Be sure independence is not impaired


In the world of smaller private company financial reporting, it is not uncommon for management, or owner-managers of businesses, to engage practitioners to perform attest engagements and certain nonattest engagements as well.

one auditor

Attest engagements span a spectrum – from a high assurance engagement, an audit, to a limited assurance engagement, a review, and all the way to a nonassurance engagement, a compilation.

When clients engage practitioners to perform any level of attest engagement, practitioners need to consider whether their independence is impaired. Independence is a precondition for performing audits and reviews. A practitioner whose independence is considered impaired cannot perform these types of engagements.

There is no precondition related to being independent to compile financial statements. But both management of reporting entities and practitioners still need to understand whether independence has been impaired so they can properly modify compilation reports to clearly stipulate that fact.

Under the provisions of AICPA Code of Professional Conduct Interpretation 101-3, Performance of Nonattest Services, practitioners need to comply with all of the “general” requirements to maintain independence with respect to clients.

Essentially, it is important for management of reporting entities, as well as practitioners, to understand the services that can and cannot be performed in order for practitioners to maintain independence, when necessary, in advance of finalizing engagements that include both attest and nonattest services.

Within the general requirements in Interpretation 101-3, there are general activities that are considered to impair independence with respect to the client. Basically, these types of activities involve management functions or other types of functions that could have the impact of impairing practitioners’ independence so that only compilation engagements could be performed.

Even then, compilation reports would need to be modified to indicate a lack of independence and may disclose the reasons that independence is impaired. So, it is important for management to understand upfront that compilation reports would need to be modified and to be sure that the modification is acceptable to any third-party users of the statements, if applicable.

The general requirements include the following activities that impair independence:

  • Authorizing, executing or consummating a transaction, or otherwise exercising authority on behalf of a client or having the authority to do so
  • Preparing source documents, in electronic or other form, evidencing the occurrence of a transaction
  • Having custody of client assets
  • Supervising client employees in the performance of their normal recurring activities
  • Determining which recommendations made by practitioners should be implemented by clients
  • Reporting to the board of directors on behalf of management
  • Serving as a client’s stock transfer or escrow agent, registrar, general counsel or its equivalent
  • Establishing or maintaining internal controls, including performing ongoing monitoring activities for a client

The focus of discussions in these materials is on the last bullet point in the listing above.

It is very important for both management and practitioners to understand the internal controls applicable to a specific engagement in order to properly comply with Interpretation 101-3 requirements to maintain independence by staying away from establishing or maintaining internal control – including monitoring – for a client. Otherwise, compliance with these requirements would occur only by chance.

To help all stakeholders understand this particular issue, the Professional Ethics Executive Committee developed some questions and answers that address some of the more frequently encountered circumstances.

An example might help to illustrate:

Issue: A practitioner is engaged to perform an audit, review or compilation of financial statements. During the course of the attest engagement, the practitioner proposes adjustments to the financial statements.

Examples of these entries include the current tax accrual and deferred tax assets or liabilities and the amount of depreciation and amortization necessary for the current year. The client reviews these entries, understands the impact of the entries on the financial statements and records the adjustments identified by the practitioner.

Would proposal of these entries constitute a nonattest bookkeeping service subject to the provisions of Interpretation 101-3?

Resolution: Proposing entries as an integral part of the audit, review or compilation engagement is a normal part of those engagements and would not constitute performing a nonattest bookkeeping service subject to the provisions of Interpretation 101-3.

To properly comply with independence requirements when practitioners are performing attest engagements, it is important for all stakeholders to understand those requirements as well as understand what the guidance means. It is hoped that these materials will be helpful in understanding how internal control-related work impacts independence.