independence information from the government auditing standards u.s. general accounting office u.s....

IndependenceIndependence

Information from the Information from the

Government Auditing Standards Government Auditing Standards

U.S. General Accounting OfficeU.S. General Accounting Office

Dr. Carlos E. Johnson, ChairmanDr. Carlos E. Johnson, Chairman

Oklahoma Accountancy BoardOklahoma Accountancy Board

General StandardGeneral Standard

““In all matters relating to the audit In all matters relating to the audit work, the audit organization and the work, the audit organization and the

individual auditor, whether individual auditor, whether government or public, should be free government or public, should be free

both in fact and appearance from both in fact and appearance from personal, external and organizational personal, external and organizational

impairments to independence.”impairments to independence.”

Entities affected by the standard:Entities affected by the standard:

Federal, state, local governments;Federal, state, local governments;Colleges, universities, and trade schools;Colleges, universities, and trade schools;Hospitals;Hospitals;Charitable organizations;Charitable organizations;School and utility districts;School and utility districts;Small businesses with SBA loans;Small businesses with SBA loans;HUD projects, lenders and public housing HUD projects, lenders and public housing authorities;authorities;Not for profit and for profit recipients of Not for profit and for profit recipients of federal grant and loan assistance.federal grant and loan assistance.

Nongovernment auditors should Nongovernment auditors should also follow the AICPA code of also follow the AICPA code of professional conduct and the professional conduct and the

code of professional conduct of code of professional conduct of the state board with jurisdiction the state board with jurisdiction over the practice of the public over the practice of the public

accountant and audit accountant and audit organization.organization.

3 classes of Impairments:3 classes of Impairments:

PersonalPersonal

ExternalExternal

OrganizationalOrganizational

Personal impairment examples:Personal impairment examples:

Family member who is a director, officer or Family member who is a director, officer or employed in a position to exert direct and employed in a position to exert direct and significant influence over the audited significant influence over the audited entity;entity;

Financial interest that is direct or is Financial interest that is direct or is significant/material though indirect, in the significant/material though indirect, in the audited entity.audited entity.

Personal Impairment examples:Personal Impairment examples:Ideas toward individuals, groups, organizations Ideas toward individuals, groups, organizations or objectives of a particular program that could or objectives of a particular program that could bias the audit;bias the audit;

Biases, political, ideological or social Biases, political, ideological or social convictions that result from employment, convictions that result from employment, loyalty or a particular type of policy.loyalty or a particular type of policy.

Seeking employment with an audited Seeking employment with an audited organization during the audit.organization during the audit.

To avoid personal impairmentsTo avoid personal impairmentsaudit organizations should:audit organizations should:

Establish policy and procedure to identify Establish policy and procedure to identify personal impairments to independence;personal impairments to independence;

Communicate policies and procedures to Communicate policies and procedures to all auditors in the organization through all auditors in the organization through training or other means and have auditors training or other means and have auditors periodically acknowledging their periodically acknowledging their understanding of independence understanding of independence requirements.requirements.

Auditors should avoid situations Auditors should avoid situations that could lead reasonable third that could lead reasonable third parties to conclude that auditors parties to conclude that auditors

are not able to maintain are not able to maintain independence in conducting independence in conducting

audits.audits.

Two Overarching PrinciplesTwo Overarching Principles1.1. Audit organizations should not provide Audit organizations should not provide

nonaudit services that involve performing nonaudit services that involve performing management functions or making management functions or making management decisions;management decisions;

2.2. Audit organizations should not audit their Audit organizations should not audit their own work or provide nonaudit services in own work or provide nonaudit services in situations where the nonaudit services situations where the nonaudit services are significant/material to the subject are significant/material to the subject matter of audits (i.e., reconcile bank matter of audits (i.e., reconcile bank statements).statements).

Overarching Principle 1:Overarching Principle 1:

Auditors should not serve as members of Auditors should not serve as members of an entity’s management committee or an entity’s management committee or

board of directors, make policy decisions board of directors, make policy decisions that affect future direction and operation of that affect future direction and operation of

an entity’s programs, supervise entity an entity’s programs, supervise entity employees, develop programmatic policy, employees, develop programmatic policy,

authorize an entity’s transactions or authorize an entity’s transactions or maintain custody of an entity’s assets.maintain custody of an entity’s assets.

