,. 516 Pan Three
Other Topics
AICPA Interpretations of the Rules of Conduct
This appendix contains the AICPA interpretations on independence and objectivity rules.
You should study them in conjunction with the definitions and rules in the module. Some
numbers in the sequence of interpretations are missing because interpretations were withdrawn long ago.
INTERPRETATION 101-1: GENERAL INDEPENDENCE
Section A
Interpretation 101-1, Section A, deals with the financial interests in a client. Note that the
."period covered by the financial statements" is not relevant to this section as it is to Section B. A member may divest a prohibited financial interest before the first work on a new
client begins after which it is improper to reinvest when the engagement will continue for
future years. Any direct financial interest (e.g., common stock, preferred stock, bonds) is
prohibited. This requirement is the strictest one in the code. The words of the rule offer no
exceptions. Indirect financial interests, on the other hand, are allowed up to the point of
materiality (with reference to the member's wealth). This provision permits members to
have some limited business transactions with clients so long as they do not reach material proportions. Items 2, 3, and 4 of Interpretation 101-1(A) define certain specific types
of prohibited and allowed indirect financial interests. Section C prohibits a covered member from acting in the capacity of a manager, employee, promoter, or trustee of a client.
Item 101-1.(A) 4 prohibits most loans from audit clients. The only loans permitted are
"grandfathered loans," and "other permitted loans." The following discussion of these
Independence shall be considered to be impaired if:
A. During the period of the professional engagement a covered
member
1. Had or was committed to acquire any direct or material indirect financial interest in the client.
2. Was a trustee of any trust or executor or administrator of any
estate if such trust or estate had or was committed toacquire
any direct or material indirect financial interest inthe client and
Ii) The covered member !individually or with others) had the
authority to make investment decisions for the trust or estate; or
(ij)The trust or estate owned or was committed to acquire
more than 10 percent ofthe client's outstanding equity securities or other ownership interests; or
(iii) The value of the trust's or estate's holdings in the client exceeded 10percent of the total assets of the trust or estate.
3. Had a joint closely held investment that was material to the
covered member.
.
4. Except as specifically permitted in interpretation 101-5[ETsection 101.0n had any loan to or from the client, any officer or director of the client. or any individual owning 10 percent or
more of the client's outstanding equity securities or other ownership interests.
B. During the period of the professional engagement, a partner or
professional employee of the firm, his or her immediate family, or
any group of such persons acting together owned more than 5
percent of a client's outstanding equity securities or other ownership interests.
C. During the period covered by the financial statements or during
the period of the professional engagement, a firm, or a partner or
professional employe~ of the firm was simultaneously associated
with the client as a(n)
L Director, officer. or employee, or in any capacity equivalent to
that of a member of management;
2. Promoter, underwriter. or voting trustee; or
3. Trustee for any pension or profit-sharing trust of the client.
Independence would be considered to be impaired if:
1. An individual participating on the attest engagement team has a
close relative who had
a. A key position with the client, or
b. A financial interest in the client that
i. Was material to the close relative and of which the individual
has knowledge; or
ii. Enabled the close relative to exercise significant influence
over the client.
2. An individual in a position to influence the attest engagement or
any partner in the office in which the lead attest engagement
partner primarily practices in connection with the attest engagement has a close relative who had
a. A key position with the client; or
b. A financial interest in the client that
i. Was material to the close relative and of which the individual
or partner has knowledge; and
ii. Enabled the close relative to exercise significant influence
over the client.
topics is from Interpretation 101-5 "Loans from financial institution clients and related
terminology."
-7
Formerly Employed by a Client or Otherwise Associated with a Client
An individual is considered to have impaired independence ifhe or she participated on1he
attest engagement, is considered a covered member, and was formerly"
.' (..V'
\1 r l·J / ...,...Employed by a client; or
..
.
Associated with a client' as an
officer,
director,
promoter,
underwriter,
or trustee for a pension or profit-sharing trust of the client
t
<:..
Covered Member's Immediate Family
A covered member's immediate family is subject to rule 101 and its interpretations and
rulings. This means that any financial interest held by an immediate family member is
deemed to be under the control of the covered member, and, therefore, a potential conflict
of interest. In addition, immediate family members cannot hold key positions in a client
company. However, employment relationships at an existing attest client that existed as of
November 200 I, are not considered deemed to impair independence provided such relationships were allowed under the ethics rules in effect at that time.
Covered Member's Close Relatives
The accompanying box cites this information.
Other Considerations
An important part of interpretation 101-1 is the recognition that ethics rules do not cover
all circumstances in which the appearance of independence might be questioned. It is the
member's responsibility to determine if the personal and business relationships would
lead a reasonable person aware of all the relevant facts to conclude that there is an unacceptable threat to the member's and the firm's independence.
li~TERPRETATIOrJ 101-2: GE£'JERAl !NDEPENDENCE
Independence problems do not end when owners (partners, shareholders) and professional
employees retire, resign, or otherwise leave an accounting firm. A former owner or professional can cause independence to be impaired if a relationship continues with a client
of the former firm. However, the problems are solved and independence is not impaired
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578 Part Three
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if (1) the person's retirement benefits are fixed, (2) the person is no longer active in t~e
accounting firm (sometimes retired owners remain "active"), and (3) the former owner 1S
not held out to be associated with the accounting firm. (ISB Standard No. 3 also speaks
to the topic of employment with audit clients, as discussed in the module.)
