I attended a PPC seminar in September 2007 on implementing the then new auditing standards. One of the highlights for me was a session led by, if my memory is correct, Harold Monk, the chair of the Auditing Standards Board. The part that really stuck with me was when he said something to like the following:
<i>Our goal is that every company that has an audit of their financial statements will use two CPA Firms - one to help them with their year-end close, and the second to do the independent audit.</i>
I understand their logic. I just don't agree with it. Did they think about asking the ultimate purchasers of an audit, namely the business entities, if they wanted this?
We do a lot of audits - primarily SEC audits but also a good number of audits of privately held entities. I can assure you the privately held companies were not overly excited to hear this. To their minds, two CPA Firms =a needless increase in fees.
I can't argue with them. Prior to these changes in the standards, one firm could generally help with the closing and drafting the financial statements, including the notes. Let's be realistic - there aren't many small businesses that can do this themselves. They may have a very good controller with a good knowledge of GAAP, but maybe they left public accounting and don't want to stay on top of the continuing changes in accounting standards (another sore point with me but that can wait for another day). So the auditor did the adjustments on some complex accounts and drafted the statements and notes.
The Auditing Standards Board decides this can't continue. Again, I understand their logic - the auditor shouldn't be a part of an entities system of internal controls.
But it just isn't likely that two CPA firms will do this for the same amount of fees. And how does this help the business entity? I still just don't get it.
There are times an audit client will ask us to adjust something like deferred taxes for them. We have to tell them to try and do so themselves. Then we audit it and fix it. This is just plain inefficient for the audit client. They waste time doing something they can't do. We have to post an adjustment that says something like "To correct error in deferred taxes" where in the past we'd have said something like "To adjust deferred taxes to actual." Do you think the client likes seeing "To correct error"? I can assure you some get irritated and don't like hearing "that is what the standards require."
All of these standards lead to a tremendous amount of checklists that need to be prepared. I have a small franchisor that I audit. It literally takes me under 30 minutes to test 100% of the transactions. The required checklists - at least 6 hours. This doesn't make sense.
I'm hoping some sanity comes in this area. Of course, if and when it does, I'm going to have to redo all of my audit documentation once again.
It just doesn't end, does it?
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thereby
Assumption 2: Management decisions are made when an auditor makes changes to financial statements.
Assumption 3: Your client is not able to take responsibility for those management decisions.
Conclusion: Therefore you're independence is impaired.
By this standard independence is impossible unless the auditor is not allowed to make changes. And this is true no matter who prepares the statement originally.
But my original point was that the major thing that impairs independence is something that would cause bias in the auditor. Preparing statements does not do that in any significant way whether or not you also audit them. Having a vested interest causes bias. A monetary interest is one of the strongest. Ignoring that and playing with minor points is, as they say in the Middle East, straining at gnats and swallowing camels.
Assumption 4 = Assumption 2
Yes, exactly Assumption 4 = Assumption 2.
and so on
Assumption 4: Management decisions are made when an auditor makes changes to financial statements.
Logical breakdown of independence impairment
Assumption 1: Independence is impaired if you make management decisions that the client's management can not take responsibility for.
Assumption 2: Management decisions are made when you prepare financial statements.
Assumption 3: Your client is not able to take responsibility for those management decisions.
Conclusion: Therefore you're independence is impaired.
Assumption 1 I believe goes without saying but is specifically stated in section 5 of interpretations under rule 101. Assumption 2 is true if in preparing the financial statements you are making decisions such as how the underlying accounts are classified, what significant accounting policies are used in presenting the financial statements, what footnote disclosures to include, how many periods to present, whether to combine the statement of changes in equity with the income statement or present separately, and so on. Assumption 3 holds if the clients in question are not versed in GAAP financial reporting which is what this whole converstation is geared towards.
independence
You're defining independence as not performing certain functions. That doesn't tell me why performing those functions lessens independence. Specifically, how does creating statements from raw data lessen your independence to audit said data?
Improving Independence
Independence improves because the first firm can lack independence and perform the year-end close including compiling the financials. That allows them to take responsibility for what the audit client is unable to, while the second firm can be truly independent with respect to the engagement. This is rule 101-3 at its heart. The client has to be able to assign someone who is competent to oversee, evaluate and take responsibility for any non-attest services (like preparing financial statements and proposing JEs) performed in order for the auditors to maintain their independence. If there is not someone competent to oversee those services then the client needs to contract with a separate firm/contractor/whoever that can fill that role.
independence
This is about one accountant taking the data and producing statements without auditing and then another accountant doing the audit and almost certainly changing the statements as a result. I don't see how that improves independence since the first accountant didn't audit. Or are you talking about auditing twice? That would certainly increase independence, but would only be useful in the very small number of cases where the first audit had significant problems. How would either of these approaches improve your client's understanding of the adjustments you made?
Definition of Independence
Whoa now! "Not that a second pair of eyes isn't useful, but it has nothing to do with independence."?! Isn't a second set of eyes a fundamental part of independence? I hope this isn't some misguided attempt to lay claim to 'management taking responsibility for the services we perform' . If I am making adjustments to the clients books and they don't understand them (to my point about clients who don't take on qualified staff) then I am not independent. I can't audit my own work (and neither can you and still make claims to be independent).
independence
If preparation of financial statements by an auditor reduces their independence, then getting a paycheck from the client must remove it entirely. What if the auditor changes the statements to suit the client? Do we need someone to check him? A person either observes ethical conduct or they don't and this little fix won't improve that. Not that a second pair of eyes isn't useful, but it has nothing to do with independence.
Chair's comment was dead on
The fact that most SMBs can't internally draft GAAP financials doesn't mean that they should get a pass and that their auditors should risk losing independence in assisting them. There are plenty of SMBs who hire competent accounting personnel to internally draft GAAP financials and incur the associated expense of doing so. Why should another business simply ignore this cost business and expect their auditors to absorb it. The Chair in his comment and the ASB on establishing the standard were dead on with this one. As a profession we should have done this voluntarily years ago, which may have helped stave off both the decreased perceived value of our services as well as some of the poor quality audits conducted by so called independent firms.