I. Requirements of SEC and PCAOB

Question 1

SEC rules for independence

Answer 1

• very similar to AICPA rules
• Any student who masters the AICPA Code of Professional Conduct and has knowledge of the SOX requirements and a modicum of common sense = should be able to handle questions regarding the SEC rules

Question 2

What are the SEC’s primary concerns regarding ethics and independence?

Answer 2

Whether a relationship with or provision of a service to an audit client:

1. Creates a conflict of interest for the auditor;
2. Results in the accountant auditing his or her own work;
3. Results in the accountant acting as an audit client’s manager or employee; or
4. Places the accountant in a position of being an advocate for the audit client.

Question 3

Does the SEC use the same definitions of family relationships as the AICPA?

Answer 3

No, but very close.

Instead of using the term, “close relative.” the SEC speaks of “close family members” (CFMs), which include “spouse, spousal equivalent, parent, dependent, nondependent child, and sibling.”

Question 4

Does the SEC use the AICPA’s concept of “covered members” to determine who must follow independence rules?

Answer 4

No, they instead of the term covered members, they use the term “covered persons.”

Covered members are:

• Audit team members
• PTIs (person to influence)
• 10-hour persons
• OPIOs (other person in the office)
• The firm itself
• Any entity controlled by the first five

Covered Persons are:

• audit team members
• “Chain of command” (PTIs)
• 10-hour persons
• OPIOs

The other two not specifically listed but would most likely be covered.

Question 5

Do direct financial investments in an audit client impair independence?

Answer 5

Yes, the firm, CPs, and their IFMs may not own stock in an audit client, even in immaterial amounts.

Example of direct investment includes:

• the firm, CPs, or IFMs either supervise or participate in the intermediary’s investment decisions, or
• The intermediary is a nondiversified mutual fund that has invested 20% or more of its money in an audit client.

Question 6

Can someone who is not a CPs impair independence?

Answer 6

Sometimes. Depends if any partner, principal, shareholder, or professional employee of the accounting firm (and any of their CFMs) own 5% or more of an audit client’s stock.

Question 7

May the firm, its CPs, or IFMs serve as trustees of trusts or executors of estates that hold securities of an audit client?

May the firm, CPs, or their IFMs own material indirect interests in an audit client?

Answer 7

No, as long as they have no authority to make investment decisions for the trust or estate.

No, remember only interests that are both indirect and immaterial are permitted.

• Ex: ownership of 5% or less of a diversified mutual fund = immaterial

Question 8

May the firm, CPs, or their IFMss borrow money from or loan money to an audit client, its officers, and directors, or its 10% shareholders?

Answer 8

NO, with exceptions:

May borrow from a financial institution under NORMAL procedures and terms:

Auto loan collateralized by the car

Loans fully collateralized by:

• surrender value of an insurance policy
• cash deposits at that same institution

Mortgage collaterized by borrower’s primary residence if obtained when borrower was not a CP

Question 9

May the firm, CPs, or their IFMs have a savings or checking account at a financial institution client?

Answer 9

Yes, but only if:

• The account balance if fully insured ($250,000 limit) by the FDIC and
• If there is an uninsured balance, the likelihood of the institution experiencing financial difficulties is remote.

Question 10

May the firm, CPs, or their IFMs have a credit card issued by an audit client?

Answer 10

Yes, if the account balance is < $10,000.

Question 11

May the firm, CPs, or their IFMs buy insurance products from an audit client?

Answer 11

No, insurance policies are permitted only if:

• They were obtained before the person became a CP, and
• The likelihood of the insurer becoming insolvent is remote.

Question 12

What the rule behind unsolicited financial interests acquired by the firm, CPs, or the IFMs?

Answer 12

An unsolicited gift or an inheritance that would normally impair independence is permitted as long as it is disposed of:

• As soon as practicable
• But no later than 30 Days after the person learns of the interest and has the right to dispose of it

Question 13

May current partner, principal, shareholder, or professional employee of the accounting firm be employed by the audit client or serve as a member of the board of director?

What about family members?

Answer 13

Noooo!!!!

A CFM of a CP my NOT work at an audit client in:

An accounting role, or

Financial Responsibility Oversight Role (FROR)

Question 14

May an accounting firm employee go to work for an audit client in accounting or FROR?

Answer 14

No, unless two requirements are met:

1. The individual:
   
   • Does not influence the accounting firm’s operations or financial policies
   • Has no capital balances in the accounting firms; and
   • Has no financial arrangement w/ accounting firm other than one providing for regular payment of a fixed dollar amount.
2. The individual has served a one-year “cooling-off” period.

Question 15

How does the “cooling-off” period work?

Answer 15

Does not apply to:

• Persons who provided 10 or fewer hours of attest services
• Persons employed by the client as result of merger or
• Persons employed by the client as a result of an emergency.