Overarching Principle 2:Overarching Principle 2:

1.1. Ongoing audits;Ongoing audits;2.2. Planned audits;Planned audits;3.3. Requirements for providing audits, including Requirements for providing audits, including

laws, rules, contractual agreements;laws, rules, contractual agreements;4.4. Policies placing responsibilities on the audit Policies placing responsibilities on the audit

organizations for providing audit services.organizations for providing audit services.

Audit organizations should not audit their Audit organizations should not audit their own work. Audit organizations should own work. Audit organizations should consider:consider:

The audit organization should The audit organization should documentdocument its consideration of the its consideration of the

nonaudit services. nonaudit services. DocumentationDocumentation should include the rationale that should include the rationale that

providing nonaudit services does not providing nonaudit services does not violate the two overarching principles.violate the two overarching principles.

Nonaudit services documentationNonaudit services documentation

In cases where nonaudit services In cases where nonaudit services impairimpair overarching principles: overarching principles:

The audit organization should The audit organization should communicate to management of the communicate to management of the audited entity that the audit organization audited entity that the audit organization WILL NOT BE ABLE TO PERFORM WILL NOT BE ABLE TO PERFORM SUBSEQUENT AUDIT WORKSUBSEQUENT AUDIT WORK;;It should be clear to management that the It should be clear to management that the audit organization would be in violation of audit organization would be in violation of the independence standard if it were to the independence standard if it were to perform such audit work.perform such audit work.

Nonaudit services impairment:Nonaudit services impairment:

The audit organization cannot maintain or The audit organization cannot maintain or prepare the audited entity’s basic prepare the audited entity’s basic accounting records or take responsibility accounting records or take responsibility for basic financial records. Information for basic financial records. Information must be approved by management.must be approved by management.

Nonaudit services that would NOT Nonaudit services that would NOT generally create an impairment:generally create an impairment:

Providing basic accounting assistance such as Providing basic accounting assistance such as preparing preparing draftdraft financial statements and notes; financial statements and notes;

Preparing a trial balance;Preparing a trial balance;

Provide limited payroll services;Provide limited payroll services;

Provide limited appraisal or valuation services;Provide limited appraisal or valuation services;

Provide limited advisory services on IT;Provide limited advisory services on IT;

Provide routine tax filings in accordance with Provide routine tax filings in accordance with IRS, state and local authorities;IRS, state and local authorities;

If the audit organization prepares If the audit organization prepares DRAFTDRAFT financial statements and notes and financial statements and notes and

performs the financial statement audit, performs the financial statement audit, management should acknowledge the management should acknowledge the

audit organization’s role in preparing the audit organization’s role in preparing the financial statements and notes and financial statements and notes and

management’s review, approval and management’s review, approval and responsibility for the financial statements responsibility for the financial statements

and notes in the management and notes in the management representation letter.representation letter.

Likewise, if the audit organization converts Likewise, if the audit organization converts cash-based financial statements to cash-based financial statements to accrual-based financial statements, accrual-based financial statements,

management should acknowledge the management should acknowledge the audit organization’s role in reflecting audit organization’s role in reflecting accruals and management’s review, accruals and management’s review,

approval, and responsibility for the accrual approval, and responsibility for the accrual adjustments in the management adjustments in the management

representation letter.representation letter.

Management representation letterManagement representation letter

A management representation letter is A management representation letter is required by generally accepted auditing required by generally accepted auditing standards (GAAS) and GAGAS.standards (GAAS) and GAGAS.

External Impairments:External Impairments:

External impairments occur when auditors External impairments occur when auditors deter from acting objectively and deter from acting objectively and exercising professional skepticism by exercising professional skepticism by pressures from management and pressures from management and employees of the audited entity.employees of the audited entity.

External impairment examples:External impairment examples:External interference that could limit the External interference that could limit the scope of an audit;scope of an audit;

Unreasonable restrictions of the time Unreasonable restrictions of the time allowed to complete an audit or issue a allowed to complete an audit or issue a report;report;

Influences that jeopardize the auditors’ Influences that jeopardize the auditors’ continued employment for reasons other continued employment for reasons other than incompetence, misconduct or the than incompetence, misconduct or the need for audit services.need for audit services.

