Mind the GAAP 2

A Family Matter

Ruth, your supervisor, meets you to discuss an upcoming audit of Bastion Construction Co.

"Tad will be on the engagement team for the Bastion audit," she says. "You're lead for the team, so I just want you to be aware—Tad is the son-in-law of Millicent, Bastion's VP of Sales and Marketing. Tad isn't technically family in this situation, and I trust his reputation. Nonetheless, I wanted you to have the information now instead of finding out later."

You consider if Tad's involvement in the audit will pose a familiarity threat to the audit. Familiarity threats can exist if a long or close relationship with an attest client might result in sympathetic treatment toward that client.

No acceptable safeguard. Because Tad is related to a senior executive for Bastion, ask your supervisor to consider another engagement partner or you will refuse to participate in the audit.

Acceptable threat with existing safeguard. Even though a son-in-law is not considered either a family member or close relative under the Code, advising the lead of the appearance of a familiarity threat is a good safeguard to ensure independence.

Acceptable threat with new safeguard. In order to make sure that Tad has not been influenced by his relationship with the client, take the initiative and give Tad's work more scrutiny than that of any other of the team members.

Acceptable threat with existing safeguard. Even though a son-in-law is not considered either a family member or close relative under the Code, advising the lead of the appearance of a familiarity threat is a good safeguard to ensure independence.

Social Snafu

Juniper Heights Country Club has approached you to have your firm conduct an audit of their books, as required by their Board and by-laws. Upon investigation, you discover that one of your firm's managers is a member of the club and she has volunteered over the past two years to help the Country Club get their books set up and in good shape.

The conceptual framework requires that you identify and evaluate safeguards to independence. You know that a management participation threat to independence exists when a member of the firm has or may take on management responsibility for a client.

Acceptable threat with existing safeguard. Because the member is volunteering her services, the firm has sufficient safeguards in place to ensure independence.

Acceptable threat with new safeguard. If the firm adds the safeguard of ensuring that the member does not work on the audit team and thus would not be a covered member, the independence of the audit team would be assured.

No acceptable safeguard. Because a member of the firm is providing accounting services, no acceptable safeguard can be put in place to provide independence for the audit team.

No acceptable safeguard. Because a member of the firm is providing accounting services, no acceptable safeguard can be put in place to provide independence for the audit team.

Hire Stakes

Your firm is looking for a part-time independent contractor to help prepare tax returns for some of the firm's nonattest clients. The lead—and so far, only—candidate is Veronica Kahn, who happens to be an employee in the accounting department of Benevolent Insurance, one of the firm's clients.

The hiring manager contacts you, since you work with Benevolent, to ask your opinion. "Veronica's a perfect fit for this job," he tells you. "If we brought her on, she'd work in our West Coast offices—a completely separate location from you and the rest of the engagement team that works with Benevolent Insurance."

The first step in the conceptual framework is identifying whether or not a threat exists. The question in your mind is whether Veronica's simultaneous employment with your firm and Benevolent could present a conflict of interest due to an advocacy or familiarity threat to the firm's independence. She may be motivated to promote the client's interests to an unreasonable extent, either because helping Benevolent helps her or because her employment causes her to see them in a favorable light.

Significant threat. Because Veronica would simultaneously be an employee of the firm and in a key position in one of the firm's clients, her employment as a part-time contract employee is a threat.

No significant threat. Because Veronica is working as an independent contractor with you and in a part of your firm that doesn't provide services to her employer, her employment is not a threat to your independence.

No threat. Because Veronica does not hold a position on Benevolent Insurance's management team or a Board of Directors, she is able to provide part-time accounting services for the firm.

Significant threat. Because Veronica would simultaneously be an employee of the firm and in a key position in one of the firm's clients, her employment as a part-time contract employee is a threat.

Separation of Powers

Your CPA firm is performing an audit on NFW Bank, and you are the lead partner. During the audit, Richard, a manager in your firm, applied for and received a home mortgage from the bank. He works in your department, but he isn't part of the audit team and he doesn't perform any services for the bank. Even though Richard has no authority over any member of the team, some members of your team have raised questions about maintaining independence.

