by Pamela W. Baker, CPA
Is
the Government Accounting Office (GAO) one step ahead of the SEC and
AICPA with its new standards regarding auditor independence?
It
is interesting to note, on the heels of the Enron debacle, that the GAO
has released the latest revision to Government Auditing Standards (the
Yellow Book), which revises the rules governing auditor independence.
More specifically, what must an auditor do or not do, when servicing
clients, to ensure that independence is not impaired?
In
reality, the GAO has been working for some time on revisions to the
independence standard. The revisions were issued January 25, 2002 and
apply to all Yellow Book audits for periods beginning on or after
October 1, 2002. The question for you is, "How does this affect our
organization and the relationship with our independent auditor?" In
order to answer that question, we need to explore the new requirements.
The
significant revisions to the independence standard address the issue of
non-audit services provided by independent auditors. In other words,
what services can your auditor perform which would not impair their
ability to render an opinion on the fair presentation of your financial
statements? Can your auditor reconcile bank accounts which have not
been reconciled for six months? Can they assist in preparation of
your financial statements and footnotes? Can they prepare routine
federal and state tax filings? To answer those questions, we must first
understand the revisions to the standard.
The revised standards adopt a principles-based approach to independence, whereby independent auditors must employ two overarching principles
when assessing whether they can provide service to an audit
organization. The first of those principles states, "Audit
organizations should not provide nonaudit services that involve
performing management functions or making management decisions."
Measuring one of the questions posed above against this principle would
lead us to conclude that your auditor could reconcile bank accounts for
the past six months, since that is not a typical management function
and would probably not necessitate management decisions. The second
principle states," Audit organizations should not audit their own work
or provide nonaudit services in situations where the nonaudit services
are significantly material to the subject matter of the audits."
Therefore, if the reconciled cash accounts are material to the
financial statements being audited, the auditor should not be
performing this function for the audited organization.
The
standard provides additional guidance in assisting the auditor and
management in determining when a nonaudit service can be performed
through the including of seven safeguards. Once the auditor determines
that the two overarching principles have been met, they then must
ensure that all seven of the safeguards are also in place.
The seven safeguards can be summarized as follows;
- The audit organization may not permit the same individuals who conduct the audit to perform the nonaudit service.
- The audit organization cannot reduce the scope of testing during the audit because of nonaudit services provided.
-
The audit organization must document that it has considered the two
overarching principles in determining its ability to provide the
nonaudit services.
- The documentation, along with the work
papers related to the non-audit service, must be included with any
audit engagement selected during the auditor organization's quality
review.
- The audit organization should document the exact
nature of the services to be provided and gain an understanding, in
writing, with management in order to ensure that both parties clearly
understand the responsibility of each, and the scope and limitations of
the services to be provided.
- The audit organization should
document the effect on the ongoing, planned and future audits when
deciding whether to perform the nonaudit service. This understanding
should be communicated to management in writing.
- In
instances where it is determined by the audit organization that
performing nonaudit services will impair its independence and
therefore, it will be unable to audit the subject matter of the
nonaudit service, that fact should be communicated to management in
writing before the nonaudit work is performed.
Using our bank
reconciliation example, the auditor would have to assess the nature of
the service and determine, once they have looked at the two overarching
principles, whether completing the nonaudit service would render them
unable to audit those bank reconciliations and, therefore, the cash
balances of the organization.
This would have to
be communicated to management, and they would have to agree to the
nonaudit service as well as to the nature and scope of the engagement.
The auditor would be required to have someone other than members of the
audit team perform the bank reconciliations. If the auditor had
determined that the performance of this nonaudit service would not
limit the ability to audit the work performed, the auditor could not,
as part of their audit engagement, perform less work than would
normally be performed had they not performed the nonaudit services.
One
other example is whether the auditor can prepare financial statements
and footnotes. Applying the two overarching principles, and provided
the auditor complies with the seven safeguards, the auditor can prepare
statements that are based on management's chart of accounts and trial
balances, and they are permitted to draft footnotes based on
information determined and approved by management. The key here, as in
several other examples of this new standard, is that the auditor not
become too closely associated with management decisions of their audit
clients. Providing training, insight and technical assistance in
understanding technical accounting pronouncements is a useful resource
of your auditor and is a permitted relationship. Relying on them to
perform nonaudit services relating to the interpretation of accounting
pronouncements is a relationship that must be looked at carefully. The
revisions to the independence standards will be key to evaluating these
relationships.
One final note with regard to nonaudit services,
which involves the single biggest accounting change in the history of
governmental reporting. These new standards will be in place by the
time that most governmental entities will be complying with the
Governmental Accounting Standards Board (GASB) Statement No. 34.
Therefore, before assuming that your auditor will be able to adjust
your books and records and make other decisions related to your
compliance with the new standard, make sure you discuss with them the
services they will be permitted to provide and the impact to your
independent audit.
