Auditor

Independence

Why Independence?
Serve the public interest
Honor the public trust

An auditor attests to managements

assertions in an audit
An audit adds credibility to
managements financial statements.
If not independent, the auditors opinion
adds no value.

Audits of Public vs. Nonpublic Clients

AICPA

CODE OF PROFESSIONAL CONDUCT

CPC Structure
PRINCIPLES

RULES

INTERPRETATIONS

ETHICS RULINGS

Requirements for Independence

CPC
Ethical Principles

Independent in Fact = actions

Am I actually independent?

Independent in Appearance
Auditor must avoid circumstances that would be
perceived by third parties as a lack of
independence

Two related rules:

Independence
Integrity & Objectivity

Requirements for 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.

Interpretation 101-1
(General interpretation of Rule 101)
Interpretation 101-2
Employment or association with attest clients
Interpretation 101-3
Performing nonattest services
Interpretation 101-4
Honorary Directorships & Trusteeships of NFPs
Interpretation 101-5
Loans from financial institution clients
Interpretation 101-6
Effect of actual or threatened litigation

Etc.

Financial Transactions
Direct

Financial interest in (or jointly with) an

attest client, such as ownership of stock
or a loan to/from/with the client.

Material
Indirect

Financial interest in an entity that is

associated with an attest client,
such as an investment in a mutual fund
that owns the clients stock.

So, only
Immaterial indirect
allowed!

Exception: Financial institution client

Normal lending procedures
Collateralized
Credit card < $10,000

Other Business Relationships

Auditor Performs Other Non-Audit Services for Audit
Client
Independence is impaired if: CPA performs a managerial role
or makes management decisions while engaged as auditor
(such as executing transactions on behalf of client, preparing
source docs, supervising employees in their daily activities,
etc.)
Auditor Leaves the Firm to Work for Client
Independence is impaired if: CPA leaves the firm and is
employed by the client in a key role unless a number of
conditions are met.

Sever professional/financial ties w/CPA

Shake up the audit
- staffing
- strategy

Who must be independent of the client?

FIRM (M&Y, LLP)
Pension, 401(k) plan

BHM OFFICE

ATL OFFICE

Pner

Pners
Client
Audit
Team

MGY OFFICE
Pner

Others w/signif. infl.

Now, lets talk about the CPAs family

Family Relationships
Immediate Family

Close Relatives

Spouse or dependents

nondependent children, brothers, sisters,

parents, grandparents, In-laws

Independence rules apply just as

they do to the CPA

Two major situations that can impair

independence:
Financial interest material to net
worth, and the CPA is aware of it.
Could exercise significant influence
over the financial/accounting
policies of the client (key role or
otherwise).

Note: Employment with client

only matters if in a key role

PRACTICE

Problem 19-28
Which of the following are violations of the CPC?
(All scenarios are for privately-held companies.)
a. Roberto, a sole practitioner, has provided extensive
advisory services for her audit client, Leather Ltd.
She has interpreted financial statements, provided
forecasts and other analyses, counseled on
potential expansion plans, and counseled on
banking relationships, but has not made any
management decisions.

b) Rackwill, CPA, has been asked by his audit client, PPS,

to help implement a new control system. Rackwill will
arrange interviews for PPSs hiring of new personnel
and instruct and oversee the training of current client
personnel. PPS will make all hiring decisions and
supervise employees once they are trained.

c) Kraemer & Kraemer recently won the audit of Garvin

Clothiers, a large manufacturer of womens clothing.
Jock Kraemer had a substantial investment in Garvin
prior to bidding on the engagement. In anticipation of
winning the engagement, Kraemer placed his shares of
Garvin in a blind trust.

d) Zeker & Assoc audits a condominium association in

which the parents of a member own a unit and
reside. The unit is material to the parents net
worth, and the member participates in the
engagement.

e) Jimmy Saad, a sole practitioner, audited DCs financial

statements for the year ended June 30, and was issued
stock by the client as payment of the audit fee. Saad
disposed of the stock before commencing fieldwork
planning for the audit of the next years June 30
financial statements.

f) Dip-It Paint Corp requires an audit for the current

year. However, Dip-it has not paid Allen & Allen the
fees due for tax-related services performed 2 years
ago. Dip-it issued Allen & Allen a note for the
unpaid fees, and Allen & Allen proceeded with the
audit.

Problem 19-29
Situation Impair Independence?
a) Partners dependent parent is a 5% limited partner in a firm client.

Yes

No

b) A partner assigned to a firms NY office is married to the President of a

client for which the firms CT office performs audit services. The partner
does not perform services out of or for the CT office, cannot exercise
significant influence over the engagement, and has no involvement with
the engagement, such as consulting on accounting or auditing issues.

c) A CPAs father acquired a 10% interest in his sons audit client. The
investment is material to the fathers net worth. The son is aware of the
investment and participates in the engagement.
d) An audit partner has a brother who owns a 60% interest in an audit client,
which is material to the brothers net worth. The partner participates in
the engagement, but does not know about his brothers investment.

