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| January 2005 | The
Monthly Newspaper of the NYSSCPA |
Vol.
8, No.1 |
Revised Ethics Interpretation 101-3 Kicks in Jan. 1
By Raymond M. Nowicki and Andrew M. Cohen
Continued from the Home Page
In reaction to the documentation requirements of this revised independence standard, effective Jan. 1, 2005, some firms have concluded that extreme measures are necessary to prevent an unplanned violation, including automatically stamping compilation reports with the phrase “We are not independent,” or eliminating compilations altogether from their services.
The AICPA Professional Ethics Executive Committee (PEEC) never intended these types of reactions to the interpretation. In fact, they discourage “automatic” or “check-the-box” solutions to fulfill the standard. In a Nov. 11, 2004, AICPA webcast on Revised Interpretation 101-3, PEEC Chairman Bruce Webb acknowledged that there are so many possible permutations of conditions that may cause a nonattest function to create an independence impairment that he was reluctant to offer a specific answer to a hypothetical situation for fear of misleading the viewers. Nonetheless, suggestions, especially pertaining to firms that primarily perform compilations and reviews, may help firms to successfully cross any 101-3 minefields and mitigate the risk of a modified peer review report.
The conceptual framework surrounding Revised Interpretation 101-3 consists of the need to recognize threats to independence, arising from the existence of an unacceptable relationship that might compromise professional judgment, and to follow safeguards, which can mitigate the threat. An example of an unacceptable relationship could be bookkeeping performed by a CPA for an attest or compilation client, and a safeguard would be systemic review, supervision and approval of the bookkeeping by the client.
Both the client and the CPA must take on certain responsibilities in order to avoid threats to independence. Of course, some independence impairments cannot be eliminated even when the client accepts his responsibilities, such as when the CPA has a financial interest in the client.
For those situations where a safeguard is available, the client must:
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Make all management decisions and perform all management functions;
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Designate a competent employee to oversee the nonattest service;
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Evaluate the adequacy and results of the nonattest service;
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Accept responsibility for the results of the nonattest service; and
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Establish and maintain internal controls, including monitoring ongoing activities related to the matter of the services.
In return, the CPA, prior to performance of the nonattest service, must:
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Be satisfied that the client will meet its responsibilities;
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Be satisfied that the client will be able to make an informed judgment, as described;
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Document in writing the understanding achieved with the client; and
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The document must be prepared before initiation of the nonattest engagement.
There is no requirement that the client sign off on the understanding.
One method to satisfy
the documentation requirement is the use of an internal memo, prepared
by the firm, as seen to the right.
Another approach would be to modify the firm’s engagement letters
with the client. Some firms add paragraphs to the engagement letters
as follows:
1. We will provide (list the nonattest service, such as) bookkeeping assistance and other accounting services as we find necessary to compile the financial statements. We will also discuss with you such suggestions and recommendations concerning your accounting methods, as may come to our attention.
2. You agree to be responsible for all management decisions and functions, and for designating a competent employee to oversee any bookkeeping, tax or other services we may provide. (It may be appropriate to list the name of the employee, if it is not otherwise evident.) You, or the designated employee, are responsible for evaluating the adequacy and results of the services performed. You are responsible for final acceptance of those services.
3. You are responsible for establishing and maintaining internal controls, including monitoring ongoing activities.
In both of the above proposed solutions, care must be exercised to update the forms for changes in the conditions of each engagement, including a change of the responsible employee, expansion of the services performed, or other material issues that may create a presumption of lack of independence.
Some firms have considered incorporating some of the above considerations into a representation letter. This approach is certainly “documentation,” but the representation letter is typically dated after the attest engagement is performed, which is likely to be too late to satisfy the standard. Both the thought process and documentation should be completed before the engagement begins. A representation letter, however, may only be useful to reaffirm the understanding with the client.
As your firm develops its own solution, you may want to ask for advice. The highest source of advice comes from a toll-free hotline offered by PEEC. Call 888-777-7077. Hit option 5 and then option 2. You also can visit the AICPA ethics website at http://www.aicpa.org/members/div/ethics/index.htm.
Peer reviewers can contact the AICPA ethics hotline at 800-841-5380. The NYSSCPA also maintains a source of help at 212-719-8300.
Revised Ethics Interpretation 101-3 contains nothing new in terms of substance, and many firms have successfully implemented formal and informal processes to assure their independence during attest and compilation engagements. Nonetheless, the revisions to Ethics Interpretation 101-3 now require documentation of the compliance with this standard. The approaches to documentation suggested above reflect current best practice in this area.
Raymond M. Nowicki, CPA, partner with Nowicki and Company LLP in Buffalo, is a member of the NYSSCPA’s board of directors. Andew M. Cohen, CPA, partner-in-charge of the Long Island practice of Weister LLP, also is a member of the Society’s board.
