By Deby MacLeod, CPA
Having a good working relationship and receiving great client service – these are consistently the two most important criteria we hear from organizations when they’re selecting an auditor, and we do our best to fill those criteria when conducting an engagement. An important aspect to keep in mind is balance – how the auditor, as an “independent third party,” develops a good working relationship and provides great client service while maintaining independence.
Audits are important for many reasons. They may be required by state regulation or grantors. They may be considered by rating organizations whose reports are widely available on the internet and used by many donors. Organizations spending more than $500,000 in federal funding during a year are required to obtain an A-133 Single Audit in addition to a financial statement audit.
No matter what the incentive, the fundamental purpose of an external audit is to add credibility, by an independent third party, to the implied assertion that your financial statements fairly represent the organization’s financial position and activities at and for a period of time.
The Relationship Between the Client and Auditor
A client-auditor relationship based on mutual trust is essential in conducting a sound audit because audits are, by nature, an evaluation of the accounting work your team has done throughout the year. An organization must have confidence that its auditor understands your industry and operations, and that the auditor will cooperate productively with management to resolve any issues or disagreements that may arise during the audit.
Likewise, auditors realize that client management have deeper specific knowledge about their organization and depend on the wealth of detailed information obtained from management. The auditor cannot rely on this information without having some level of trust in the client.
An audit is a large investment in time and resources for most organizations; being able to count on great service and cooperation from your auditor is important. Conversely, great client service is built largely on reciprocal communication, cooperation, consistency of service and responsiveness. Management bringing certain issues to light well before the audit begins allows for the resolution of the issue and avoids surprises during the audit.
An auditor keeping its clients well informed of changes that may affect the organization allows ample time to plan for and implement the necessary changes. Cooperation and support are generally valuable only if they’re timely; therefore, responsiveness and accessibility to your auditor are hallmarks of good client service.
Recall that the primary purpose of an audit is to enhance the credibility of financial statements by providing reasonable assurance from an independent source that the financial statements are free of material misstatement. To that end, auditor independence is crucial, and this objective will not be met if the auditor is influenced by other parties, specifically those with a direct interest in the audited organization.
Maintaining Auditor Independence
There are many bodies of rules both outside and within the United States dealing with auditor independence. The primary sources in the U.S. include the following:
- American Institute of Certified Public Accountants (AICPA) – governs auditors who are members of the AICPA.
- Government Auditing Standards, known as the “Yellow Book” – applies to both financial and performance audits of governments and A-133 Single Audits.
- Department of Labor (DOL) – governs auditors performing audits of employee benefit plans.
- Securities and Exchange Commission as part of the Sarbanes-Oxley act (SEC) – governs auditors of publicly traded companies.
However, they all have similar overarching principles in that the independent auditor:
- Must be independent in both fact and appearance.
- Cannot make management decisions.
- Cannot have a financial interest in the audited organization.
- Must carry out the audit freely and in an objective manner.
Independence in fact means that the auditor must perform the attest services without being affected by influences that may compromise professional judgment, and must act with integrity, objectivity and professional skepticism.
Independence in appearance means the avoidance of circumstances that may cause a reasonable and uninformed third party to conclude the auditors’ integrity, objectivity or professional skepticism has been compromised.
However, all this does not mean that client service or trusted relationships must suffer. Your auditor is not “off limits” or unable to assist you in technical areas or best practices. Following is a summary of what you can reasonably expect your auditor to be able to do without impairing independence, activities that require safeguards and activities that are prohibited.
Routine Audit Services are Okay
Routine audit services pertain directly to the audit and generally involve providing advice or assistance to the organization on an informal basis or as part of the normal, ongoing professional relationship. Routine audit services are typically insignificant in terms of time incurred, and generally do not result in a specific project or engagement, or in producing a formal report or other formal work product. Examples of routine activities may include:
- Providing advice to the organization on technical or accounting issues or questions regarding tax laws.
- Providing information or advice on general or routine business matters.
- Providing information that is readily available to the auditor, such as best practices or benchmarking studies.
Non-Audit Services Requiring Safeguards But May Still be Okay
If the service is not “routine,” it may be a “non-audit” or “non-attest” service. In this case, the auditor must evaluate whether the activity threatens independence, and if it does, apply safeguards to reduce the risk to an acceptable level that meet these criteria:
- The auditor must not perform management functions or make management decisions for the client.
- The client must agree to perform the following functions in connection with the engagement to perform non-audit services:
- Make all management decisions and perform all management functions.
- Designate an individual who possesses suitable skill, knowledge and/or experience, preferably within senior management, to oversee the services.
- Evaluate the adequacy and results of the services performed.
- Accept responsibility for the results of the services.
- Establish and maintain internal controls, including monitoring ongoing activities.
If the risk to auditor independence cannot be reduced to an acceptable level, the activity should not be performed by the auditor.
Common non-attest services include the following and should only be performed if the safeguard criteria noted above can be achieved:
- Preparing financial statements based on information in the trial balance.
- Recording transactions, so long as they have been determined and/or approved by management, including account classification.
- Preparing cash-to-accrual entries to be approved by management.
- Preparing depreciation schedules or account reconciliations.
- Providing internal audit assistance services.
- Providing corporate finance services such as developing strategies or assisting in analyzing effects of proposed transactions.
- Performing enterprise risk management or business risk consulting.
- Consulting on information technology systems, installation and integration.
- Providing valuation services, if not material to the financial statements on the whole.
- Providing executive or employee search services.
- Providing certain employee benefit plan administration.
- Providing tax compliance services as long as the CPA does not have custody or control over the client’s funds.
Prohibited Services That Always Impair Auditor Independence
- Assuming management responsibilities.
- Making policy or strategy decisions on behalf of management.
- Taking responsibility for designing, implementing or monitoring internal controls.
- Authorizing payment of the audited entity’s funds.
- Having a financial interest in the audited entity.
Independence rules can be complex, and some are more restrictive than others depending on the authoritative regulatory bodies issuing them. However, independence rules are designed to ensure the integrity and credibility of the auditors’ opinion on your financial statements. Proactive, open communication with your auditor well before your audit begins will help resolve any independence questions and provide the best of both worlds – a high quality independent audit with great client service.
© Clark Nuber PS, 2013. All Rights Reserved