INDEPENDENCE

AICPA Code of Professional Conduct (Article IV):
“A member should maintain objectivity and
be free of conflicts of interest in discharging
professional responsibilities. A member
in public practice should be independent
in fact and appearance when providing
auditing and other attestation services.”
INDEPENDENCE
Rule 101 – “A member in public
practice shall be independent in
the performance of professional
services as required by standards
promulgated by bodies
designated by Council.”
INDEPENDENCE

Independence applies to:



The firm as a whole
The individuals who make up
the firm
It is possible for the firm to be
independent even when certain
individuals within the firm are
not independent
Rule 101 only applies to
attestation services:



Financial statement audits
Financial statement reviews
Other attest services covered by SSAEs:
Forecasts and projections
 Pro forma statements
 Internal control
 Compliance with laws

INDEPENDENCE

Independence is not required to
perform non-attest services:
Tax preparation or advice
 Consulting


Independence is not required
when performing a compilation,
but lack of independence must
be acknowledged in the report.
INTERPRETATIONS UNDER
RULE 101 – WHO MUST BE
INDEPENDENT?

Old rules: a member or
a member’s firm:



All partners
All managerial employees
in controlling office
All professional staff personally
participating in engagement
NEW RULES –
“COVERED MEMBERS”






Individuals on engagement team
Individuals in position to influence
engagement team
Partner or manager who provides 10 or
more hours of non-attest services to client
Partner in office of the lead engagement
partner
The firm, including firm’s employee benefit plans
An entity controlled by individuals or entities above
“COVERED MEMBER”
(NOTES)


The term “covered member”
is completely unrelated to
whether you are a member of
the AICPA or a state CPA society
Non-CPAs may qualify as
“covered members”
Independence is impaired if, during the
period of the professional engagement,
a covered member:




Had or was committed to acquire any direct or
material indirect financial interest in the client
Was a trustee or executor of an entity that had
or was committed to acquire any direct or material
indirect financial interest in the client
Had a joint closely held investment
that was material to the covered member
Had any loan to or from the client, any officer or
director of the client, or any 10% owner of the client
(except for loans specifically permitted)
INDEPENDENCE IS IMPAIRED IF:

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%
of a client’s outstanding equity securities
other ownership interests
or
BIG CHANGE IN RULES


Old rules: no partners or designated
staff could have any direct investment in
a client
New rules: partners and staff not directly
participating in the engagement or in a
position to influence the engagement may
have small direct investments in the client
INDEPENDENCE IS IMPAIRED IF:

During the period covered by the financial statements or
during the period of the professional engagement, a
partner or professional employee of the firm was
simultaneously associated with the client as a(n):
 Director, officer, employee, or member of
management
 Promoter, underwriter, or voting trustee
 Trustee for any pension or profit-sharing
trust of the client
APPLICATION OF RULE 101 TO
IMMEDIATE FAMILY MEMBERS

A covered member’s immediate family
(spouse and dependents) is subject to
Rule 101, with two minor exceptions:
 Employed by client, not in “key position”
 Family members have financial interest
through employee benefit plan (only
applies to partners and managers
providing non-attest services and partners
in office of lead engagement partner)
APPLICATION OF RULE 101 TO
CLOSE RELATIVES
(siblings, parents, nondependent children)

Independence is impaired if an engagement team
member, or person in position to influence the
engagement, or any partner in the office of the lead
engagement partner has a close relative who had:
 A key position with the client
 A financial interest in the client that was material
to the close relative and known to the individual
and/or enabled close relative to exercise significant
influence over the client
EXAMPLES OF
FINANCIAL INTERESTS






Shares of stock
Mutual fund shares
Partnership units
Stock rights
Options or warrants
Puts, calls, or straddles
WAYS TO EVIDENCE
DIRECT FINANCIAL INTERESTS






Through shares of stock
Through a retirement plan
(401(k), IRA, etc.)
Through an investment club
Through a partnership as a
general partner
Through an estate as executor
Through a trust as trustee
WAYS TO ACQUIRE
INDIRECT FINANCIAL
INTERESTS


Through mutual funds
Through partnerships
as a limited partner
May I (or my immediate family) own
shares in a mutual fund audit
client?

No: your interest in the mutual
fund would constitute a direct
financial interest in the client.
What if I own shares of a mutual
fund that invests in my clients?


Financial interests that you have
through mutual funds are
considered indirect financial
interests
If such financial interests are
material, they would compromise
independence
EXAMPLE

Suppose ABC Mutual Fund owns shares
in a client, XYZ:




ABC’s net assets are $10 million
Your shares in ABC are worth $50 thousand
ABC has 2% of its assets invested in XYZ
Your indirect financial interest in XYZ
is $1,000 ($50,000 x .02)

If $1,000 is material to your net worth,
independence is impaired
May I have an outside investment
with a client or person associated
with a client?


If you are a “covered member,”
such an investment would be considered
a “joint closely held investment”
If this investment is material to your net
worth, your independence is impaired
May I borrow money from, or loan
money to, a client, or invest in a
client’s bonds?


No: such actions would constitute
impermissible loans to or from that client
Note: there are a few types of loans from a
client financial institution that are permitted
under AICPA rules (car loans, credit card
balances < $5,000, passbook loans, etc.)
May I have a bank account with
a client financial institution?

Yes: as long as your deposits
are fully insured by state or
federal
deposit insurance
agencies
and any uninsured
amounts are not
material to
your net worth
May I accept a gift
from a client?


Yes: but a “covered member”
may accept only token gifts
from a client; otherwise,
independence would be
considered impaired
Be careful of appearances!
What rules restrict nonattest or
“other” services provided to
clients?

The independence rules impose
limits on the nature and scope
of your firm’s accounting and
consulting services
BASIC PRINCIPLE

You may not serve - or even appear
to serve - as a member of a client’s
management. For example,
you may not:



Make operational or financial decisions
for client
Perform management functions for client
Report to board of directors on behalf
of management
ACTIVITIES THAT IMPAIR
INDEPENDENCE




Authorizing, executing, or consummating
transactions on behalf of client
Preparing source documents or
originating data
Having custody of a client’s assets
Supervising client employees in
performance of normal recurring
activities
What about performing
bookkeeping services for a client?

Independence is not impaired if you:






Record transactions determined or
approved by management
Post coded transactions to general ledger
Prepare financial statements based on
client’s trial balance
Post client-approved entries to trial balance
Propose journal entries
Provide data processing services
What about commissions and
contingent fees?

You and your firm may not
have commission or contingent
fee arrangements with an
attestation client
What about commissions and
contingent fees?

You and your firm may not
have commission or contingent
fee arrangements with a client
for whom you provide compiled
financial statements when a third
party will rely on those statements
unless the report discloses your
lack of independence
What about commissions and
contingent fees?

You and your firm may have
commission and contingent fee
arrangements with persons
associated with the client,
such as officers, directors,
and principal stockholders
What about unpaid fees?


When a client owes your firm fees,
and those fees have been outstanding
for more than one year, that unpaid
fee is treated as a loan to the client.
Generally, fees for prior year’s audit
must be paid before issuing current
year’s report to be independent.