Tag Archives for " Independence "

Yellow Book Independence
Feb 02

Yellow Book Independence and Preparing Financial Statements

By Charles Hall | Auditing , Local Governments

Yellow Book independence is a big deal. And if you prepare financial statements in a Yellow Book audit, you need to be aware of the independence rules. Below I tell you how to maintain your independence—and stay out of hot water,

Yellow Book Independence

Yellow Book Independence Impairment in Peer Review

Suppose that--during your peer review--it is determined your firm lacks independence in regard to a Yellow Book engagement.

What could happen? Well, I can't say for sure, but I think it would be nasty. At a minimum, you would probably receive a finding for further consideration--or worse, a negative peer review report. The engagement is definitely nonconforming (not conforming to professional standards).

Then, you'd need to provide a response--explaining what you intend to do about the lack of independence. And this could get very interesting. Not where you want to be.

Preparation of Financial Statements is a Significant Threat

If you prepare financial statements (a nonattest service) for your audit client, you have a significant threat. Why? You are auditing something (the financial statements) that you created. There is a self-review threat. 

When there is a significant threat, you must use a safeguard (to lessen the threat). Such as? A second partner review. So, for example, you might have a second audit partner (someone not involved in the audit) review the financial statements. Since the second partner did not create the financial statement, the self-review threat is mitigated.

Notice the safeguard (the second partner review) is something the audit firm does--and not an action of the audit client. Therefore, it qualifies as a safeguard.

2018 Yellow Book

The 2018 Yellow Book states the following in paragraph 3.88:

Auditors should conclude that preparing financial statements in their entirety from a client-provided trial balance or underlying accounting records creates significant threats to auditors' independence, and should document the threats and safeguards applied to eliminate and reduce threats to an acceptable level...or decline to provide the services. (CPAHallTalk bolded the preceding words in this section.)

But My Client has Sufficient SKE

You've heard your audit client must have sufficient skill, knowledge and experience (SKE) and that they must oversee and assume responsibility for nonattest services. This is true and is always required when nonattest services are provided to an audit client. 

Even so, the client's SKE does not address the self-review threat

Think of the SKE issue as a minimum requirement. Do not pass "go" if the client does not assign someone (with SKE) to oversee the nonattest service. You are not independent. End of discussion. 

SKE is not a safeguard

The January AICPA Reviewer Alert distinguishes the SKE requirement from safeguards saying, "Client SKE should not be viewed as a safeguard, but rather a mandatory condition before performing any nonaudit services."

Once the client SKE issue is dealt with, consider if safeguards are necessary. If you are asked to prepare the financial statements, a second issue arises--the self-review threat. And this threat has to be addressed. A second review--whether a second partner review or an EQCR--is a good way to do so. 

The AICPA (in its AICPA Yellow Book Pratice aid) provides examples of safeguards including:

  • 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.

See Appendix E of the AICPA Yellow Book Practice Aid for additional examples of safeguards and how to apply them.

Independence Documentation is Required

The Yellow Book requires that your independence be documented. If it is not, a violation of professional standards exists. 

So, document the SKE of the client and the safeguards used to address significant threats. Also, document which nonattest services are signficiant threats.

Document Significant Threats

The January 2019 Reviewer Alert (an AICPA newsletter provided to peer reviewers) provides a scenario where an audit firm performs a Yellow Book audit and prepares financial statements. Then the firm has an engagement quality control review (EQCR) performed, but it does not identify the preparation of financial statements as a significant threat. The newsletter states "the engagement would ordinarily be deemed nonconforming for failure to document identification of a significant threat." So, even if a safeguard (e.g., a second partner review) is in use, the lack of documentation makes the engagement nonconforming.