Organizational Impairments:Organizational Impairments:

A government audit organization’s ability A government audit organization’s ability to perform work and report the results to perform work and report the results impartially can be affected by its place impartially can be affected by its place within government and the structure of the within government and the structure of the government entity that the audit government entity that the audit organization is assigned.organization is assigned.

Audit organizations may be free Audit organizations may be free from organizational impairment if:from organizational impairment if:A federal auditor auditing a state government A federal auditor auditing a state government program;program;

If assigned to a different branch of government If assigned to a different branch of government within the same level of government as the within the same level of government as the audited entity;audited entity;

Audit organization’s head directly elected by Audit organization’s head directly elected by voters of the jurisdiction being audited;voters of the jurisdiction being audited;

If statutory protections prevent the abolishment If statutory protections prevent the abolishment of the audit organization by the audited entity.of the audit organization by the audited entity.

Questions about Applying the Independence Questions about Applying the Independence

Standard in Specific Nonaudit Circumstances:Standard in Specific Nonaudit Circumstances:

Taken from Government Auditing StandardsTaken from Government Auditing Standards

Dated July 2002Dated July 2002

GAO-02-870GGAO-02-870G

Bookkeeping Services Bookkeeping Services

Several questions have been raised Several questions have been raised regarding an audit organization’s regarding an audit organization’s development of development of draftdraft financial statements financial statements and notes and other bookkeeping and notes and other bookkeeping services. Before responding to those services. Before responding to those questions, in the next Government questions, in the next Government Auditing Standards update, we plan to add Auditing Standards update, we plan to add the following requirement as a footnote the following requirement as a footnote after the first sentence in paragraph 3.26a. after the first sentence in paragraph 3.26a.

Bookkeeping ServicesBookkeeping Services

If an audit organization has prepared If an audit organization has prepared draftdraft financial financial statements and notes and performed the financial statements and notes and performed the financial statement audit, it should obtain from the audited entity’s statement audit, it should obtain from the audited entity’s management an acknowledgement in its management management an acknowledgement in its management representation letter, required by Government Auditing representation letter, required by Government Auditing Standards, the audit organization’s role in this regard Standards, the audit organization’s role in this regard and entity management’s review, approval, and and entity management’s review, approval, and responsibility for the financial statements and related responsibility for the financial statements and related notes. Likewise, if the audit organization converts cash-notes. Likewise, if the audit organization converts cash-based financial statements to accrual-based financial based financial statements to accrual-based financial statements, it should obtain from the audited entity’s statements, it should obtain from the audited entity’s management an acknowledgement in its management management an acknowledgement in its management representation letter the audit organization’s role in representation letter the audit organization’s role in reflecting accruals and entity management’s review, reflecting accruals and entity management’s review, approval, and responsibility for the accrual adjustments. approval, and responsibility for the accrual adjustments.

Question 46Question 46

46. Can an audit organization be involved 46. Can an audit organization be involved in preparing a trial balance and in preparing a trial balance and draftdraft financial statements and notes without financial statements and notes without impairing its independence to audit the impairing its independence to audit the financial statements? Can audit financial statements? Can audit engagement team members perform these engagement team members perform these activities? activities?

Question 46 AnswerQuestion 46 Answer

Maintaining the audited entity’s books and Maintaining the audited entity’s books and records is the responsibility of its records is the responsibility of its management. Accordingly, management is management. Accordingly, management is responsible for ensuring that these books responsible for ensuring that these books and records adequately support the and records adequately support the preparation of financial statements in preparation of financial statements in accordance with generally accepted accordance with generally accepted accounting principles and that records are accounting principles and that records are current and in balance. current and in balance.

Question 46 Answer (cont.)Question 46 Answer (cont.)

If an audit organization were asked to prepare a trial If an audit organization were asked to prepare a trial balance, the audit organization balance, the audit organization would not impairwould not impair its audit its audit independence if the preparation of the trial balance was independence if the preparation of the trial balance was purely purely technicaltechnical in nature. The trial balance should be in nature. The trial balance should be based on management’s chart of accounts, and the based on management’s chart of accounts, and the audited entity’s management must take responsibility for audited entity’s management must take responsibility for the trial balance. In other words, the preparation of the the trial balance. In other words, the preparation of the trial balance is a matter of formatting the chart of trial balance is a matter of formatting the chart of accounts into a trial balance. Work involving more than accounts into a trial balance. Work involving more than the the technicaltechnical formatting of the trial balance formatting of the trial balance would impairwould impair independence because the audit organization would be independence because the audit organization would be performing a management function, which would violate performing a management function, which would violate an overarching principle. an overarching principle.


