Insights from PCAOB Inspection Reports: Wrestling with Independence
insights-from-pcaob-inspection-reports-wrestling-with-independence

Insights from PCAOB Inspection Reports: Wrestling with Independence

PCAOB inspection reports continue to highlight issues involving auditor independence, as noted in a recent PCAOB staff inspection brief previewing the results of 2015 inspections of broker and dealer auditors. On the positive side, PCAOB inspectors observed fewer independence impairments of auditors of broker-dealers than in prior years. However, inspectors did continue to observe situations where auditors were involved in the preparation of the financial statement or accounting records of their audit clients.

Let’s walk through the applicable independence rules so, hopefully, this issue won’t show up in your PCAOB inspection report!

images/user-uploads/Judge Gavel.jpg

Overview of Independence Rules

According to the AICPA Plain English Guide to Independence, independence is defined as follows:

  • Independence of Mind – State of mind that permits a member to perform 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 in Appearance – Avoidance of circumstances that would cause a reasonable and informed third party, who has knowledge of all relevant information, including safeguards applied, to reasonably conclude that the integrity, objectivity, or professional skepticism of a firm or member of the attest engagement team is compromised.

PCAOB Rule 3520 states auditors must be independent of their audit clients throughout the audit and professional engagement period. It also states that auditors have an obligation to satisfy all other independence criteria applicable to the engagement, including the independence criteria set out in the rules and regulations of the SEC under the federal securities laws.

The SEC regulates registrants and issuers, as well as establishes the qualifications of independent auditors. In addition to its detailed rules, the SEC looks to its general standard of independence and four basic principles to determine whether independence is impaired. Under these principles, an auditor cannot:

  1. Function in the role of management;
  2. Audit his/her own work;
  3. Serve in an advocacy role for the client; or
  4. Have a mutual or conflicting role with the client.

An auditor is not independent of its clients if the auditor:

  • Maintains or prepares the client’s accounting records,
  • Prepares the client’s financial statements that are filed with the SEC, or
  • Prepares or originates source data underlying the client’s financial statements.

Let’s look at an example that is at the root of the PCAOB inspection findings.

images/user-uploads/PCAOB_DSC_7425.jpg

Practical Example

Eddie Haskell is the manager on the audit of Beaver Financial, a small non-issuer, introducing broker-dealer. Eddie will do whatever it takes to make his clients happy and has agreed to help Beaver draft their financial statements, including proper footnote disclosures. Beaver has no idea what they are doing when it comes to financial reporting and, let’s be honest, Eddie would have to redo them anyway. Eddie makes sure Beaver reviews the financial statements after he drafts them to ensure they take ownership of the final product given that they are ultimately management’s responsibility.

Question: Do you have any concerns with the work performed by Eddie?

Answer: Yes. While independence standards generally allow an auditor to perform non-audit services for an audit client, certain non-audit services may impair independence, and an auditor has a professional responsibility to evaluate the effect that such services may have on his, her, or the firm’s independence.

The independence rules of the Securities and Exchange Commission (SEC) have for overarching principles regarding prohibited work:

  • Having a mutuality of interest with an audit client
  • Auditing one’s own work
  • Acting as management of an audit client
  • Acting as an advocate for an audit client

Generally, the SEC considers independence impaired if the following bookkeeping or other services are performed (Rule 2-01 (c)(4)(i) of SEC Regulation S-X):

  • Maintain or prepare an audit client’s accounting records;
  • Prepare an audit client’s financial statements that are filed with the SEC or form the basis of financial statements filed with the SEC; or
  • Prepare or originate source data underlying an audit client’s financial statements.

Based on the scenario above, it appears Eddie is performing a prohibited service and is also auditing one’s own work and, therefore, independence is impaired.

images/user-uploads/pcaob_DSC_7033.jpg

Final Thoughts

Regulators take compliance with independence rules very seriously. The PCAOB has issued settled orders imposing disciplinary sanctions against 22 audit firms for independence violations when auditing brokers and dealers. In one case they permanently revoked the firm’s PCAOB registration and permanently barred the accountant from associating with a registered public accounting firm. Yikes!

The SEC also routinely sanctions audit firms for violating independence rules, like when it sanctioned eight firms that prepared financial statements of brokerage firms that were their audit clients. “To ensure the integrity of our financial reporting system, firms cannot play the roles of auditor and preparer at the same time,” said Stephen L. Cohen, Associate Director of the SEC’s Division of Enforcement. “Auditors must vigilantly safeguard their independence and stay current on the applicable requirements under the rules.”

We couldn’t have said it better ourselves!

We encourage you to seek out the many resources dealing with independence published by the AICPA, PCAOB, SEC, and others. One such resource we find helpful is the AICPA Plain English Guide to Independence released on March 1, 2015.

We also recommend that you refresh your professionals’ knowledge of the independence requirements by including this topic in your annual Accounting & Auditing Update training.

 
PCAOB Inspection

Comments (0)


Add a Comment




Allowed tags: <b><i><br>Add a new comment:


Ready To Make a Change?

Cookies on the GAAP Dynamics website

To give you the best possible experience, this website uses cookies. By continuing to browse this website you are agreeing to our use of cookies. For more details about cookies and how to manage them, please see our privacy policy.