Multiple Choice 19-18

In which of the following circumstances would independence be impaired
according to the CPC?
I.
CPA has a car loan from a bank that is an audit client. The loan was
made under the same terms available to all customers.
II. The CPA has a direct financial interest in an audit client, but the
interest is in a blind trust.
III. The CPA owns a commercial building and leases it to an audit client.
The rental income is material to the CPA.
a)
b)
c)
d)

1 and 2
2 and 3
1 and 3
1, 2, and 3

Multiple Choice 19-19

A client has not paid its 2011 audit fees.
According to the AICPA CPC, for the auditor to
be considered independent with respect to the
2012 audit, the 2011 fees must be paid before
the
a)
b)
c)
d)

2011
2012
2012
2013

report is issued
fieldwork is started
report is issued
fieldwork is started

Takeaways from last class

Whats the deal with
Financial relationships?
Providing nonaudit services to an audit client?
Leaving firm to go work for an audit client?

Who (in the firm) must be independent of audit

client?
What about spouse? Family?

Requirements for
Integrity & Objectivity

Rule 102:
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.

Interpretation 102-1
Knowing misrepresentations in the F/S or records
Interpretation 102-2
Conflicts of interest
Interpretation 102-3
Obligations of a member to his or her employers
external accountant
Interpretation 102-4
Subordination of judgment by a member
Interpretation 102-5
Applicability of Rule 102 to members performing
educational services
Interpretation 102-6
Professional services involving client advocacy

Absent guidance

Would a reasonable
person
believe that the

Requirement for Objectivity

CPC
Ethical Principles

Be objective in thought and procedures

Be free of conflicts of interests

PCAOB & SEC

ADDITIONAL REQUIREMENTS

SOX adds another layer of

independence requirements
(from Title II)
Related to services provided to audit clients
Tax compliance services okay (not much else)
Audit committee must approve all
Client must disclose fees (paid to firm) & nature of services

Audit
Audit-related
Tax
All Other

SOX - Independence
SOX Section 201

it shall be unlawful for a registered public accounting firm to provide any non-audit
service to an issuer contemporaneously with the audit, including: (1) bookkeeping;
(2) financial information systems design and implementation; (3) appraisal or
valuation services, fairness opinions, or contribution-in-kind reports; (4) actuarial
services; (5) internal audit outsourcing services; (6) management functions or human
resources; (7) broker or dealer, investment adviser, or investment banking services;
(8) legal services and expert services unrelated to the audit; (9) any other service
that the Board determines, by regulation, is impermissible.

SOX Section 301

requires that the audit committee of an issuer shall be directly responsible for the
appointment, compensation, and oversight of the work of any registered public
accounting firm employed by that issuer.

10:
11:
12:
13:
14:

91%
86%
69%
68%
66%

is
is
is
is
is

audit
audit
audit
audit
audit

 Related to audit firm practices

Mandatory partner rotation
Every 5 yrs
Cool for 5 yrs

Placement of audit staff with client

Not in key role for one year

Partners not directly compensated for selling

non-audit services

PRACTICE

Prob 19-34
Have SEC independence rules been violated?
(All companies are publicly-traded.)

a) Adrian Reynolds now works as a junior member of the

accounting team at Swiss Precision Tooling, a publicly
traded manufacturing company. Three months ago, he
worked as a staff auditor for Crowther & Sutherland, a local
accounting firm, where he worked on the Swiss Precision
Tooling audit team. Crowther & Sutherland is still the
auditor for Swiss Precision Tooling.

b) Susana Miller finished working for Bircham, Dyson & Bell in August
2012. During that time, she was a concurring partner on the
Unigate Dairies assignment (the engagement period on this audit
ended in April 2013). In February 2014, Susana took a position as
controller of Unigate Dairies. Bircham, Dyson & Bell is still the
dairys auditor and plans to finish its current audit assignment in
March 2014 (19 months after Susana left the firm).

c) Janay Butler, a senior auditor, is aware that under SEC rules her
accounting firm should not conduct appraisal or valuation services
for a public company audit client. However, her manager has
requested that she appraise some specific large inventory items to
verify a public clients estimates, which are relied upon by others.

d)

Heath & Associates, CPAs, is the auditor of Halifax Investments, Inc., a

public company. Heath makes most of its money by selling nonaudit
services to its audit clients, but it ensures every service it provides for
Halifax is in accordance with SEC rules and is preapproved by the
companys audit committee. Last year, it billed the following to Halifax:
audit fees $0.8 million, tax fees $2.3 million, and other fees $5.2 million.
No services prohibited by the SEC were provided by Heath to Halifax,
and the fee figures are appropriately disclosed in Halifaxs financial
statements.

Multiple Choice 19-16

All of the following nonaudit services are identified by the
SEC as generally impairing an auditors independence
except
a)Information systems design and implementation.
b)Human resource services.
c)Management functions.
d)Valuations and appraisals for tax purposes.
e)All of the above are seen by the SEC as impairing
independence.

 Fees (8/31/00)
$58 M ( $1 M / week)
$25 M in audit fees
35-40% of Houstons revenues

Non-audit svcs
Internal Auditing
Management Consulting
Tax Compliance & Consulting

Partners Compensation
Incentive: Sell other services
Tied closely to book of business

Engagement Partner
(97 ), Duncan
Partnership as of 95 (TX A&M 81)
Salary, $1 M/yr
Close friend of CAO, Causey

Andersen Alumni at Enron

CAO, Causey
Treasurer, McMahon
VP, Sherron Watkins
84 other accountants

Enron Alumni at Andersen

Former VP of Internal Audit, Chambers
40 internal auditors

Workspace
1 floor @ Enron
150+ (Houston office: 1400)