The audit organization’s preparation of The audit organization’s preparation of draftdraft financial financial statements and note disclosures from a trial balance statements and note disclosures from a trial balance provided by entity management (or prepared by the audit provided by entity management (or prepared by the audit organization as described above), which the organization as described above), which the management of the audited entity then reviews and management of the audited entity then reviews and approves, approves, would not impairwould not impair the auditor’s independence the auditor’s independence (see paragraphs 3.26 and 3.26a). This work is (see paragraphs 3.26 and 3.26a). This work is considered considered technical assistancetechnical assistance and as part of the audit. and as part of the audit. The audit organization must be careful not to make The audit organization must be careful not to make management decisions, and management of the audited management decisions, and management of the audited entity must have the knowledge to evaluate and approve entity must have the knowledge to evaluate and approve the the draftdraft financial statements and notes and take financial statements and notes and take responsibility for them. responsibility for them.


Further, the audit engagement team that Further, the audit engagement team that prepared the trial balance and prepared the trial balance and draftdraft financial financial statements and notes could also perform the statements and notes could also perform the financial statement audit. The audit organization financial statement audit. The audit organization must comply with all other safeguards in must comply with all other safeguards in paragraph 3.25. Also, the management paragraph 3.25. Also, the management representation letter, required by auditing representation letter, required by auditing standards, should acknowledge the audit standards, should acknowledge the audit organization’s role in preparing the trial balance organization’s role in preparing the trial balance and and draftdraft financial statements and related notes, financial statements and related notes, and management’s review, approval, and and management’s review, approval, and responsibility for the financial statements and responsibility for the financial statements and related notes. related notes.


Likewise, auditors can convert cash-based financial Likewise, auditors can convert cash-based financial statements to accrual-based financial statements, as statements to accrual-based financial statements, as long as management is in the position to make informed long as management is in the position to make informed judgments to review, approve, and take responsibility for judgments to review, approve, and take responsibility for the appropriateness of the conversion. In providing this the appropriateness of the conversion. In providing this service, the audit team that proposed the accruals could service, the audit team that proposed the accruals could also perform the financial statement audit since this also perform the financial statement audit since this service is in substance the same as proposing adjusting service is in substance the same as proposing adjusting or correcting entries as long as management makes the or correcting entries as long as management makes the decision on accepting the entries. Similarly, as stated decision on accepting the entries. Similarly, as stated above, the management representation letter should above, the management representation letter should also acknowledge the audit organization’s role in also acknowledge the audit organization’s role in reflecting accruals and management’s review, approval, reflecting accruals and management’s review, approval, and responsibility for the accrual adjustments. and responsibility for the accrual adjustments.


It is important to reiterate that the answer to this question It is important to reiterate that the answer to this question is conditioned on the audit organization starting with is conditioned on the audit organization starting with appropriate books and records that balance and the appropriate books and records that balance and the audited entity having knowledgeable management. audited entity having knowledgeable management. Where this is not the case, the audit organization must Where this is not the case, the audit organization must be careful not to cross the line of making management’s be careful not to cross the line of making management’s decisions or performing management functions and find decisions or performing management functions and find itself in a position where reasonable third parties with itself in a position where reasonable third parties with knowledge of the relevant facts and circumstances could knowledge of the relevant facts and circumstances could conclude that the auditor has, in effect, maintained the conclude that the auditor has, in effect, maintained the audited entity’s books or records and, therefore, has audited entity’s books or records and, therefore, has impaired its independence to conduct the financial impaired its independence to conduct the financial statement audit. statement audit.


