Independence: Flirting, Skirting or the Real Thing

Ethics

Ethics is about how we meet the challenge of doing the right thing when that will cost more than we want to pay The Josephson Institute of Ethics

When Ethics Cost You Money

Client wanted a “clean opinion” We believed the client should receive a going

concern opinion Client threatened to not renew our contract Fee of $100,000 per year

When Ethics Cost You Money

Doing the right thing is easy when it doesn’t cost you anything

Of What Value is a Dishonest CPA? Nada Nothing Zilch Zero Naught

Integrity is Key

Competence as an accountant is a must But Integrity is More Important than Competence

Current Education Tends to Focus on Competence

The Thomas Jefferson Institute found that approximately 90% of the educational thrust in early America was of a “moral, ethical or religious nature”

The result was, of a population of approximately 3 million people, the country produced: George Washington Thomas Jefferson John Adams James Madison And Many More

By 1950s, this moral educational thrust was so small that it could not be measured

CPA Firm Conversation

Focus of a CPA firm’s leadership: Purely on profit or Doing what is right first

Which Category Represents You?

1. I am always ethical

2. I am mostly ethical

3. I am somewhat ethical

4. I am seldom ethical

5. I am never ethical

What Leads a Person to Fail Ethically? Load factor - The overall force to which a

structure is subjected in supporting a weight or mass or in resisting externally applied forces

What Leads a Person to Fail Ethically? How have you responded to ethical

pressures in the past? History is usually an indicator of future actions

Do you have a moral compass? Morals don’t happen by accident

What Leads a Person to Fail Ethically? Desire to please others – peer pressure Desire to look good personally Rationalization

Ethics – It’s Not Always Simple

Code of Conduct provides boundaries. These boundaries are subject to

interpretation Two honest people may differ on the

interpretation

What If I’m Not Sure?

Research Call AICPA Ethics line Seek counsel from persons outside the

engagement

Independence – Foundation of the Attest Function

Situations that Impair Independence Audit team member is on the board of the

auditee Prior year fee has not been paid Audit team member’s spouse has a financial

interest (e.g., owns stock) in the auditee Nonengagement partner’s brother is the

controller of the auditee

Situations that Impair Independence CPA firm codes transactions and provides

bookkeeping services to the auditee (without approval of coding)

Financial statements are created by the CPA firm and are issued without review and acceptance by the client

Independence of Mind

The state of mind that permits the performance of an attest service without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism

Independence of Appearance

The avoidance of circumstances that would cause a reasonable and informed third party …to reasonably conclude that the integrity, objectivity, or professional skepticism of a firm or a member of the attest engagement team had been compromised

When is Independence Required? Whenever the firm performs an attest service

for a client Audits Reviews

Compilations may be performed, even though the CPA is not independent Compilation report must state that you are not

independent You can now state why you are not independent

Who Establishes Independence Rules? AICPA Government Accountability Office (GAO) SEC PCAOB DOL State Board of Accountancy And Other Governing Bodies

Which Independence Rules Do I Follow? Use the strictest rule for any applicable

standard setters, for example: AICPA rules allow you to provide bookkeeping

services SEC rules do not allow you to provide

bookkeeping services If you are auditing an SEC client, the SEC rules

are to be followed

When Do the Independence Rules Apply to Me?

Covered Member an individual on the client’s

attest engagement team an

individual in a position to influence the client’s attest engagement

a partner or manager who provides more than 10 hours of nonattest services to the attest client

a partner in the office in which the lead attest engagement partner primarily practices in connection with the client’s attest engagement

the firm

Financial Relationships

As a covered member, you may not have the following: A direct financial interest in an attest client

(regardless of how immaterial it would be) A material indirect financial interest in an attest

client e.g. Defined contribution plan that is not participant

directed and you have no authority over investment decisions

When is My Family Subject to the AICPA Rules?

If you are a covered member with respect to a client, members of your immediate family (your spouse and your dependents) generally must follow the same rules that you do. Exception – An immediate family member may

work for a client if they are not in a key position. e.g. Partner’s wife works as a pharmacist at a hospital;

the hospital is audited by the partner’s firm.

What is a Key Position?

One in which a person can prepare financial statements or accounting records or are otherwise able to influence the client’s statements or records; examples include: Controller CFO Treasurer

Other Close Relatives

Close relatives include: Siblings Parents Nondependent children

Close relatives of most covered members are subject to some employment and financial restrictions.

