Ethics Interpretation No. 101-3, Performance of Nonattest Services Proposed Revisions Clarify Independence Requirements On February 28, 2011, the AICPA Professional Ethics Executive Committee (PEEC) issued an omnibus exposure draft containing proposed revisions to Interpretation No. 101-3, “Performance of nonattest services,” under Rule 101, Independence (AICPA, Professional Standards, ET sec. 101 par. .05). The PEEC believes these revisions will add clarity to the nonattest services guidance and enhance practitioners’ understanding of the interpretation’s requirements. An overview of the proposed revisions follows. Establishing or maintaining internal control One of the proposed revisions relates to a general activity that would impair a member’s independence: establishing or maintaining internal controls, including performing ongoing monitoring activities for a client. The PEEC recognized that an inconsistency existed within the current interpretation in that certain bookkeeping and other nonattest services permitted under the interpretation could be viewed as maintaining internal controls for the client and, as such, may appear to be prohibited by the general activity. For example, under the proposed revisions to the interpretation, a practitioner could prepare monthly bank reconciliations for an audit client without impairing independence provided the general requirements of the interpretation are met, such as ensuring that the client reviews and approves the bank reconciliations and sufficiently understands the services performed to oversee them. However, preparing bank reconciliations for a client is also considered to be maintaining an internal control for the client. Because it was never the PEEC’s intent to have the permitted activities listed in the interpretation be considered as impairing independence, the committee agreed to revise the general activity to state accepting responsibility for designing, implementing or maintaining internal control. The PEEC believes the phrase “designing and implementing” is not only clearer than “establishing,” but is more reflective of the language used in the professional standards (for example, auditing standards) and the Code of Ethics for Professional Accountants issued by the International Ethics Standards Boards for Accountants (IESBA Code). The addition of the phrase “accepting responsibility for” is intended to clarify that practitioners are able to assist their clients by performing services to design, implement, or maintain certain aspects of internal control when management accepts responsibility for such services and the other general requirements of the interpretation are met. Even if client management accepts responsibility for internal control related services, threats to independence (for example, self-review and management participation threats) may still exist. The general requirements of the interpretation serve as safeguards to mitigate these threats to an acceptable level and, therefore, are necessary in order to maintain independence. Copyright © 2011 by American Institute of Certified Public Accountants, Inc. New York, NY 10036-8775 All rights reserved. For information about the procedure for requesting permission to make copies of any part of this work, please e-mail copyright@aicpa.org with your request. Otherwise, requests should be written and mailed to the Permissions Department, AICPA, 220 Leigh Farm Road, Durham, NC 27707-8110. Specifically, in addition to accepting responsibility for the services, management must make all significant judgments and decisions in connection with the engagement and must also designate an individual who has the skill, knowledge, and or experience to oversee the services and evaluate the adequacy and results of the services performed. While the general requirements are generally sufficient to safeguard independence, there could be situations in which the practitioner may cross the line and impair independence due to the scope and extent of internal control services performed. For example, as discussed in the proposed revisions to the interpretation, the management participation threat created when a practitioner performs ongoing monitoring procedures is so significant that no safeguards could reduce the threat to an acceptable level. In addition, management is responsible for designing and maintaining the company’s internal control process and, therefore, should not rely on the practitioner’s work as the primary basis for its assertion regarding the effectiveness of its internal control over financial reporting. Accordingly, in cases in which the practitioner’s involvement in the client’s internal control process is so extensive that it results in management relying on the practitioner’s work as the primary basis for its assertion, no safeguards could reduce the threats to independence to an acceptable level, and independence would be impaired. Practitioners should use judgment in determining whether services performed would constitute ongoing monitoring activities or whether management appears to be relying on its work as the basis for its assertion on internal control effectiveness. Defining management responsibilities In addition to the proposed revision to the general activity, the PEEC is proposing several other clarifications to enhance the guidance in the interpretation. For example, the PEEC believes the term management responsibilities is clearer than management functions and, therefore, proposes certain revisions to reflect this change. The revised interpretation also incorporates a description of the term management responsibilities as well as additional examples of management responsibilities. The examples previously referred to as general activities have also been merged into the examples of management responsibilities because the reason they impair independence is because they are deemed to be responsibilities of management. The proposed language is consistent with the IESBA Code, and, therefore, it aligns the AICPA Code closer with international standards. The PEEC does not consider these revisions to be more restrictive than the existing independence requirements of Interpretation No. 101-3, and, therefore, such changes are not expected to change current practice. Performing ongoing monitoring versus separate evaluations One proposed revision to the interpretation may be viewed as more restrictive. Specifically, the PEEC is proposing to include a requirement that members