The first step in the conceptual framework is identifying whether or not a threat exists. The question your team raised is whether Richard's loan from NFW Bank may motivate him to protect the bank's interests to an unreasonable degree, creating a self-interest threat to the firm's independence.

Not a significant threat. Even if Richard is not involved in the audit, the appearance of a threat is strong enough that a third party would judge the firm's independence as impaired.

No threat. Because Richard is not a covered member under the Code, not involved in any work your firm is doing with NFW Bank, and can't influence the process, no threat is present.

Significant threat. Because Richard has a motive to influence you and your audit, the independence of the team is compromised.

No threat. Because Richard is not a covered member under the Code, not involved in any work your firm is doing with NFW Bank, and can't influence the process, no threat is present.

Taking Stock

Your firm's East Coast office has been asked to perform an audit of Ironclad Industrial Group, a manufacturing company. Three managers in the West Coast office have pooled their money to purchase stock in Ironclad. Each of the three managers owns 2% of the company's stock, but none of those managers are involved in the audit.

The first step of the conceptual framework is to identify threats. The question is whether the managers' stake in Ironclad may constitute advocacy or self-interest threats to their or the firm's independence as they seek to maximize their return on investment.

Significant threat. Because the managers pooled their money and, as a group, own more than 5% of the company's stock, safeguards to independence need to be considered.

No significant threat. Because no individual in the firm owns more than 5% of the company's stock, no-one has to consider any further safeguards to independence.

No threat. Because the managers work in a separate office and have no involvement in the audit, the stock ownership is not material.

Significant threat. Because the managers pooled their money and, as a group, own more than 5% of the company's stock, safeguards to independence need to be considered.

Vote of Confidence

A member of your firm, Alex, has accepted a position as campaign treasurer for Carol Vaughn, a mayoral candidate in your city. Now, Carol Vaughn's campaign manager has approached you to perform audit services. When you ask Alex about the matter, he dismisses the concern. "I wouldn't be working on the audit," he says. "Just keep your work separate from mine and we'll be fine."

As you reflect on Alex's answer, you find yourself evaluating the management participation threat to the firm's independence, given his involvement in managing the Vaughn campaign's finances.

No acceptable safeguard. Because you would be auditing your co-worker's work product, the threat cannot be reduced to an acceptable level.

Acceptable with existing safeguards. Because Alex is not going to be working on the audit, sufficient safeguards are in place to mitigate any threat to independence.

Acceptable with new safeguards. If you ensure that any questions about the audit are fielded by another member of the campaign in addition to Alex not being part of the audit team, the audit team will be able to maintain independence in this engagement.

No acceptable safeguard. Because you would be auditing your co-worker's work product, the threat cannot be reduced to an acceptable level.

Offering Advice

While performing an audit for Seva Regional Medical Center, a member of the engagement team, Alicia, receives a job offer. She excitedly shares the news with you, one of her co-workers.

"I've been offered a position in Seva's accounting department," she says. "I haven't accepted yet, and if I did, I wouldn't start for a few weeks—well after the audit is concluded. I don't know what I should do in the meantime. What do you think?"

Consider the possibility of an undue influence or self-interest threat—could the employment offer Alicia received cause her to act favorably toward the client?

No acceptable safeguard. "If you're considering the offer, you need to report it to our supervisor and stop working on the audit."

Acceptable threat with existing safeguards. "As long as you haven't accepted the offer, you're fine. You can work on the audit until you formally accept."

Acceptable threat with new safeguards. "Let Ruth know about the offer you received. She's the boss—she'll decide if you can keep working on the audit or not."

No acceptable safeguard. "If you're considering the offer, you need to report it to our supervisor and stop working on the audit."

Money in the Bank

Appalachia Bank and Trust has approached your firm requesting services. Your coworker Mark raises a potential concern.

"The firm maintains a primary checking account at Appalachia Bank and Trust," he says. "Many of the business expenses for our southern offices come out of that account. Can we take them on as a client given that relationship?"

As you consider the first step of the conceptual framework, whether or not a threat to your independence exists, you recall that a self-interest threat to independence appears when you or your firm stands to benefit, financially or otherwise, from an arrangement with a client.

No threat. You don't have to worry about your independence being threatened because the account is owned by the firm, not by an individual member of the firm.