Other Close Relatives

Employment Restriction A close relative’s employment by a client in a key

position impairs independence

Other Close Relatives

Financial Restriction If you are a covered member because you

participate in the attest engagement, then your close relative may not: Have a material financial interest in that

client

Can I Borrow Money From a Client? Covered members (including immediate

family) may not have a loan to or from the following: The client An officer or director of the client

Can I Borrow Money From a Client That is a Financial Institution? If you are a covered member, you and your

immediate family may not have a loan from the client Exceptions:

Collateralized car loans Credit card and overdraft reserve account balances that

are kept current and do not exceed $10,000 Grandfathered home mortgages or other secured loans

Grandfathered – loans obtained prior to becoming a covered member or prior to the bank becoming a client

Can I Borrow Money From a Client That is a Financial Institution? SEC rules do not allow grandfathered loans

(e.g. secured loans) One exception: Home mortgage

May I Have a Bank Account With a Client?

As a covered member, you may have a bank account with a client financial institution if the deposits are fully insured

SEC prohibits covered persons and their immediate families from having bank account balances in excess of FDIC insurance limits

May I Give Gifts or Entertainment To or Accept Gifts or Entertainment From a Client? Independence is impaired if the firm, a

member of the attest team, or a person able to influence the engagement accepts a gift that is not clearly insignificant

A covered member may give a gift to persons associated with the client and not impair independence if the gift is reasonable in the circumstances

Which Business Relationships With a Client Impair

Independence? You may not serve a client as: Employee, director, officer, or in any management

activity True even if you are a voluntary board member

In essence, any time you are able to make management decisions on behalf of a client or exercise authority over a client’s operations or business affairs, independence is impaired

General Requirements

You may not serve – or even appear to serve – as a member of a client’s management

The client must agree to assume certain responsibilities related to nonattest services

The CPA firm should establish and document its understanding with the client regarding objectives of the engagement, services to be performed and client’s acceptance of its responsibilities

Examples of Nonattest Services Bookkeeping Internal audit services Benefit plan administration Tax compliance services Forensic accounting services

AICPA Rules for Nonattest Services

When a CPA firm performs a nonattest service for an attest client, the client must: Make all management decisions Designate an individual who possesses suitable

skill, knowledge, and experience to oversee the services

Accept responsibility for the results of the services Evaluate the adequacy and results of the services

performed

Trigger for Rule 101-3

Perform attest and nonattest services If you just provide attest services, 101-3 is

not in play If you just provide nonattest services, 101-3

is not in play

Routine Activities Exempted

Rule 101-3 does not apply to your providing routine services to a client Examples:

Providing advice on an accounting matter Providing routine business advice Educating the client on matters within the

technical expertise of the member

AICPA Rules for Nonattest Services Before performing nonattest services, the firm

should establish and document its understanding with the client

Can be documented in: Attest engagement letter (usually done here) Audit planning memo Tax Organizer (if tax services)

AICPA Rules for Nonattest Services The following would impair independence:

Authorizing or executing a transaction on behalf of a client

Preparing the client’s source documents (e.g. purchase orders)

Having custody of client’s assets Establishing or maintaining internal controls,

including monitoring ongoing activities

Providing Internal Audit Services? The CPA firm cannot act – or appear to act –

as a member of the client’s management The firm cannot:

Make decisions on the client’s behalf Report to the client’s governing body

What Are the Rules Concerning Bookkeeping Services?

If a member provides bookkeeping services, the client must: Approve all account classifications Provide source documents to the member so that

the member can prepare journal entries Take responsibility for the results of the member’s

services

Approval of Journal Entries

Rule 101-3 does not require that the member document the client’s review and approval of journal entries Nevertheless, the member may desire to

document the name of the client representative who reviewed and approved the journal entries to provide evidence that such a review and approval took place

If journal entries are not approved by the client, independence is impaired

Provide Valuation Services?

The Business Combinations Topic requires the use of fair value accounting

The following services are allowed: Providing advice on valuation methods Providing valuation templates or other tools

Independence is impaired if the member performs appraisals or valuation services for an attest client

Final Word

When in doubt, ask. AICPA Ethics Hotline 888-777-7077 or

ethics@aicpa.org SEC www.sec.gov/about/offices/oca/ocaprof.htm GAO 202-512-9535 or yellowbook@gao.gov DOL 866-4-USA-DOL

Best Guidance – AICPA Plain English Guide to Independence (see July 1, 2010 version)