CPA Exam AUD: AICPA Independence Rules and Requirements

AICPA Independence Rules: What CPA Candidates Need to Know

Independence is the cornerstone of the auditing profession. The AICPA Code of Professional Conduct requires that members in public practice be independent in fact and in appearance when performing attest engagements, including audits, reviews, and certain other attestation services. Independence rules are heavily tested on the AUD exam under the broader topic of professional responsibilities.

Independence in Fact vs. Independence in Appearance

Independence in fact is an unbiased mental attitude that allows the auditor to act with integrity and exercise objectivity and professional skepticism. Independence in appearance means avoiding circumstances that would cause a reasonable and informed third party, having knowledge of all relevant information, to reasonably conclude that the auditor's integrity, objectivity, or professional skepticism has been compromised. Both forms of independence are required; impairment of either is a violation.

The Conceptual Framework Approach

The AICPA Code of Professional Conduct uses a conceptual framework approach to independence. Under this framework, the auditor identifies threats to independence, evaluates the significance of those threats, and applies safeguards to eliminate or reduce threats to an acceptable level. If no safeguards can adequately address the threat, the engagement cannot be accepted or must be terminated.

Categories of Threats

The AICPA identifies seven categories of threats to independence:

• Self-review threat: The threat that a member will not appropriately evaluate results of a previous judgment or service performed by the member and that the member will rely on that service in forming a judgment as part of an attest engagement.
• Advocacy threat: The threat that a member will promote a client's interests to the point that objectivity is compromised.
• Adverse interest threat: The threat that the member will not act with objectivity because the member's interests are in opposition to the client's interests.
• Familiarity threat: The threat that the member will be too sympathetic to client interests or too accepting of the client's work because of a close or longstanding relationship.
• Undue influence threat: The threat that a member will subordinate judgment to that of the client because of the client's reputation, personality, position, or attempts to coerce.
• Self-interest threat: The threat that a member will benefit, financially or otherwise, from an interest in or relationship with a client.
• Management participation threat: The threat that a member will take on the role of management or otherwise assume management responsibilities for a client.

Financial Interests

A covered member must not have a direct financial interest in an attest client. A direct financial interest includes ownership of stock, bonds, or other securities of the client, regardless of amount. An indirect financial interest (such as through a mutual fund) impairs independence only if it is material to the covered member. Covered members include the individual on the engagement team, the firm, and any individual in a position to influence the engagement. Close family members of covered members are also subject to independence rules regarding financial interests.

Nonattest Services

Performing certain nonattest services can impair independence. The general rule is that the member must not assume management responsibilities for an attest client. When performing nonattest services, the client must agree to perform certain functions: the client's management must designate a competent individual to oversee the service, management must make all management decisions and perform all management functions, management must evaluate the adequacy and results of the service, and management must accept responsibility for the results. Specific prohibited services include serving as a director or officer of an attest client, having custody of client assets, and making management decisions on behalf of the client.

Bookkeeping, Tax, and Advisory Services

An auditor may provide bookkeeping, tax preparation, and certain advisory services to a nonpublic audit client without impairing independence, provided the general requirements for nonattest services are met and the member does not assume management responsibilities. However, for public companies (SEC issuers), the rules are significantly more restrictive under SOX and SEC independence rules, which prohibit many nonattest services entirely.

Former and Prospective Clients

Independence considerations extend to former practitioners joining a client and former client personnel joining the firm. A former practitioner who joins an attest client should not have a continuing connection with the firm (such as retirement benefits that are not fixed and determinable), and the firm should consider whether the individual will have influence over the attest engagement. A partner who joins a client in a key position may require the firm to assess whether prior work should be reperformed.

Fee Arrangements and Independence

Contingent fees for attest engagements are prohibited because they create a self-interest threat. Fees for attest services should not be contingent on the results or findings of the engagement. Additionally, overdue fees from an attest client that are equivalent to lending money to the client may impair independence if they remain unpaid for an extended period (generally more than one year for fees billed for prior-year services).

Exam Tips for Independence Rules

• Direct financial interests always impair independence, regardless of materiality.
• Indirect financial interests impair independence only if material to the covered member.
• The member must not assume management responsibilities when providing nonattest services.
• Contingent fees impair independence for attest engagements.
• Know the seven categories of threats to independence under the conceptual framework.