Independence standards--putting it all together.

Do you provide services for your audit, review or compilation clients that impair your independence? Separation of nonattest services from attest services no longer applies just to audit clients. All CPAs are subject to new rules following a major revision of AICPA Ethics Interpretation 101-3, Performance of Nonattest Services, which took effect Dec. 31, 2003. The new requirements do not apply to arrangements in existence Dec. 31, 2003 and completed by Dec. 31, 2004. Additionally, the revision includes a documentation requirement that is not effective until Dec. 31, 2004.

Again, CPAs who perform compilations, reviews, audits and other attest services need to be familiar with the revisions to Interpretation 101-3. This also applies to non-AICPA members since California Code of Regulations, Sec. 65, says that a licensee shall be independent in performance of services in accordance with professional standards. The AICPA Code of Professional Conduct, www.aicpa.org/about/code/index.html, dictates conduct in California even to those who are not AICPA members.

Avoiding making management decisions for a client remains the mainstay of this rule, but the recent changes help define and document the CPA's role in nonattest services so as not to impair independence. It is important to note that a CPA can still provide advice, research material and recommendations for clients.

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CHANGES IN INTERPRETATION 101-3

The client must agree to perform the following functions in connection with the engagement to perform nonattest services:

* Make all management decisions and perform all management functions;

* Designate a competent employee to oversee the services;

* Evaluate the adequacy and results of the services performed;

* Accept responsibility for the results of the services; and

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

The CPA must be satisfied that the client will be able to meet all of these criteria, otherwise independence is impaired. The designated employee could be the business owner. In fact, for some smaller clients, a bookkeeper may not be sufficiently knowledgeable and the business owner would be the best choice. An alternative for some CPA firms is to simply state they are not independent for all or part of their compilation practice.

Before beginning nonattest services, the CPA should establish and document the engagement's objectives; services to be performed; client's acceptance of its responsibilities; the CPA's responsibilities; and any limitations on the engagement.

Interpretation 101-3 should be consulted if you have any questions regarding general and specific nonattest services. There is a matrix that describes the impact on independence for the following services: bookkeeping; payroll and other disbursements; benefit plan administration; investment (advisory or management); corporate finance (consulting or advisory); executive or employee search; business risk consulting; and information systems (design, installation or integration).

The revision eliminated discussion of appraisal, valuation and actuarial services and significantly changed information systems services.

The following is from the AICPA auditing standards, but applies to all forms of attestation services:

"The profession has established, through the AICPA's Code of Professional Conduct, precepts to guard against the presumption of loss of independence. 'Presumption' is stressed because the possession of intrinsic independence is a matter of personal quality rather than of rules that formulate certain objective tests. Insofar as these precepts have been incorporated in the profession's code, they have the force of professional law for the independent auditor."

GOVERNMENT AUDITING STANDARDS

In addition to the AICPA Code of Professional Conduct, auditors who perform financial audits, attestation engagements or performance audits under Government Auditing Standards also must comply with the independence rules for these standards.

Generally, audits are performed under these standards if a governmental unit or nonprofit organization spends $500,000 or more in a year in federal awards. In addition, a grantor or state law can require an audit to be performed under these standards. For example, California law requires California redevelopment agencies to have audits under Government Auditing Standards, but there is no such requirement at this time for special districts.

Government Auditing Standards were revised in 2003 effective for financial statement audits for periods ending on or after Dec. 31, 2003. One of the main changes was the expansion of the independence rules regarding nonaudit services in Secs. 3.10-3.18, which primarily address auditors who do not perform management functions and do not provide nonaudit services where the amounts or services involved are material to the audit. The U.S. General Accounting Office has issued extensive guidance in the form of questions and answers at www.gao.gov/govaud/ybk01.htm. CalCPA's Governmental Accounting and Auditing Committee has summarized this Q&A below.

SARBANES-OXLEY

All firms for audit clients filing periodic reports with the SEC are subject to the new independence requirements in Sec. 201 of the Sarbanes-Oxley Act. Most of the prohibited services were already prohibited under the SEC rules.

What has been added to this mix are the lucrative financial information systems design and implementation, internal audit outsourcing and certain other expert services.

Sarbanes-Oxley lists nine service areas impacting independence: bookkeeping; financial information systems design and implementation; appraisal or valuation services; actuarial services; internal audit outsourcing services; management functions; investment services; legal or expert services not related to the audit; and any other service that the PCAOB determines is impermissible.

Accounting firms can engage in other nonaudit services, including tax services, provided that the audit committee pre-approves the services and that those services are disclosed to investors.

For more information, visit www.aicpa.org/sarbanes/index.asp.

RELATED ARTICLE: GAO Q&A

Independence Standards

The numbers below refer to questions in the Q&A

CAN PERFORM FOR AN AUDIT CLIENT:

* Provide year-end journal entries (if approved by client)--Questions 59, 53

Provide training, advice on accounting or internal controls--27

Provide GASB 34 training and advice--55

Review a department's internal controls as a performance audit or an agreed upon procedures engagement--14, 89, 63

* Prepare financial statements from client maintained G/L--46

* Convert cash to accrual basis--46, 53

Prepare depreciation schedules--49

Prepare other audit lead schedules based on client produced data--48

Prepare tax forms, HUD forms, data collection forms--57, 81, 83

Organizational studies as a performance audit--14, 89

Agreed upon procedure engagements--63

Forecasting program outcomes under various assumptions as a performance audit--87

Provide bookkeeping services for no longer than one month as a result of a rare and cataclysmic event (opinion must disclose this situation)--54

Third-party revenue audits--63

Prepare indirect cost studies or rate studies that are NOT material to the financial statements as a whole--64

Training for new accounting software--69, 72

Recommend two or more alternative software programs or analyze one as a performance audit--74

Serve on a human resources evaluation panel--92

CANNOT PERFORM FOR AN AUDIT CLIENT:

During the year, prepare journal entries or code transactions or post transactions--Questions 50, 51, 52

Reconstruct the accounting records--47, 59

Prepare bank reconciliations (determine outstanding checks, dep. in transit, etc.)--56--56

Approve entries or transactions or supervise employees--34

Compile infrastructure records or prepare MD&A--24, 55

Outsourcing the entire internal audit function--66

Estimate an actuarially-related liability--79

Initiate or prepare source documents such as payroll records or purchase orders--48

Prepare a client's budget or strategic plan--86, 90

Prepare indirect cost studies or rate studies that are material to the financial statements as a whole--64

Design or install accounting software--62, 68, 69, 73

Recommend one software program as the best for that client--74

Recommend a single individual or conduct a recruiting program--92

The GAO independence rules are effective for audits performed for periods ending on or after Dec. 31, 2003. They are only applicable to entities receiving federal funds or to audits where the auditor has agreed to perform the audit in accordance with generally accepted government auditing standards.

* For these services, management must knowledgeably and meaningfully approve any entries created by the auditor and the audit representation letter must acknowledge management's review, approval and responsibility for the financial statements and the accruals and adjustments reflected therein.

Performance Audit--an objective and systematic examination of evidence for the purpose of providing an independent assessment of the performance of a government activity or function to provide information to improve public accountability and facilitate decision-making.

BY LINDA McCRONE, CPA & ARTHUR KORN, CPA

Linda McCrone, CPA is CalCPA's director of technical services. You can reach her at [e-mail]. Arthur Korn, CPA is CalCPA's director of technical member services and the Audit and Accounting Answerline. You can reach him at [e-mail].