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  1. INDEPENDENCE • 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.”

  2. 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.”

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

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

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

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

  7. NEW RULES – “COVERED MEMBERS” • 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

  8. “COVERED MEMBER”(NOTES) • 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”

  9. Independence is impaired if, during the period of the professional engagement,a covered member: • 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)

  10. INDEPENDENCE IS IMPAIRED IF: • 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 actingtogether owned more than 5% of a client’s outstanding equity securities or other ownership interests

  11. BIG CHANGE IN RULES • 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

  12. INDEPENDENCE IS IMPAIRED IF: • 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): • Director, officer, employee, or member of management • Promoter, underwriter, or voting trustee • Trustee for any pension or profit-sharing trust of the client

  13. APPLICATION OF RULE 101 TO IMMEDIATE FAMILY MEMBERS • A covered member’s immediate family (spouse and dependents) is subject to Rule 101, with two minor exceptions: • Employed by client, not in “key position” • 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)

  14. APPLICATION OF RULE 101 TO CLOSE RELATIVES(siblings, parents, nondependent children) • 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: • A key position with the client • 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

  15. EXAMPLES OFFINANCIAL INTERESTS • Shares of stock • Mutual fund shares • Partnership units • Stock rights • Options or warrants • Puts, calls, or straddles

  16. WAYS TO EVIDENCEDIRECT FINANCIAL INTERESTS • Through shares of stock • Through a retirement plan (401(k), IRA, etc.) • Through an investment club • Through a partnership as a generalpartner • Through an estate as executor • Through a trust as trustee

  17. WAYS TO ACQUIREINDIRECT FINANCIAL INTERESTS • Through mutual funds • Through partnerships as a limited partner

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

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

  20. EXAMPLE • Suppose ABC Mutual Fund owns shares in a client, XYZ: • 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 is $1,000 ($50,000 x .02) • If $1,000 is material to your net worth, independence is impaired

  21. May I have an outside investment with a client or person associated with a client? • 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

  22. May I borrow money from, or loan money to, a client, or invest in a client’s bonds? • No: such actions would constitute impermissible loans to or from that client • Note: there are 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.)

  23. May I have a bank account with a client financial institution? • 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

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

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

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

  27. ACTIVITIES THAT IMPAIR INDEPENDENCE • 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

  28. What about performing bookkeeping services for a client? • Independence is not impaired if you: • 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

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

  30. What about commissions and contingent fees? • 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

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

  32. What about unpaid fees? • When a client owes your firm fees, and those fees have been outstanding for 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.