No significant threat. Independence would not be threatened as long as the bank is in no realistic danger of experiencing financial difficulties.

Significant threat. Both the individual's and the firm's independence would be threatened, because the firm's account provides a motivation for members of the team to promote the bank's interests.

No significant threat. Independence would not be threatened as long as the bank is in no realistic danger of experiencing financial difficulties.

Quick Fix

While preparing a client's tax return, you notice an easily-corrected error. You call her to inform her of the necessary change. Before you can get into to any details, the client cuts you off.

"Look," she says. "I trust you, and I don't have the time to respond to every little issue. Just fix it." Before you can say more, she hangs up. Try as you might, you can't reach her again and the deadline to submit the return is fast approaching. You know the client will be upset if you file an extension or delay the return, so you consider simply making the change and submitting the corrected return to the client.

You know that a management participation threat can occur if you, as a member of the firm, take on management responsibilities for a client-for instance, making a change that would normally require the client's involvement. You wonder if you have sufficient safeguards in place to overcome the possible threat to your independence.

No acceptable safeguard. Because you are being asked to make a management decision about the client's tax return instead of them making the decision, you need to terminate the engagement to maintain your independence.

Acceptable threat with existing safeguard. Because the client will be reviewing the final return and signing it before submission, you are not making any inappropriate management decisions for her. No additional safeguards are needed.

Acceptable threat with new safeguard. Because the client does not know the detail of the change but has given a general go-ahead, you should send a confirming letter of the changes you are making to ensure that you are not making any inappropriate management decisions.

Acceptable threat with existing safeguard. Because the client will be reviewing the final return and signing it before submission, you are not making any inappropriate management decisions for her. No additional safeguards are needed.

The Delinquent

As you head to the break room, you hear two of your direct reports discussing a client.

"I can't believe he still hasn't paid!" Albert says. "How many times do we need to keep reminding this guy?"

"He's a deadbeat," Katya replies. "Four months late already. And just today he made another 'promise' to pay soon. But in the same message, he asked for some additional work from us."

"I'll put it on the list—why not? He might as well owe us more money. I know that we can go up to a year of delinquency before some sort of trigger gets pulled. But he's not going to be my priority," Albert says.

As Katya and Albert trade complaints, you find yourself wondering if their perspective poses an adverse interest threat to the firm's independence. If they are less inclined to provide services to the client because of their opinion of him, you wonder whether you need to consider safeguards to that implicit threat even when they agree to take on more work.

Acceptable threat with existing safeguard. Because the fees are less than a year past due, the existing policy of the firm to continue to take work for a client until the year threshold is met is a sufficient safeguard for this adverse interest threat.

No acceptable safeguard. Because your employees are clearly incapable of impartiality, you will direct them not to take any additional work from the client until his bill has been made current.

Acceptable threat with new safeguard. Because your colleagues' comments indicate that they might not do a professional job for the client, an additional safeguard might be needed to ensure they have independence of mind, if not independence in appearance.

Acceptable threat with new safeguard. Because your colleagues' comments indicate that they might not do a professional job for the client, an additional safeguard might be needed to ensure they have independence of mind, if not independence in appearance.

The More Things Change...

As a member of the firm's merger and acquisition team, you have been requested to create the financial reports for one of the firm's clients who is about to enter into a major deal. A few months ago, another member of your firm prepared financial statements for the client's Board as part of their end of the year review. Your client has suggested that you just include that statement in the new report in order to save money. You know that your colleague has a stellar reputation in the firm for very detailed and careful work. However, you have not independently reviewed the report.

As you consider including the previous report in the new document, you review your decision for a potential self-review threat to your independence. Self-review threats may occur when previously-made judgments or services are relied upon without proper evaluation.

Acceptable threat with new safeguard. To satisfy yourself that the information is accurate and pertinent, check the report to ensure nothing would need updating. If no changes are required, you can include the report with the original date.

Acceptable threat with existing safeguard. No additional safeguard is necessary because the report was created by a reputable colleague in your firm.

No acceptable safeguard. Because your did not use your independent judgment in the creation of the document, you should re-do the financial analysis and not use any of the information from your colleague.

Acceptable threat with new safeguard. To satisfy yourself that the information is accurate and pertinent, check the report to ensure nothing would need updating. If no changes are required, you can include the report with the original date.

