independence when it is required. b. Members engaged in educational services and client advocacy must act with integrity and objectivity.
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Auditing 1 Update – 2008 and 2009 Editions
Item 2
PCAOB Auditing Standard No. 6
PCAOB Auditing Standard No. 6, Evaluating Consistency of Financial Statements, was approved by the
SEC in September 2008 and became effective on November 15, 2008. We do not anticipate that it will be tested prior to July 1, 2009, but we are providing this information early in case it appears in an earlier window. According to the new standard:
If a material misstatement in previously issued financial statements is corrected, an explanatory paragraph should be added to the auditor’s report describing this situation.
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