47. The AICPA defines the compilation of financial 47. The AICPA defines the compilation of financial statements as presenting in the form of financial statements as presenting in the form of financial statements information that is the representation of statements information that is the representation of management without undertaking to express any management without undertaking to express any assurance on the statements. This definition assurance on the statements. This definition acknowledges that the audit organization might find it acknowledges that the audit organization might find it necessary to perform other accounting services to necessary to perform other accounting services to compile the financial statements, such as adjusting the compile the financial statements, such as adjusting the books of accounts or consulting on accounting matters. books of accounts or consulting on accounting matters. Can an audit organization provide a compilation service Can an audit organization provide a compilation service without impairing independence to audit subsequent without impairing independence to audit subsequent period financial statements? period financial statements?


Yes. Compilations are generally performed to Yes. Compilations are generally performed to periodically supply financial information in an periodically supply financial information in an understandable format, such as quarterly financial understandable format, such as quarterly financial statements. Similar in substance to drafting financial statements. Similar in substance to drafting financial statements and notes, the compilation of financial statements and notes, the compilation of financial information information would not impairwould not impair the audit organization’s the audit organization’s independence as long as it does not make management independence as long as it does not make management decisions and management of the audited entity has the decisions and management of the audited entity has the knowledge to evaluate and approve the compilation and knowledge to evaluate and approve the compilation and to take responsibility for it. Also, the team that performed to take responsibility for it. Also, the team that performed the compilation could perform the financial statement the compilation could perform the financial statement audit as long as the audit organization complies with the audit as long as the audit organization complies with the other safeguards in paragraph 3.25. other safeguards in paragraph 3.25.


Similar to our answer to the previous question Similar to our answer to the previous question regarding the preparation of regarding the preparation of draftdraft financial financial statements and notes, we reiterate that our statements and notes, we reiterate that our answer is conditioned on the audit organization answer is conditioned on the audit organization starting with appropriate books and records and starting with appropriate books and records and the audited entity having knowledgeable the audited entity having knowledgeable management. Therefore, the audit organization management. Therefore, the audit organization was able to perform the compilation without was able to perform the compilation without having to reconstruct the books and records, having to reconstruct the books and records, and the audited entity’s management was in a and the audited entity’s management was in a position to take responsibility for the compilation. position to take responsibility for the compilation.


48. Paragraph 3.26a of the independence 48. Paragraph 3.26a of the independence standard states that independence is standard states that independence is impaired if the audit organization impaired if the audit organization maintains or prepares an audited entity’s maintains or prepares an audited entity’s basic accounting records or maintains or basic accounting records or maintains or takes responsibility for basic financial or takes responsibility for basic financial or other records that an audit organization other records that an audit organization will audit. What is considered to be an will audit. What is considered to be an entity’s basic accounting records and entity’s basic accounting records and basic financial or other records? basic financial or other records?


Basic accounting and financial records are considered to Basic accounting and financial records are considered to be source documents or originating data evidencing be source documents or originating data evidencing transactions have occurred (for example, purchase transactions have occurred (for example, purchase orders, payroll time records, and customer orders). Such orders, payroll time records, and customer orders). Such records would also include an audited entity’s general records would also include an audited entity’s general ledger and subsidiary records, or equivalent. Supporting ledger and subsidiary records, or equivalent. Supporting schedules are not considered to be basic accounting or schedules are not considered to be basic accounting or financial records, as long as management has made all financial records, as long as management has made all the decisions in key areas regarding these supporting the decisions in key areas regarding these supporting schedules. An example of a supporting schedule is a schedules. An example of a supporting schedule is a depreciation schedule, which the next question depreciation schedule, which the next question discusses further. discusses further.


49. Can an audit organization assist an 49. Can an audit organization assist an audited entity’s management in preparing audited entity’s management in preparing depreciation schedules without impairing depreciation schedules without impairing its independence to perform the financial its independence to perform the financial statement audit? statement audit?


Yes, as long as the audited entity’s management Yes, as long as the audited entity’s management has determined such key factors as the method has determined such key factors as the method and rate of depreciation and the salvage value and rate of depreciation and the salvage value of the assets. If the audit organization makes of the assets. If the audit organization makes these decisions, it has violated an overarching these decisions, it has violated an overarching principle. To not principle. To not impairimpair its independence, the its independence, the audit organization’s service must be limited to audit organization’s service must be limited to calculating the depreciation, and the audited calculating the depreciation, and the audited entity’s management must take responsibility for entity’s management must take responsibility for the depreciation schedules. the depreciation schedules.


