Preparation of Financial Statements and Independence

Your firm’s preparation of financial statements for an attest client may impair your independence. And, of course, you can’t perform audits or reviews if you are not independent.

When might your firm’s independence be impaired?

When a client does not have a person with suitable skill, knowledge, and/or experience (SKE) to review the financial statements (prepared by the auditor) and assume responsibility.

If the client can’t assume responsibility, the auditor is deemed to be attesting to his own work (the self-review threat).

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PEEC Adopts New Code of Conduct

As I recently posted, the AICPA Professional Ethics Executive Committee (PEEC) adopted a revised Code of Conduct that will be effective for engagements covering periods beginning on or after December 15, 2014. The new Code provides enhancements to independence standards, highlighting that preparation of financial statements is a nonattest service.

AICPA and GAO Independence Standards Converging

If you followed the changes to Yellow Book independence standards, this all sounds familiar. And it should. The AICPA and the GAO are intentionally moving in the same direction, which is a good thing–no need for competing standards.

A problem arises however.

Say your small business client does not have a person with sufficient education or experience to assume the responsibility for the financial statements, then what? You would no longer be independent and could not provide audit or review services.

Recently I received my Reviewer Focus newsletter from the AICPA (information provided to peer reviewers), and this letter plainly states that auditors must be “satisfied that management has agreed and can assume all management responsibilities.” This includes overseeing the preparation of financial statements. An engagement would be considered “nonconforming” if the auditor lacks independence (due to the client’s lack of requisite SKE). Clearly, the AICPA is placing more emphasis on clients being able to assume responsibility for their financial statements.

I believe this dynamic creates significant problems for small businesses when CPAs review or audit their financial statements. If the independence issue arises, it may be necessary to involve a second person or firm (another CPA or CPA firm). This second party would review the statements on behalf of the client, thus enabling the client to assume responsibility. (Yes, I know this increases the client’s cost–just saying.)

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To remain independent, you need to determine that the client has requisite skill, knowledge, and/or experience.

Documentation of Independence

Documentation of your independence is another issue, but a CPA’s lack of documentation does not–in and of itself–lead to an impairment of independence.

You’re familiar with the standard language that goes into most engagement letters with regard to performing nonattest services such as maintaining depreciation schedules or providing tax services. Well now you will add one more: preparation of financial statements. But remember this issue is more than just adding a few words to the engagement letter.

It’s about determining that the client has sufficient SKE.

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6 thoughts on “Preparation of Financial Statements and Independence

  1. Excellent document, thanks Charles. While I understand it creates a pressure on the very small client, I believe it would significantly enhance the auditor independence. We always hear of audit being expensive, but not enough about having reliable financial statements and related disclosures, with the auditor’s report. I think this is a good step forward.

  2. Armando, prior to the issuance of SSARS 19, there was talk of allowing CPAs to issue review reports without being independent, as we sometimes do with compilations. I think this would be a good compromise. Of course, with audits, you would never desire to have that option.

  3. What are the general accepted standards to evaluate the sufficient skill, knowledge and experience for client’ accountant? I have passed the Uniformed CPA exam and the Professional Ethical test and work for a small size company now. I hope I could be a licensed CPA to do more for my company and accounting field in the near future. Is any licensed CPA could give me some guidance to follow up? Thanks and appreciate all kind of information. Thanks Charles, I enjoyed so much reading all the articles posted by you.

  4. In my humble opinion, this is the right direction we need to go so we can improve the public confidence in our profession. I believe that CPA firms that perform attest engagements to an organization must be forbidden in performing non-attest services, including its related consulting or tax organization and even though they are separate organization but have the same name; because at the end, there will be the appearance that they are related.

    • Juan, no doubt that nonattest services can and does sometimes impair independence. This is what happened with Arthur Anderson. It is a difficult issue, especially when CPAs assist smaller clients: These small businesses often become dependent on the CPA for a multitude of services. Then when those clients need an attest product for a bank loan, there is an independence problem.