In Summary

Here's the lowdown to protect your firm:

  1. Document the nonattest services you are to perform
  2. Document the client person that will oversee and assume responsibility for the nonattest service
  3. Document the SKE of the designated person
  4. Consider whether any nonattest services are significant threats 
  5. Document which, if any, nonattest services are significant threats
  6. Use (and document) a safeguard to address each significant threat (examples of safeguards include an EQCR or a second-partner review)

Looking for a tool to document Yellow Book independence? Consider the AICPA's practice aid. Here is the free PDF version. You can also purchase the fillable version here. (Cost is $39 for AICPA members.) This is the 2011 Yellow Book aid. I am thinking the AICPA will create a 2018 Yellow Book version as well. 

Uncollected prior year fees affect your independence
Nov 06

Uncollected Prior Year Fees: Can They Impair Your Independence?

By Charles Hall | Auditing

Can uncollected prior year fees impair your independence?

Answer: It depends. If a covered member has unpaid fees from an attest client for any previously rendered professional service provided more than one year before the date of the current-year report, he is not independent.

Section 1.230.010 (Unpaid Fees) of the Code of Professional Code states:

Threats to the covered member’s compliance with the “Independence Rule” would not be at an acceptable level and could not be reduced to an acceptable level by the application of safeguards if a covered member has unpaid fees from an attest client for any previously rendered professional service provided more than one year prior to the date of the current-year report (my bold). Accordingly, independence would be impaired. Unpaid fees include fees that are unbilled or a note receivable arising from such fees.

uncollected prior year fees

The picture is courtesy of DollarPhotoClub.com.

Applies to All Fees

Note that the rule states that independence is impaired if a covered member has unpaid fees from an attest client for any previously rendered professional service. Impairment exists when any prior year fee has not been paid, including tax or consulting work.

Billed or Unbilled Services

Also, the CPA should look back one year from the report date to see if billed or unbilled amounts exist. Here’s an example:

  1. The CPA provided tax services to ABC Company on April 25, 2015.
  2. The CPA billed for the tax services on June 1, 2015.
  3. ABC Company needs an audit report with a May 15, 2016, date.
  4. ABC Company has not paid the June 1, 2015, bill.

Is the CPA independent? If the audit report is dated May 15, 2016, the CPA is not independent.

Why? If we look back one year from the report date of May 15, 2016, we see that the April 25, 2015 work has not been paid. So an unpaid service for more than one year before the report date exists. If the CPA issues the May 15, 2016 report, he is in violation of the Code of Conduct.

How do you cure the independence impairment? ABC Company has to pay for the April 25, 2015 service.

An Odd Collection Procedure

Oddly, the potential impairment of independence may assist you in collecting past-due accounts. If the client needs the current year audit report, and the CPA can’t provide it to him without payment for the prior-year work, then the client may be willing to come up with the money.

AICPA Code of Conduct
Apr 17

AICPA Code of Professional Conduct: Answers to Your Ethical Questions

By Charles Hall | Auditing , Preparation, Compilation & Review

Are you a CPA looking for answers to independence or other ethical questions? Below, you’ll see two handy AICPA resources:

  • AICPA Code of Professional Conduct
  • Plain English Guide to Independence
AICPA Code of Conduct

Picture from AdobeStock.com

AICPA Code of Professional Conduct

The AICPA provides online access to the Code of Conduct. You can also download a PDF copy here (this PDF covers all standards issued through August 31, 2016).

Online access is free, and users are able to save searches and bookmark content.

The Code is organized into three parts:

  1. Public practice
  2. Members in Business
  3. All other members (including those who are in between jobs or retired)

The Code includes a threats and safeguards framework. CPAs should identify threats and then consider safeguards to mitigate those threats. The CPAs can proceed with the engagement if threats–after considering safeguards–are at an acceptance level.

Plain English Guide to Independence

As the Quality Control partner for our firm, I receive quite a few questions about ethical issues (mainly about independence). Nine out of ten times I find the answers to those questions in the AICPA’s Plain English Guide to Independence. I download this guide and keep it handy. When I need to research an issue, I open the document and perform word searches. If you aren’t already using this resource, I highly recommend it. 

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