FAQs About Revised Ethics Interpretation 101-3

FAQs About Revised Ethics Interpretation 101-3

By Raymond M. Nowicki and Andrew M. Cohen

Question: For what attest services would independence be impaired by a violation of Interpretation 101-3?
Answer: Any CPA service requiring independence would be impaired by a violation of Interpretation 101-3. Generally, such services include engagements performed under Statements on Auditing Standards (SASs), Statements on Standards for Attestation Engagements (SSAEs) and Statements on Standards for Accounting and Review Services (SSARSs).

Question: Can a sole proprietor of a small business be “competent” in the context of Interpretation 101-3?
Answer: Most small business owners know the complete picture of their own businesses’ operations and financial condition as well as anyone. They also understand the nonattest services they might require from a CPA and what those services are meant to accomplish. As business owners, they routinely make important decisions about their businesses and the quality of services provided by a number of independent contractors, including their CPA. Interpretation 101-3 leaves the determination of competence to the CPA, who must document this assessment as discussed in our previous article, but most small business owners generally are able to understand the nonattest services a CPA might perform, to take responsibility for decision making, and to determine whether the CPA performs according to specifications.

Question: Is it necessary that a “competent” client employee possess the same technical expertise as a CPA performing a nonattest service?
Answer: Interpretation 101-3 does not require that the client have an employee with the same technical expertise as the CPA. Nor does it require that the client’s “competent” employee be able to reperform the service in order to determine that it has been done appropriately. Interpretation 101-3 does require that the client employee designated to oversee the nonattest service have suitable skills, knowledge or experience to understand the nature, objective and scope of the service and take responsibility for all significant judgments, for evaluating whether the results are adequate, and for ensuring that the service satisfies the specifications of the agreement between the client and the CPA.

Question: What criteria should be used to determine the competence of the client’s designated employee to oversee the nonattest service?
Answer: CPAs might consider indicators of skill, knowledge or experience such as the employee’s understanding of the nature of the service, knowledge of the client’s business and industry, general business knowledge, education and position. The nature of the nonattest service could affect the weight given the indicators. Many employees’ competence to oversee nonattest services may be reflected in their position in the business. Knowledge of the business and industry as reflected by the employee’s position at the client, coupled with the ability to understand the nature of the nonattest service, can often be an indicator of competence. It is not necessary that the designated employee have formal education in the nonattest service area to be competent.

Question: Can another consultant who is not an employee oversee the CPA’s performance of a nonattest service?
Answer: A client may contract with a third party to oversee the CPA or to advise on the CPA’s performance. Such outside consultants may serve in the role of the competent client employee if they possess the necessary skill, knowledge or experience; have the authority from the client to make decisions and evaluations; and function in a similar capacity as an employee.

Question: What level of competence is required to oversee bookkeeping services?
Answer: When CPAs perform routine bookkeeping services for audit, review or compilation clients, the designated competent employee should understand why journal entries are proposed and their effect on the financial statements. The client may already understand some recurring journal entries, such as depreciation, because of previous explanations. On the other hand, the CPA may have to explain the reason and basis for nonrecurring journal entries, or very complex journal entries, and their effects on the financial statements, such as for deferred taxes, inventory or derivatives. In all cases, the client should be able to approve the proposed journal entries and take responsibility for the financial statements.

Question: Must the client understand the tax law in order to be “competent”?
Answer: The client does not have to understand all the tax laws to satisfy Interpretation 101-3’s requirements for tax return preparation engagements. The CPA should review the tax return with the client, emphasizing the important tax positions taken, and be satisfied that the client understands the company’s tax situation, understands generally how the amounts on the return were determined, and makes all decisions about significant tax positions.

Question: Are business advice and responses to technical questions required to be documented?
Answer: Interpretation 101-3 covers non-attest engagements, generally bookkeeping, tax-preparation and consulting engagements. Routine business advice and responding to technical questions are normal parts of a CPA’s relationship with attest clients in the performance of their attest engagements and would not need to be separately documented.

Raymond M. Nowicki, CPA, partner with Nowicki and Company LLP in Buffalo, is a member of the NYSSCPA’s board of directors. Andrew M. Cohen, CPA, partner-in-charge of the Long Island practice of Weiser LLP, also is a member of the Society’s board.

Editor’s Note: The authors have received a number of questions about aspects of AICPA Ethics Interpretation 101-3 (Revised) since writing their article “Revised Ethics Interpretation 101-3 Kicks in Jan. 1,” which appeared in the January 2005 Trusted Professional. The questions asked most frequently and the authors’ responses appear below.