Case study: ethical considerations when auditing a small business.

Are you confident what bookkeeping services may or may not be provided when auditing a private company? Through this case study, The Ohio Society illustrates the tricky questions, and more importantly, the correct ethical response in such situations. *

ZAP Cleaners

Betty Brown, CPA * is a sole practitioner who maintains monthly general ledgers and prepares annual tax returns for a number of small business clients. Betty's largest client, ZAP Cleaners, requests that she conduct an audit that will be required by ZAP's bank to renew financing. ZAP is not a publicly traded company, and does not receive government funding.

Q: Can Betty conduct an audit for ZAP if she is also providing bookkeeping services?

A: Possibly. In late 2001, the AICPA Professional Ethics Executive Committee reexamined Interpretation 101-3 of the code of professional conduct, Performance of Other Services. In March 2003, the committee issued an exposure draft with proposed revisions to Interpretation 101-3 to ensure the standard's continued effectiveness when a member provides non-attest services for an attest client. While some engagements may be subject to the more restrictive independence rules of other authoritative bodies, such as the SEC or GA0, the AICPA rules apply to most other attest engagements, including private companies not receiving government funding in Ohio, such as the ZAP audit. Non-attest services examined in the draft included bookkeeping; internal audit; appraisal, valuation and actuarial services; and financial information systems design and implementation.

The final revised Interpretation 101-3 was published in the September 2003 Journal of Accountancy According to the revised rule, members may still provide certain non-attest services for attest clients, provided that the member does not perform management functions or make management decisions for the attest client. The Interpretation also defines services that would and would not impair independence in each of the areas examined.

Q: If so, what conditions must be in place for Betty to be independent with respect to this client?

A: For bookkeeping services, independence would be impaired if Betty does any of the following:

** Determine or change journal entries, account codings or classification for transactions without obtaining client approval.

** Authorize or approve transactions.

** Prepare source documents, or make changes in source documents without client approval.

Betty's independence would not be impaired by doing the following:

** Recording transactions for which account classification has been approved by management.

** Preparing financial statements based on information in the trial balance.

** Proposing adjusting entries, provided that the client reviews the entries and the member is satisfied that management understands the nature of the proposed entries and the impact the entries have on the financial statements.

Q: What actions must Betty take with the client prior to conducting this engagement?

A: The revised Interpretation requires that an understanding he established with the client in writing regarding:

** Objectives of the engagement.

** Services to be performed.

** Client's acceptance of its responsibilities.

** Member's responsibilities.

** Any limitations of the engagement.

The client must agree to perform the following functions in connection with the engagement for the member to provide non-attest services:

** Make all management decisions and perform all management functions.

** Designate a competent employee, preferably within senior management, to oversee the services.

** Evaluate the adequacy and results of the services performed.

** Accept responsibility for the results of the services.

** Establish and maintain internal controls, including monitoring ongoing activities.

The revised Interpretation requires that members evaluate the ability of the client's designated employee to understand the services to be performed in order to oversee them and accept responsibility. In a case where the individual does not have the necessary competence, independence would be impaired by providing the non-attest service.

Q: What other considerations may Betty have prior to accepting an audit engagement, if she previously did not provide audit services?

A: If Betty previously did not provide attestation services, she would need to report to the Accountancy Board of Ohio (AB0) within 90 days that she is now providing services subject to peer review. As the administering entity of the Board for peer review, The Ohio Society of CPAs would need to be notified to schedule Betty for peer review within the next 18 months. Betty should also be mindful of Rule of Conduct 201, general standards, and its requirement for professional competence--that a member undertake only those professional services that she can reasonably expect to complete with professional competence.

Q: Would any of the above answers change if ZAP had requested a review or compilation report?

A: No, with the exception that a compilation curl be performed if Betty is not independent, as long as her lack of independence is disclosed in the report. Betty will still be required to participate in peer review if she accepts the engagement.

** All specific names used in article are fictitious.

** A key objective of The Ohio Society of CPAs is to promote and maintain high professional standards of practice by its members. In accordance with this objective, the bylaws of the Society include as a requirement of membership adherence to a Code of Professional Conduct. The Ohio Society participates with the AICPA in a Joint Ethics Enforcement Program, whereby complaints regarding members are received and investigated to determine whether a member may have departed from these criteria for membership, and whether remedial or corrective actions are necessary. In addition, Ohio Society staff responds to member inquiries regarding rules of conduct which are requirements of membership. This article represents the responses of Society staff to frequently encountered member concerns regarding the Code of Professional Conduct. Note that these responses are not official pronouncements or positions of the Professional Ethics Committee of The Ohio Society of CPAs, nor do they address the requirements of other regulatory bodies, such as the Accountancy Board of Ohio or the SEC, whose positions may differ from The Ohio Society's.

For more information:

See "New and Revised Ethics Rules" at: http://www.aicpa.org/download/ethics/interp_revisionsjun03.pdf

A "Basis for Conclusions" paper on revised independence interpretations for nonattest services will soon be available at: http://www.aicpa.org/members/div/ethics/index/bfcl.htm

Laura Hay, CPA is vice president, finance and technical services for The Ohio Society of CPAs. She can be reached at [e-mail], or 800.686.2727, ext 322.