Audit Chapter 4 - Independence & Ethics

Independence Framework

-2 requirements: 1) Independence in Mind: specific, prohibited actions, set rules or interpretations by the AICPA, aka independence in fact 2) Independence in Appearance: "Reasonable Investor Rule", independence is violated if in light of all relevant facts & circumstances a reasonable investor would conclude that the auditor would not be capable of acting without bias

Immediate Family vs. Close Relative

-Immediate Family: spouse or equivalent and dependents -Close Relative: immediate family, plus parents, siblings, & nondependent children

Independence: Conceptual Framework

-Reasonable Investor Rule: In the absence of an independence interpretation that addresses a particular relationship or circumstance, a member should evaluate whether that relationship or circumstance would lead a reasonable and informed third party who is aware of the relevant information to conclude that there is a threat to either the member's or the firm's independence, or both, that is not at an acceptable level -*Even when specific rules or interpretations exist, you must still pass the reasonable investor rule!!!* -Applying the framework: 1. Identify threats 2. Evaluate the threats 3. Identify any safeguards

Practice Question 2: It is five years in the future and you have successfully completed your degree and you are now a manager in the New York office of Big Firm Accounting LLP - congratulations! Big Firm's Atlanta office audits Wolfpack, Inc. a publicly held company. You are not on the audit team for Wolfpack, but you are a member of the technical standards group for the firm and the engagement team for Wolfpack asked you for guidance on how to deal with an accounting issue - which you provided. Your spouse was just named CFO of Tar Heel, Wolfpack's biggest competitor. Is your independence impaired? Is Big Firm's? Thoroughly discuss the factors that affect this judgment.

-Your independence is impaired because since your wife is the CFO their competitor a reasonable investor could think you'd be biased against Wolfpack -The firm would be independent if you weren't on the audit engagement team

Direct Financial Interests

-a direct financial interest exists when the auditor owns equity or debt instruments of a client directly 1) Covered persons and their immediate families are prohibited from ANY direct investments in clients 2) Direct investment of > 5% of equity of audit client/affiliates prohibited by *all audit firm professionals*, their immediate family, and close relatives

Mutual Funds

-although mutual funds < 5% are not independence violations, investments of > 5% must be evaluated for based on an individuals net worth -for example: a non diversified mutual fund owns shares in client company A, the mutual fund's net assets are $10 million, the covered member owns 1% of the outstanding shares of the mutual fun having a value of $100,000 and the mutual fund has 10% of its assets invested in company A -the covered member's indirect financial interest in the company is $10,000 ($100,000 x 10%), compare to the individuals net worth to determine if it would be considered material

Indirect Financial Interests

-an indirect financial interest exists when a person owns shares of a client through another entity or has a mutual interest with a client -the firm, covered persons, & immediately family are prohibited from *material* indirect investment including owning > 5% of an entity that own interest in an audit client, or owning >5% of an entity of which the audit client owns an interest -note that investments by covered persons & immediate family of < 5% of a diversified investment company that invests in an audit client (i.e. a mutual fund) is *NOT* a violation

Key Position

-an individual at a client who has primary responsibility for significant accounting functions, preparation of F/S, or the ability to influence contents of the F/S -ex: director, CEO, CAO, COO, president, general counsel, controller, director of internal audit or financial reporting, treasurer, or equivalent

Independence: Employment Relationships

-covered persons and their close family members are prohibited from having Key Positions in audit client -former partners or professional employees have a one year cooling period required by SOX before they can be in Key Position roles -former audit client employees are profited from becoming partner in the audit firm and being involved in the audit

Proxy Disclosure

-disclose fees paid to auditor for audit, audit-related, tax, & all other services provided -state whether audit committee has considered whether provision of non-audit services is compatible with maintaining independence

Attest Engagement Team

-individuals (including tax & consulting) participating in the attest engagement including those performing concurring and 2nd partner reviews

AICPA Code of Professional Conduct

-principles -> rules -> interpretations (how to apply the rules in certain situations) -6 principles: responsibilities, the public interest, integrity, objectivity and independence, due care, scope & nature of services -rules: most prominent rule is the Independence Rule

Practice Question 1: It is ten years in the future and you are now an audit engagement partner at Smith and Bamber, CPAs in Atlanta, but you are not involved in firm management in any way. S&B's Las Vegas office has just landed a new client, Call and Ramalingegowda, Inc. but you will not be assigned to the engagement. Your sister owns 6 percent of Call and Ramalingegowda. Which of the following is true? A. You are not independent of Call and Ramalingegowda, but Smith and Bamber is still independent. B. Neither you nor S&B are independent of Call and Ramalingegowda. C. You and S&B are both independent of Call and Ramalingegowda. D. Your sister is not independent of Call and Ramalingegowda, but you are.

B. Neither you nor S&B are independent of Call and Ramalingegowda.

Individuals in Position to Influence Attest Engagement:

someone who... -evaluates performance -recommends compensation -directly supervises/manages engagement partner (ALL the successively senior people in the firm) -consults/advises with team on technical/industry-related matter -participates in quality control activities

Independence: Non-Audit Services

the following *cannot* be provided to a public audit client: -bookkeeping -appraisal/valuation -actuarial services -management functions -human resources -broker-dealer services -legal services -*financial info system design and implementation* -*internal audit services* -certain tax services for public clients

Quality Control

Rules provided *limited* exceptions from independence violations, if: -the individual did not know the circumstances giving rise to the violation -the violation was corrected promptly once it became apparent -the firm has quality controls in place that provide reasonable assurance that the firm and its employees maintain independence

Covered Members

Includes: -individuals on the engagement team -individuals in position to influence the engagement team -partner or manager who provides 10+ hours of non-attest services -partner in the office of the lead engagement partner -the firm & its employee benefit plans -an entity that can be controlled by any covered members or combination of covered members