The audit organization must take care that the The audit organization must take care that the extent of its work does not cross the line and extent of its work does not cross the line and place it in a position where reasonable third place it in a position where reasonable third parties with knowledge of the relevant facts and parties with knowledge of the relevant facts and circumstances could conclude that the auditor’s circumstances could conclude that the auditor’s independence is impaired. Also, given the nature independence is impaired. Also, given the nature of this nonaudit service, the audit organization of this nonaudit service, the audit organization would not have to apply the safeguard would not have to apply the safeguard precluding personnel who provided the nonaudit precluding personnel who provided the nonaudit services from auditing their own work. However, services from auditing their own work. However, the remaining safeguards in paragraph 3.25 the remaining safeguards in paragraph 3.25 would apply. would apply.


50. If the audit organization posts 50. If the audit organization posts transactions coded by the audited entity’s transactions coded by the audited entity’s management, would the audit management, would the audit organization’s independence be impaired organization’s independence be impaired to perform the financial statement audit? to perform the financial statement audit?


Yes. Paragraph 3.26a specifically Yes. Paragraph 3.26a specifically addresses the posting of transactions, addresses the posting of transactions, whether coded by management or not, to whether coded by management or not, to an entity’s financial records or to other an entity’s financial records or to other records that subsequently provide data to records that subsequently provide data to an entity’s financial records. An audit an entity’s financial records. An audit organization cannot provide this service organization cannot provide this service without impairing its independence to without impairing its independence to perform the financial statement audit.perform the financial statement audit.


51. An audit organization arrives at an audited 51. An audit organization arrives at an audited entity for the first day of fieldwork and finds that entity for the first day of fieldwork and finds that the last quarter’s cash receipts and the last quarter’s cash receipts and disbursements and other transactions have not disbursements and other transactions have not been recorded. To assist the audited entity in been recorded. To assist the audited entity in updating its financial records, the audit updating its financial records, the audit organization agrees to prepare and post all organization agrees to prepare and post all transactions to the general ledger based on the transactions to the general ledger based on the audit organization’s professional judgment. audit organization’s professional judgment. Would the audit organization’s independence be Would the audit organization’s independence be impaired to perform the financial statement impaired to perform the financial statement audit? audit?


Yes. The audit organization would be Yes. The audit organization would be posting transactions to the audited entity’s posting transactions to the audited entity’s general ledger, which impairs its general ledger, which impairs its independence as discussed in paragraph independence as discussed in paragraph 3.26a. 3.26a.


52. An audited entity provides an audit organization with 52. An audited entity provides an audit organization with a record of all cash receipts and cash disbursements a record of all cash receipts and cash disbursements made during the period. The audit organization (1) made during the period. The audit organization (1) determines the appropriate classification of each determines the appropriate classification of each transaction based on the available information (such as transaction based on the available information (such as payee and description), (2) posts current-year payee and description), (2) posts current-year transactions to the prior-year adjusted balance sheet and transactions to the prior-year adjusted balance sheet and then determines necessary adjustments to convert the then determines necessary adjustments to convert the financial information to the accrual basis of accounting, financial information to the accrual basis of accounting, and (3) uses this adjusted information to and (3) uses this adjusted information to draftdraft financial financial statements, which are reviewed with and approved by an statements, which are reviewed with and approved by an audited entity. In this case, would an audit organization’s audited entity. In this case, would an audit organization’s independence be considered impaired to perform the independence be considered impaired to perform the financial statement audit? financial statement audit?


Yes. Determining the appropriate classification Yes. Determining the appropriate classification of receipts and disbursements, in substance, of receipts and disbursements, in substance, would be the same as maintaining/preparing an would be the same as maintaining/preparing an audited entity’s basic accounting records. audited entity’s basic accounting records. Likewise, posting current year transactions to Likewise, posting current year transactions to the prior year’s balance sheet has the same the prior year’s balance sheet has the same affect as posting transactions to the audited affect as posting transactions to the audited entity’s financial records. As discussed in entity’s financial records. As discussed in paragraph 3.26a, activities such as these paragraph 3.26a, activities such as these would would impairimpair an audit organization’s independence to an audit organization’s independence to perform the financial statement audit. perform the financial statement audit.