Appraising the Threat

You are preparing financial statements for a client. To finish the financial statements, the client needs to provide you with an appraisal of the assets of the company. After making the request, the client sends you a message asking for help.

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Greetings,

I'm stumped. The last appraisals I had done were completed over a year ago by a member of your firm who helped me get a new round of financing complete. Can we use those? If they are too old, can you point me in the right direction so we can get the financial statements finished?

Thanks!

Kyla

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Before you reply to Kyla's request, you know you must keep alert for potential self-review or management participation threats to your independence. A self-review threat may arise if you rely on your own or your firm's previous judgments or services without proper evaluation. A management participation threat may present itself if you take on responsibilities that should be performed by the client.

Acceptable threat with existing safeguards. No safeguard is necessary because you are only providing materials and advice rather than performing the appraisal yourself.

Acceptable threat with new safeguard. You can't use the old appraisals because they were completed by a member of the firm. However, you can provide the client with names of appraisers outside the firm, or you can recommend templates not developed by the firm.

No acceptable safeguard. Request that the client have another member of the firm perform the appraisal services. Ensure that the member you recommend is not involved in the preparation of the client's financial statement.

Acceptable threat with new safeguard. You can't use the old appraisals because they were completed by a member of the firm. However, you can provide the client with names of appraisers outside the firm, or you can recommend templates not developed by the firm.

Windfall

You are the lead audit partner for an audit of TekInform, a large technology company. During the course of the audit, you receive an email from Patricia, one of your firm's managers, who performs tax services for TekInform but is not part of the audit team.

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Good afternoon,

As you're the lead on the TekInform audit, I wanted to let you know that my husband recently inherited some TekInform stock. Since you and I work in different offices, I don't anticipate a problem, but I wanted to give you a heads up.

Patricia

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As you read Patricia's email, you wonder if her husband's stock presents a self-interest threat to the firm's independence. Patricia's husband's stock ownership might give her a reason to promote TekInform's interests. You know that the first step of the conceptual framework is identifying whether or not a threat exists.

No significant threat. Because Patricia is diligent to not let the stock ownership influence her or anyone else in the firm, the threat is only a threat to independence in appearance, and therefore not significant.

Significant threat. Because Patricia's immediate family owns stock in a company for which she's performing tax services, the firm's independence may be compromised.

No threat. Because Patricia is not involved in the audit of TekInform, the independence of your team and the firm is not threatened.

Significant threat. Because Patricia's immediate family owns stock in a company for which she's performing tax services, the firm's independence may be compromised.

Audit or Oughtn't It?

Your firm is in conversation about performing an audit for G-BioSport, a sports medicine and biotech company. Larry, one of your firm's partners, owns 3% of G-BioSport and is being proposed as an advisor to the team.

Ruth, your supervisor, meets with you to discuss the audit. "I know Larry's ownership interest in the client is a concern, but I trust him implicitly and the team could use his expertise. He is an asset we should use—I'm confident that if we tell everyone that he is an advisor to the engagement team, he can keep his work compartmentalized."

Larry has proven very trustworthy, but you know to be wary of undue influence threats to independence. If members of the audit team subordinate Larry's judgment to their own, the integrity of the audit may be called into question.

No acceptable safeguard. In this situation, because of Larry's economic interest in the client, he should not perform any services for the client nor take on any positions where he could influence the engagement team.

Acceptable threat with existing safeguard. If Larry is an advisor to the engagement team but doesn't perform any services for the client, the safeguard the firm has already put in place should be sufficient to mitigate the threat to independence.

Acceptable threat with new safeguard. If you disclose Larry's interest to the engagement team and remind Larry of his duty to be independent, that notice should provide a sufficient safeguard to overcome any threat of partiality.

No acceptable safeguard. In this situation, because of Larry's economic interest in the client, he should not perform any services for the client nor take on any positions where he could influence the engagement team.

Legal Power

One of your firm's clients, Terebro Energy Co., is involved in a legal battle. They have sought representation from Holsinger & Associates, a law office that is also an attest client of your firm. Holsinger & Associates has requested that your firm perform forensic accounting services to prepare Terebro's defense.

