INDEPENDENCE n AICPA Code of Professional Conduct Article

INDEPENDENCE n AICPA Code of Professional Conduct (Article IV): “A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services. ”

INDEPENDENCE Rule 101 – “A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council. ”

INDEPENDENCE n Independence applies to: The firm as a whole n The individuals who make up the firm n n It is possible for the firm to be independent even when certain individuals within the firm are not independent

Rule 101 only applies to attestation services: n n n Financial statement audits Financial statement reviews Other attest services covered by SSAEs: Forecasts and projections n Pro forma statements n Internal control n Compliance with laws n

INDEPENDENCE n Independence is not required to perform non-attest services: Tax preparation or advice n Consulting n n Independence is not required when performing a compilation, but lack of independence must be acknowledged in the report.

INTERPRETATIONS UNDER RULE 101 – WHO MUST BE INDEPENDENT? n Old rules: a member or a member’s firm: All partners n All managerial employees in controlling office n All professional staff personally participating in engagement n

NEW RULES – “COVERED MEMBERS” n n n Individuals on engagement team Individuals in position to influence engagement team Partner or manager who provides 10 or more hours of non-attest services to client Partner in office of the lead engagement partner The firm, including firm’s employee benefit plans An entity controlled by individuals or entities above

“COVERED MEMBER” (NOTES) n n The term “covered member” is completely unrelated to whether you are a member of the AICPA or a state CPA society Non-CPAs may qualify as “covered members”

Independence is impaired if, during the period of the professional engagement, a covered member: n n Had or was committed to acquire any direct or material indirect financial interest in the client Was a trustee or executor of an entity that had or was committed to acquire any direct or material indirect financial interest in the client Had a joint closely held investment that was material to the covered member Had any loan to or from the client, any officer or director of the client, or any 10% owner of the client (except for loans specifically permitted)

INDEPENDENCE IS IMPAIRED IF: n During the period of the professional engagement, a partner or professional employee of the firm, his or her immediate family, or any group of such persons acting together owned more than 5% of a client’s outstanding equity securities other ownership interests or

BIG CHANGE IN RULES n n Old rules: no partners or designated staff could have any direct investment in a client New rules: partners and staff not directly participating in the engagement or in a position to influence the engagement may have small direct investments in the client

INDEPENDENCE IS IMPAIRED IF: n During the period covered by the financial statements or during the period of the professional engagement, a partner or professional employee of the firm was simultaneously associated with the client as a(n): n Director, officer, employee, or member of management n Promoter, underwriter, or voting trustee n Trustee for any pension or profit-sharing trust of the client

APPLICATION OF RULE 101 TO IMMEDIATE FAMILY MEMBERS n A covered member’s immediate family (spouse and dependents) is subject to Rule 101, with two minor exceptions: n Employed by client, not in “key position” n Family members have financial interest through employee benefit plan (only applies to partners and managers providing non-attest services and partners in office of lead engagement partner)

APPLICATION OF RULE 101 TO CLOSE RELATIVES (siblings, parents, nondependent children) n Independence is impaired if an engagement team member, or person in position to influence the engagement, or any partner in the office of the lead engagement partner has a close relative who had: n A key position with the client n A financial interest in the client that was material to the close relative and known to the individual and/or enabled close relative to exercise significant influence over the client

EXAMPLES OF FINANCIAL INTERESTS n n n Shares of stock Mutual fund shares Partnership units Stock rights Options or warrants Puts, calls, or straddles

WAYS TO EVIDENCE DIRECT FINANCIAL INTERESTS n n n Through shares of stock Through a retirement plan (401(k), IRA, etc. ) Through an investment club Through a partnership as a general partner Through an estate as executor Through a trust as trustee

WAYS TO ACQUIRE INDIRECT FINANCIAL INTERESTS n n Through mutual funds Through partnerships as a limited partner

May I (or my immediate family) own shares in a mutual fund audit client? n No: your interest in the mutual fund would constitute a direct financial interest in the client.

What if I own shares of a mutual fund that invests in my clients? n n Financial interests that you have through mutual funds are considered indirect financial interests If such financial interests are material, they would compromise independence

EXAMPLE n Suppose ABC Mutual Fund owns shares in a client, XYZ: n n ABC’s net assets are $10 million Your shares in ABC are worth $50 thousand ABC has 2% of its assets invested in XYZ Your indirect financial interest in XYZ $1, 000 ($50, 000 x. 02) n If $1, 000 is material to your net worth, independence is impaired is

May I have an outside investment with a client or person associated with a client? n n If you are a “covered member, ” such an investment would be considered a “joint closely held investment” If this investment is material to your net worth, your independence is impaired

May I borrow money from, or loan money to, a client, or invest in a client’s bonds? n n No: such actions would constitute impermissible loans to or from that client Note: there a few types of loans from a client financial institution that are permitted under AICPA rules (car loans, credit card balances < $5, 000, passbook loans, etc. )

May I have a bank account with a client financial institution? n Yes: as long as your deposits are fully insured by state or federal deposit insurance agencies and any uninsured amounts are not material to your net worth

May I accept a gift from a client? n n Yes: but a “covered member” may accept only token gifts a client; otherwise, independence would be considered impaired Be careful of appearances! from

What rules restrict nonattest or “other” services provided to clients? n The independence rules impose limits on the nature and scope of your firm’s accounting and consulting services

BASIC PRINCIPLE n You may not serve - or even appear to serve - as a member of a client’s management. For example, you may not: n n n Make operational or financial decisions for client Perform management functions for client Report to board of directors on behalf of management

ACTIVITIES THAT IMPAIR INDEPENDENCE n n Authorizing, executing, or consummating transactions on behalf of client Preparing source documents or originating data Having custody of a client’s assets Supervising client employees in performance of normal recurring activities

What about performing bookkeeping services for a client? n Independence is not impaired if you: n n n Record transactions determined or approved by management Post coded transactions to general ledger Prepare financial statements based on client’s trial balance Post client-approved entries to trial balance Propose journal entries Provide data processing services

What about commissions and contingent fees? n You and your firm may not have commission or contingent fee arrangements with an attestation client

What about commissions and contingent fees? n You and your firm may not have commission or contingent fee arrangements with a client for whom you provide compiled financial statements when a third party will rely on those statements unless the report discloses your lack of independence

What about commissions and contingent fees? n You and your firm may have commission and contingent fee arrangements with persons associated with the client, such as officers, directors, and principal stockholders

What about unpaid fees? n n When a client owes your firm fees, those fees have been outstanding more than one year, that unpaid fee is treated as a loan to the client. Generally, fees for prior year’s audit must be paid before issuing current year’s report to be independent. and for