53. An audited entity provides its cash receipts 53. An audited entity provides its cash receipts and disbursements journals to the audit and disbursements journals to the audit organization, which, as part of its financial organization, which, as part of its financial statement audit, proposes adjusting entries to statement audit, proposes adjusting entries to convert from a cash basis to an accrual basis of convert from a cash basis to an accrual basis of accounting. The audited entity’s management, accounting. The audited entity’s management, which has requested the conversion, reviews, which has requested the conversion, reviews, approves, and posts the entries and has approves, and posts the entries and has sufficient knowledge and ability to take sufficient knowledge and ability to take responsibility for them. Would the audit responsibility for them. Would the audit organization’s independence be considered organization’s independence be considered impaired for the financial statement audit? impaired for the financial statement audit?


No. An audit organization could perform these activities No. An audit organization could perform these activities as part of a financial statement audit without impairing its as part of a financial statement audit without impairing its independence, provided management of the audited independence, provided management of the audited entity is in a position to evaluate and take responsibility entity is in a position to evaluate and take responsibility for results of the conversion. As with the answers to the for results of the conversion. As with the answers to the earlier question related to converting financial earlier question related to converting financial statements from a cash to an accrual basis, this answer statements from a cash to an accrual basis, this answer assumes that the cash receipts and disbursements assumes that the cash receipts and disbursements journals only have to be converted and do not have to be journals only have to be converted and do not have to be reconstructed to such an extent that the audit reconstructed to such an extent that the audit organization, in substance, would be maintaining or organization, in substance, would be maintaining or preparing the audit entity’s basic accounting records. preparing the audit entity’s basic accounting records.


Also, similarly to previous answers, the Also, similarly to previous answers, the management representation letter should management representation letter should acknowledge the audit organization’s role acknowledge the audit organization’s role in the conversion and management’s in the conversion and management’s review, approval, and responsibility for the review, approval, and responsibility for the conversion. conversion.


54. A small audited entity’s sole accountant 54. A small audited entity’s sole accountant suddenly leaves due to an emergency situation, suddenly leaves due to an emergency situation, and it asks an audit organization to provide a and it asks an audit organization to provide a temporary staff person until a new accountant is temporary staff person until a new accountant is hired. If the staff person that the audit hired. If the staff person that the audit organization assigns to provide this assistance organization assigns to provide this assistance is not part of the audit engagement team and the is not part of the audit engagement team and the audit organization complies with all of the audit organization complies with all of the required safeguards, would its independence be required safeguards, would its independence be considered impaired on a financial statement considered impaired on a financial statement audit? audit?


First, an emergency situation should be a rare First, an emergency situation should be a rare and cataclysmic event that is unexpected and and cataclysmic event that is unexpected and has a severe adverse impact on the audited has a severe adverse impact on the audited entity. Second, the audit organization would entity. Second, the audit organization would have to document that, under the circumstances, have to document that, under the circumstances, the audited entity had no other viable option to the audited entity had no other viable option to address the emergency, such as hiring address the emergency, such as hiring temporary help to carry them over. The audit temporary help to carry them over. The audit organization should ensure that the audited organization should ensure that the audited entity understands the need to exhaust all other entity understands the need to exhaust all other viable options and that the audit organization viable options and that the audit organization should be viewed as the last resort. should be viewed as the last resort.


Considering the caveats included in the question Considering the caveats included in the question and assuming that this represents the rare case and assuming that this represents the rare case where there is no other viable option, an audit where there is no other viable option, an audit organization could provide this emergency organization could provide this emergency service for a short time (no longer than 1 month) service for a short time (no longer than 1 month) without impairing its independence, as long as it without impairing its independence, as long as it included in its audit report the circumstances included in its audit report the circumstances related to the emergency situation and makes related to the emergency situation and makes clear its role and the safeguards taken. clear its role and the safeguards taken.


55. An audited entity asks an audit 55. An audited entity asks an audit organization to assist with implementing organization to assist with implementing GASB Statement No. 34, Basic Financial GASB Statement No. 34, Basic Financial Statements--and Management’s Statements--and Management’s Discussion and Analysis--for State and Discussion and Analysis--for State and Local Governments. Would an audit Local Governments. Would an audit organization’s independence be impaired? organization’s independence be impaired?