You consider the possibility of an undue influence threat to your firm's independence, which would occur if your firm's judgment were subordinated by or influenced by someone from Holsinger & Associates.

Acceptable threat with new safeguard. As long as you ensure that your forensic accounting services for the law firm remain completely separate from your services for the energy company and from your attest services for the law firm, the threat to independence will be acceptable.

No acceptable safeguard. Because you are already providing accounting and attest services for the two parties, no safeguard short of terminating your engagement with one of the two clients could reduce the threat to independence to an acceptable level.

Acceptable threat with existing safeguard. With just the knowledge of the existing relationships, you can perform forensic accounting services for Terebro without impacting your existing client relationship with Holsinger & Associates.

Acceptable threat with new safeguard. As long as you ensure that your forensic accounting services for the law firm remain completely separate from your services for the energy company and from your attest services for the law firm, the threat to independence will be acceptable.

Following Suit

You overhear a heated exchange between your coworker, Benicio, and one of his clients. The discussion ends with the client saying, "I've had enough! I intend to sue you! I'll sue your whole firm if necessary!" before storming off.

"He's all talk," Benicio says to you after the client leaves. "He's annoying, but I'm sure he doesn't really intend to sue us. I've still got to finish preparing his financial statements. I'm sure he'll forget it all by tomorrow."

As you haven't worked with the client, you can't be sure of the seriousness of his claim, but you do know to look out for adverse interest threats. An adverse interest threat can exist when a member of the firm and a client have opposing interests that might threaten the member's objectivity.

No acceptable safeguard. "He announced the intent to start litigation. You don't know whether he'll follow through or not, but you have to assume the worst. You have to end the engagement now."

Acceptable threat with existing safeguard. "He sounds like a piece of work. But you know him better than I do. So if you say he's not serious about suing you, I don't see a problem."

Acceptable threat with new safeguard. "You might want to hand off the work to someone else in the firm. Sounds like the client might have it out for you—maybe he'll be pacified if someone else is working with him.

No acceptable safeguard. "He announced the intent to start litigation. You don't know whether he'll follow through or not, but you have to assume the worst. You have to end the engagement now."

Honest Work

During your lunch break, you notice Benicio, one of your coworkers, chatting excitedly with anyone who will listen. "My son just got his first job!" he says. "Out of 20 applicants, he was chosen to be an inventory clerk for the summer, working at K&V Hardware. I hope his younger brother is taking notes...." As Benicio continues beaming, you stop to consider. You know that K&V Hardware is one of the firm's clients, and Benicio works closely with the lead engagement partner.

Benicio's son's job could impose a familiarity threat to either the firm's or Benicio's independence—a relationship that could make someone more sympathetic to the client.

Not a significant threat. Because the son does not hold a key position for the client, the threat would not be significant.

No threat. Benicio is not part of the engagement team, therefore threats to his independence are not material.

Significant threat. Any employment of an immediate family member of anyone in the firm by a client of the firm creates a significant threat to independence.

Not a significant threat. Because the son does not hold a key position for the client, the threat would not be significant.

The Best-Laid Plans

One of your clients is SM Wellness Network, a nationwide health plan. Michelle, who is on the engagement team for SMWN with you, comes to ask your advice.

"I just found out," she says, "that after the last enrollment period my husband is now covered by SMWN as part of his job. Everyone in his company is, in fact. He's not involved in their management or their Board or anything, but I'm not sure I can be considered independent. If I can't remain on the team, I understand."

As part of your reflection on identifying and evaluating safeguards, you try to remember what you know about self-interest threats to independence and to determine whether Michelle's husband's participation in the health plan would create such a threat.

Acceptable threat with existing safeguard. "You said all your husband's coworkers are also on the plan, right? And he's not in a position of governance with the plan, so you can remain independent."

No acceptable safeguard. "Thanks for telling me. Unfortunately, I have to consider these circumstances a severe threat to your independence, as helping the client would be helping your husband's wellbeing."

Acceptable threat with new safeguard. "I trust you, but we have to consider how an outside observer would see the situation. The threat isn't severe; however, I think a third party would be concerned, so we should minimize your involvement."

Acceptable threat with existing safeguard. "You said all your husband's coworkers are also on the plan, right? And he's not in a position of governance with the plan, so you can remain independent."