And the cooling-off period is an entire year before the audit cycle begins.

So if the audit cycle runs from May 1 - Apr 30. for 2020. Bib works as audit team for ABC and whats to switch to ABC accounting role.

• If he leaves Feb 1, 2020: He would start his audit cycle in May 1, 2021. Remember: Skip a full year audit cycle.
• If he leaves audit team June 14, 2020 (which is right after the start of the audit cycle): He would have to wait until that current audit cycle ends and then wait another whole year of the entire audit cycle, to be able to switch over to the accounting role.

Question 16

May a CP have a direct or material indirect business relationship with an audit client?

Answer 16

No, they cannot have direct or indirect material, however, they can provide services to a client or buying goods and services from a client in the ordinary course of business.

Question 17

May the firm, CPs, or their IFMs have a savings or checking account at financial institution client?

Answer 17

Yes, but only if:

• The account balance if fully insured ($250,000 limit) by the FDIC and
• If there is an uninsured balance, the likelihood of the institution experiencce financial difficultities is remote.

Question 18

Who may an auditor provide Non-Audit Services (NAS) to?

Answer 18

A public company that is not an audit client

and

to a private company that is an audit client.

Question 19

May an accountant accept contingent fees or a commission from a public company audit client?

Answer 19

No, not for any service or product, and it would impair independence.

Question 20

What must public company rotate from time to time?

Answer 20

There are no requirements that public companies rotate audit firms.

Accounting firms must rotate:

• Lead and concurring audit partners every 5 years (five on, five off)
• Other partners who provide more than 10 hours of attest services every seven years (seven on, two off)
• There are exemption for firms w/ fewer than five audit clients and fewer than 10 audit partners.

Question 21

What is the role of audit client’s audit committee?

Answer 21

Among other things, it must preapprove:

• Hiring of the auditor and
• The auditor’s provision of NAS

Question 22

Does SOX address auditor compensation?

Answer 22

Only to say that a firm is not independent if any audit partners earn/receives compensation based on selling NAS to the audit client.

Question 23

Under SOX and the SEC what is their rule being quality control?

Answer 23

Usually for firms auditing more than 500 companies.

Their quality control system provides such reasonable assurance only if it has the following features:

1. Written independence policies and procedures;
2. An automated system tracking investments of partners and managerial employees that might impair independence;
3. For all professionals, a system that provides timely information about entities from which the accountant is required to maintain independence;
4. An annual or ongoing firm-wide training program on independence rules;
5. An annual internal inspection and testing program to monitor adherence to independence rules;
6. Notification to all firm employees of the name and title of the member of senior management responsible for compliance with independence rules; and
7. A disciplinary mechanism to ensure compliance.

Question 24

How does quality control provide reasonable assurance?

Answer 24

Firms that audit > 500 companies, their quality control provides reasonable assurance only if:’

• Written independence policies and procedure
• Automated system that tracks investment of partners and manage things that might impair independence
• For ALL professional, a system that provide timely information about entities
• Firm wide-training on independence

Question 25

What are the ethical requirements of the PCAOB?

Answer 25

All rules must be consistent with the SEC as well as approved by them.

Question 26

In relation to providing NAS, what are the three steps that must be done to be approved by the audit committee?

Is this independence review an ongoing obligation?

Answer 26

1. Describe
   
   • The scope of the service, the fee structure for the engagement, and any other related agreement between the firm and the audit client.
   • Any compensation arrangement or other agreement, such as a referral fee or fee-sharing arrangement between the firm and any person (other than the audit client) regarding the promoting, marketing, or recommending of a transaction covered by the service.
2. Discuss
   
   • with the audit committee the potential effects of the services on the firm’s independence.
3. Document
   
   • the discussion.

Yes, at least annually with respect to each public company audit client, the firm should go through the three step procedure

Question 27

What are the forms of compensation that may get a public company audit firm in trouble? Give a brief meaning behind them

Answer 27

1. Contigent Fees
2. Commissions

Rule 3521, consistent with AICPA rules, provides that if a firm or any affiliate provides “any service or product” to an audit client in exchange for a contingent fee or commission, independence is impaired.

Consistent with AICPA rules, a fee is not considered contingent if it is fixed by courts or other public authorities and is not dependent on a particular finding or result.

Question 28

What are the types of tax transactions that may not be serviced for a public company audit client? Describe each

Answer 28

Confidential - one that is offered to a taxpayer under conditions of confidentiality and for which the taxpayer has paid the advisor a fee; or

Aggressive - initially recommended by the accounting firm and a “significant purpose” of which is tax avoidance, unless the proposed tax treatment is at least more likely than not to be allowable under applicable tax laws.

Question 29

What is FROR and is there any exception to the FROR rule?