It would depend on the nature of the assistance It would depend on the nature of the assistance provided. GASB Statement No. 34 significantly provided. GASB Statement No. 34 significantly changed the state and local governmental changed the state and local governmental financial reporting model by redefining the financial reporting model by redefining the general-purpose external financial statements general-purpose external financial statements and by requiring a new section on and by requiring a new section on Management’s Discussion and Analysis and that Management’s Discussion and Analysis and that all capital assets, including infrastructure assets, all capital assets, including infrastructure assets, be reported in the financial statements. be reported in the financial statements.


An audit organization could provide the An audit organization could provide the type of services covered under the type of services covered under the independence standard in paragraph independence standard in paragraph 3.23--such as providing routine advice, 3.23--such as providing routine advice, explaining explaining technicaltechnical requirements, and requirements, and providing training--without impairing its providing training--without impairing its independence. Generally, such assistance independence. Generally, such assistance relating to an audit organization’s relating to an audit organization’s knowledge and skills would be considered knowledge and skills would be considered routine and routine and not impairnot impair audit independence. audit independence.


However, if an audit organization is asked to However, if an audit organization is asked to perform work that goes beyond routine advice, perform work that goes beyond routine advice, this work needs to be considered in light of the this work needs to be considered in light of the overarching principles and the safeguards. This overarching principles and the safeguards. This would be the case, for example, if an audit would be the case, for example, if an audit organization were asked to perform extensive organization were asked to perform extensive valuation services (such as may be related to an valuation services (such as may be related to an audited entity’s infrastructure assets or to audited entity’s infrastructure assets or to prepare an audited entity’s Management’s prepare an audited entity’s Management’s Discussion and Analysis. Discussion and Analysis.


56. If an audit organization arrives at an 56. If an audit organization arrives at an audited entity to perform a financial audited entity to perform a financial statement audit and finds that bank statement audit and finds that bank account reconciliations were not account reconciliations were not performed during the year, can the audit performed during the year, can the audit organization perform this service without organization perform this service without impairing independence? impairing independence?


It would depend on the facts and It would depend on the facts and circumstances. Reconciling cash balances circumstances. Reconciling cash balances to bank statements or related records is an to bank statements or related records is an internal control that is the responsibility of internal control that is the responsibility of entity management. In deciding whether to entity management. In deciding whether to provide this nonaudit service, the audit provide this nonaudit service, the audit organization must consider the organization must consider the overarching principles and the safeguards, overarching principles and the safeguards, applying the substance over form doctrine. applying the substance over form doctrine.


If the extent of an audit organization’s efforts in If the extent of an audit organization’s efforts in assisting the audited entity is extensive, which assisting the audited entity is extensive, which would seem to be the case in this situation, an would seem to be the case in this situation, an audit organization needs to consider whether its audit organization needs to consider whether its efforts, in fact, constitute performing a efforts, in fact, constitute performing a management function. Also, the audit management function. Also, the audit organization needs to consider the materiality of organization needs to consider the materiality of cash to the financial statements and whether cash to the financial statements and whether management has the knowledge to evaluate and management has the knowledge to evaluate and approve the auditor’s work. approve the auditor’s work.


57. Over the last few years, the U.S. Department 57. Over the last few years, the U.S. Department of Housing and Urban Development (HUD) has of Housing and Urban Development (HUD) has introduced a number of electronic filing introduced a number of electronic filing requirements for financial information for public requirements for financial information for public housing authorities and multifamily housing housing authorities and multifamily housing projects. HUD will soon introduce new electronic projects. HUD will soon introduce new electronic filing requirements for the lender community. filing requirements for the lender community. Would independence be considered impaired if Would independence be considered impaired if an audit organization assists an entity in making an audit organization assists an entity in making the electronic submission? What if the the electronic submission? What if the transmitted amount was material to the financial transmitted amount was material to the financial statements? statements?


No. This would be considered a routine No. This would be considered a routine byproduct of the audit and is permissible byproduct of the audit and is permissible irrespective of the materiality of the irrespective of the materiality of the transmitted amount and without applying transmitted amount and without applying the safeguards. the safeguards.

Questions?Questions?

Oklahoma Accountancy BoardOklahoma Accountancy Board

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www.oab.state.ok.uswww.oab.state.ok.us

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