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.

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.

Peer Reviews: Avoiding Independence Problems

By Charles Hall | Accounting and Auditing

Peer reviewers continue to hammer independence and related documentation. So it is vitally important that we not only be independent but that we also properly document its presence. My prior independence post pointed out that peer review checklists require reviewers to examine your independence documentation. This short video provides tips regarding independence and staying out of the dog house.

AICPA Code of Professional Conduct: Answers to Your Ethical Questions

By Charles Hall | Auditing , SSARS

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 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. 

Yellow Book Independence: When Should You Apply Safeguards?

By Charles Hall | Auditing

In some me Yellow Book audits, you need to apply safeguards to lessen threats to independence. This article provides you with guidance about those safeguards.

When I was a kid living in Donalsonville, Georgia, my mother would drive into our open garage, leave the keys in the ignition (where they remained for the evening), and then would walk into our home (which had not been locked all day).

Over time, I noticed that she left the keys in the car less and less, and we began to lock the doors of our home. At one point we even bought deadlocks.

Why?

It seems our neighbors were, from time to time, having small thefts, and one even had a burglar in the home as they returned one afternoon.

My parents were responding to risks. The greater the thefts and burglaries, the greater the safeguards.

Safeguards Required by Yellow Book

Whenever an external auditor performs nonattest services (e.g., preparation of financial statements), then the auditor should consider whether the nonattest service adversely affects his independence.

The Government Auditing Standards (known as the Yellow Book) requires that safeguards be applied whenever independence threats are significant – but only if they are significant – in order to eliminate or reduce such threats to an acceptable level.

Yellow Book Independence Safeguards

Examples of safeguards that may eliminate or reduce significant threats to an acceptable level include the following:

• Discussing independence issues with those charged with governance of the entity
• Assigning separate engagement personnel for the audit and nonaudit service
• Obtaining secondary reviews of the nonaudit services by professional personnel who were not members of the audit engagement team (e.g., second partner review of financial statements prepared by the external audit firm)
• Discussing the significance of the threats to management participation or self-review with the engagement team and emphasizing the risks associated with such threats
• Educating management on the nonaudit services performed by reviewing and explaining the reason and basis for all significant transactions, as well as authoritative standards, so that management is in a position to determine or approve all assumptions and judgments and take responsibility for the nonaudit services
• When financial statement preparation is the nonaudit service being performed, determining that there has been review of the financial statements and successful completion of a disclosure checklist by the audited entity

Not all safeguards listed would be appropriate for all significant threats identified and, often, may require combinations of more than one safeguard. When determining the type and number of safeguards to be applied, the auditor should consider the significance of the threats, both individually and in the aggregate.

Some safeguards have a higher level of mitigation of threats than others. Also safeguards that involve personnel who are independent of the audit process are generally more effective than those who are not independent.

Determining which safeguards to apply involves professional judgment and is dependent on the facts and circumstances of each specific situation.

Prohibited Services

Finally remember that safeguards cannot be used to ameliorate risk related to prohibited services (e.g., the external audit firm signs checks for the client); if the external auditor performs prohibited services, then safeguards cannot remedy the lack of independence. Examples of prohibited services follow:

• Setting policies and the strategic direction for the audited entity
• Directing and accepting responsibility for the actions of the audited entity’s employees in the performance of their routine, recurring activities
• Having custody of an audited entity’s assets
• Accepting responsibility for designing, implementing, or maintaining internal control

Preparing Financial Statements 

Is a Continuance Decision Necessary for Attest Engagements?

By Charles Hall | Accounting and Auditing , SSARS

Most accounting firms do a fine job of thinking about and documenting the initial client acceptance. But after the first year, the continuance decision and related documentation are sometimes forgotten or ignored. Why?

Continuance Decision

The CPA may think the continuance decision is one those “management by exception” things–only to be thought about when apparent issues arise.

However, independence threats sometimes arise subtly. For example, what if a partners’ spouse invests in an audit client? Or maybe a staff member becomes a board member of a nonprofit audit client and he doesn’t tell anyone.

Also, problems can also arise on the client-side. Have they paid last year’s audit fees? Has the client engaged in any unethical activities? Some actions may cause you to question their integrity.

The time to discover changing engagement dynamics is before the engagement letter is signed. We certainly don’t want to near the end of an audit and realize we are not independent.

Need another reason to document the continuance decision? Think about peer review.

Peer Review

AICPA peer review checklists focus on independence documentation–whether an acceptance or continuance decision is made. So, if for no other reason, we need to consider and document the continuance decision to be safe in peer review.

Nonattest Services

While you are documenting continuance, summarize the nonattest services being performed and the client personnel that will oversee and assume responsibility for those services. Potential independence issues can arise from changes in client personnel. If a key accounting person leaves the employ of your attest client, is there a replacement with sufficient skill, knowledge, and experience to assume responsibility for the financial statements (if you create them)?

Check Your Files

Now would be a good time to sample a few of your files to see if they contain requisite acceptance or continuance documentation. Such documentation is necessary for the following types of engagements:

• Audits
• Reviews
• Compilations (when the report is not disclosing a lack of independence)
• Attestation engagements including agreed-upon-procedures