Answer 29

Anyone that can or do exercise influence over the financial statements or anyone who preparees them

Ex: Directors, CEOs, presidents, CFOs, COOs, general counsel, CAOs, controllers, directors of internal audit, director of financial reporting, treasurers, or other equilvalent positions.

Yes, there are three, Independence is not impaired if:

Person is a FROR only if they are member of the board of directors.

Only because of a relationship to an affiliate of the entity being audit where it is not material to the consolidated financial statement of the audit client.

The person was not a FROR before hiring, or promotions, or similar changes in employment

Question 30

Who must comply with the ethical and professional requirements of the GAO’s Yellow Book?

What do the Yellow Book require?

Answer 30

Those who conduct GAGAS audits of:

Governemental Entities (federal, state, and local) and

Entities that receive government awards (e.g colleges, trade schools, and charities, local governments)

The yellow book requires those who audit to GAGAS are expected to audit:

1. Independently
2. In accordance with these key ethical principles:
   
   • Public interest
   • Intergrity
   • Objectivity
3. Proper use of gov. info, resources, and positions
4. Professional behavior

Question 31

What are the four key parts of the Yellow Book’s Provisions on ethics and independence?

Answer 31

Conceptual framwork for making independence determination

Requirements for and guidancee on:

• Independence for audit organization (AOs) structurally located within the entities they audit
• Independence for performing NAS and
• Documentation of the auditor’s independence

Question 32

What does GAO mean by “independence”?

Answer 32

Two types:

Independence of Mind

• Ability to act with integrity, objectivity, and professional skepticism

Independence in Appearance

• Objective their parties should have no reason to question integrity, objectivity, and/or professional skepticism

Question 33

Does GAO’s conceptual framework for answering independence questions resemble the AICPA’s?

Answer 33

Yes. with three steps:

1. Identfying threats to indepoendence
2. Evaluating the significance of the threats identified
3. Applying a saeguards as necessary to eliminate threats or reduce them to acceptable level

Question 34

What threats to independence does GAO recognize and give an example of each of them?

Answer 34

1. Self-interest threat

Ex: Auditor has financial/other interest in the audited entity or program

Note: Circumstances creating structural threats may also create undue influence and/or mgmt participation threats.

1. Self-review threat

Ex: Auditor audits source documents she prepared

1. Bias threat

Ex: Auditor has political, idealogical or social convictions that could bias the audit

1. Familiarity threat

Ex: A close friend/family member is an official in the audited entity

1. Undue influence threat

Ex: External party threats undermine auditor’s objectivity

1. Management participation threat

Ex: Auditor takes management role in audited entity

1. Structural Threat

Ex: Threat resulting from AO’s placement within a government entity, in combination with structure of the entity being audited.

Question 35

How are structural threat reduced to acceptable level?

Answer 35

1. Constitional or statutory safegaurds may mitigate the effects of structural threats.
2. If the head of the AO meets any of the following criteria:
   
   • Directly elected by voters of the jurisdiction being audit
   • Elected or appointed by a legislative body and accountable to it
   • Appointed by someone other than a legislative body, but confirmed by and accountable to a legislative body
   • Appointed by and accountable to a statutorily created governing body. majority of whose members are independently elected or appointed are outside the organization being audited

If neither of the above applies, then statutes should do all of the following:

• Prevent audited entity from abolishing the AO
• Provide that if head of the Ao is removed, the head of the agency reports this to the legislative body
• Prevent audited entity from interfering with the initiation, scope, timing, and completion of any audit
• Prevent audited entity from interering with audit reporting, findings, conclusions or the manner, means, or timing of the AO’s reports.
• Require AO to report regularly to legislative body or other independent governing body
• Give AO sole authority over the selection, retention, advancement, and dismissal of its staff
• Guarantee access to records and documents related to the agency, program, or function being audited and access to the officials or others as needed to conduct the audit.

Question 36

What about the independence of an internal auditor?

Answer 36

If the head of the organization meets all of the following:

• Accountable to head of the government entity or to those charged with governance and
• Reports audit results both to the head of the government entity and to those charged w/ governance
• Locate organizationally outside the staff or line
• has access to those changed w/ governance
• Is sufficiently removed from political pressure to conduct audits and report findings

Question 37

What are the provisions to Non-audited services (NAS)?

Answer 37

Don’t perform mgmt functions

Ensure that the entiry to which you are providing NAS has the expertise to supervise, evaluate, and take responsibilty for those services.

Question 38

To est. independence, auditors should document:

Answer 38

• Threats to independence that require application of safeguards,
• If the audit organization is structually located within a government entity and considered independent based on safeguard
• Consider of audit entity mgmt ability to effectively oversee a NAS to be provided by the auditor
• The Auditor understanding w/ an audited entity for which auditor will perform a NAS.

Question 39

Who are close family members?