In addition to the preceding consideration, the attestation firm must ensure that appropriate consideratiori is given to any increase in risks that may exist due to the former partner's or professional's knowledge of the firm's audit plan and procedures. The firm must
consider the following:
• The interaction with the former partner or professional.
• The ability of attest team members to manage the interaction
or professional employee.
with the former partner
• Modifying the engagement procedures.
• The appropriateness of the review to determine that an appropriate
was maintained.
level of skepticism
INTERPRETATION 101-3: PERFORMANCE OF
NONAlTEST SERVICES
If a CPA performs the bookkeeping and makes accounting or management decisions for a
.company whose management does not know enough about the financial statements to take
primary responsibility for them, the CPA cannot be considered independent for audit and
other attest services. The problem in this situation is the appearance of the CPA having both
prepared the financial statements or other data and provided an audit report or other attestation on his or her own work, In the final analysis, the management must be able to say,
"These are our financial statements (or other data); we made the choices of accounting
principles; we take primary responsibility for them," The auditors cannot authorize transactions, have control of assets, sign checks or reports, prepare source documents, supervise
the client's personnel, or serve as the client's registrar, transfer agent, or general counsel.
INTERPRETATION 101-4: HONORARY DIRECTORSHIPS AND
TRUSTEESHIPS OF NOT-FOR-PROFIT ORGANIZATIONS
Ordinarily, independence is impaired if a CPA serves on an organization's board of directors. However, members can be honorary directors of organizations such as charity hospitals, fund drives, symphony orchestra societies, and similar not-for-profit organizations
so long as (l) the position is purely honorary, (2) the CPA is identified as an honorary director on letterheads and other literature, (3) the only form of participation is the use of
the CPA's name, and (4) the CPA does not vote with the board or participate in management functions. When all of these criteria are satisfied, the CPAiboard member can perform audit and attest services because the appearances of independence will have been
preserved.
INTERPRETATION 101-5: LOANS FROM FINANCIAL INSTITUTION
CLIENTS AND RELATED TERMINOLOGY
Independence is considered impaired if a covered member has a loan from a client, officer, director, or any individual owning 10 percent or more of a client.
'
Grandfathered Loans
A erA's independence is not impaired by holding certain specified types of loans from
clients if
• The loans were obtained before February 5, 2001, and met the requirements of rule 101
in effect at that time.
Module
B
Professional Ethics
57'1
• The loans were obtained between February S, 2001, and May 31,2002, and met the requirements of rule 101 in effect at that time.
• Loans were obtained from a financial institution before it became a client for services
requiring independence.
• Loans were obtained from a financial institution for which independence was not required but were later sold to a client for which independence is required.
• Loans were obtained from a financial institution client before the CPA became a
"member" subject to the independence rules.
These grandfathered loans must at all times be current under all of their terms, and the
terms shall not be renegotiated. The specific types of loans that can be grandfathered are
home mortgages, loans not material to the CPA's net worth, and secured loans for which
the collateral value must exceed the balance of the loan at all times.
Other Permitted loans
Independence is not considered impaired by a member obtaining these kinds of personal
loans from attest clients:
•
•
•
•.
Auto loans and leases collateralized by the automobile.
Insurance policy loans based on policy surrender value.
Loans collateralized by cash deposits at the same financial institution.
Credit card balances and cash advances of $5,000 or less.
Thus, an individual involved in the audit of a bank can have an auto loan at the bank, borrow money secured by cash in a certificate of deposit, and have the bank's credit card with
a balance of less than $5,000. (The SEC rule cites a $10,000 limit for credit card balances.) For insurance company clients, the CPA can borrow against the cash surrender
value of a life insurance policy. However, notice that these loans are limited to personal
loans, with the unwritten understanding that they are for personal convenience, not large
loans for business purposes.
INTERPRETATION 101-6: EFFECT OF ACTUAL OR THREATENED
LITIGATION ON INDEPENDENCE
Independence can be threatened by appearances of a CPA trying to serve his or her own
best interests. This condition can arise when a CPA and a client move into an adversary
relationship instead of the cooperative relationship needed in an attest engagement. CPAs
are considered not independent when
• Company management threatens or actually initiates a lawsuit against the CPA alleging deficiencies in audit or other attestation work.
• A covered member threatens or initiates litigation against the company management alleging fraud or deceit.
Such cases may be rare, but the AICPA has provided auditors a way out of the difficult
audit situation by this rule requiring them to declare "non independence" and the ability to
give only a disclaimer on financial statements or other data. Essentially the CPA-client
relationship ends, and the litigation begins a new relationship.
Occasionaliy, the CPA firm may find that it is a defendant in a lawsuit initiated by a
third party or parties. Normally, this type of litigation is not considered to adversely
impact the independence of the firm. However, sometimes these lawsuits result in
claims from management that existing problems are the result of audit deficiencies or
claims from the auditor that deficiencies are the result of fraud or deceit on the part of
management. When such cross-claims are threatened or filed, independence may be
impaired.