evaluate the significance of the management participation threat created by performing separate evaluations on the client’s internal control system. The PEEC believes that an inconsistency in the interpretation exists by prohibiting a member from performing ongoing monitoring procedures for a client while permitting separate evaluations because, depending on the scope or extent of the controls being tested and frequency of the separate evaluations, the member may be performing services equivalent to ongoing monitoring procedures. Accordingly, the PEEC is proposing that the significance of the threat created by performing separate evaluations should be evaluated and safeguards applied when necessary to eliminate the threat or reduce it to an acceptable level. Incorporating nonauthoritative guidance American Institute of CPAs Page 2 Other proposed revisions to the interpretation involve incorporating certain nonauthoritative guidance contained in the Ethics Division’s answers to Frequently Asked Questions: Performance of Nonattest Services. One such revision relates to clarifying the difference between performing bookkeeping services and performing activities that are considered to be part of the attest engagement. For example, proposing adjusting journal entries or making suggestions about the form or content of the financial statements for a client (subject to management’s review and approval) as part of an audit engagement would generally not be considered a nonattest service subject to the requirements of Interpretation No. 101-3. However, the practitioner is expected to use judgment in determining whether his or her involvement has become so extensive that it would constitute performing a separate service which would be subject to the interpretation’s general requirements. A client’s books and records should be substantially complete and current in order to perform an audit or review of those books and records. If practitioners find themselves performing a service to bring those books and records current or complete, the service may be considered outside the scope of the normal audit or review process and, therefore, a bookkeeping service subject to Interpretation No. 101-3. To learn more about these and other proposed revisions to Interpretation No. 101-3, view the exposure draft. Comments on revised Interpretation No. 101-3 and other proposals contained in the exposure draft are due by May 31, 2011. American Institute of CPAs Page 3 Assignment: This is a take home test. This is an individual assignment, so no cheating and talking to anyone else about the questions. The idea is to teach you ethics and help you to get ready for the CPA exam and your professional practice. You will need to know these rules in the practice of auditing, so you might as well learn them now. First read, Ethics Interpretation No. 101-3, Performance of Nonattest Services Proposed Revisions Clarify Independence Requirements Then, answer all 10 questions. Submit to turnit in. Also bring your answers to class for an in-class discussion. QUESTIONS 1. A sole practitioner performs a review engagement for a small company owned by two partners. The two partners are involved in the sale of the company’s products and neither has ever performed an accounting function. The client has an office manager who maintains the accounting records among his various responsibilities. The office manager is not a CPA and does not have a degree in accounting. The company’s remaining employees work in the production facilities. The sole practitioner performs certain tax and bookkeeping services permitted under Interpretation 101-3 for the client. Based on the fact that none of the client’s employees have an accounting background, can the sole practitioner perform the nonattest services and still remain in compliance with the general requirements of Interpretation 101-3? 2. Based on the fact pattern in Question 1, the sole practitioner calculates the deferred tax asset for the financial statements. Neither of the partners nor the office manager possesses the skills to calculate the deferred tax asset in the current year nor do they intend to learn how to perform such a calculation in future years. Is the sole practitioner’s independence impaired? 3. A CPA audits a small privately held company. The owners of the company are considering offering some key employees life insurance as part of their compensation. The owners inquired with the CPA on the effects such a plan may have on their financial statements. Would the CPA have to follow the general requirements of Interpretation 101-3 in providing the advice? 4. A CPA performs the audit of a small privately held company. The client has a bookkeeper, but no CPA on staff. During the audit, the CPA proposes adjustments to the financial statements. The journal entries include adjustments to the accumulated depreciation account, a reclassification of long-term assets and an adjustment based on sales cutoff testing. Would the proposal of these entries be considered a bookkeeping service subject to Interpretation 101-3? 5. A CPA performs a review engagement for a small company that has limited staff for its accounting and finance functions. The CPA receives copies of check disbursements, invoices and purchase orders, and books the journal entries accordingly for the client. The client has identified each cash disbursement, invoice and purchase order (for example, inventory, phone bill, payroll, misc., etc.). As the CPA is booking the entry, the CPA assigns the general ledger account number for the type of expense as identified by the client. Would this be considered determining or changing journal entries, account codings or classifications as prohibited by Interpretation 101-3? 6. Based on the fact pattern in Question 5, the CPA also receives a copy of the client’s bank statement and performs a bank reconciliation at the end of each month. The client reviews and approves the bank reconciliation. Would preparing the client’s bank reconciliation be considered “maintaining internal controls” for the client and impair independence? 7. In the questions above, must the CPA document the client’s review and approval of the bank reconciliation and the journal entries made? 8. A CPA performs an audit for a private closely held company. The two owners of the company are heavily involved in day-to-day operations and the accounting and finance functions. The CPA is asked to perform financial planning activities for the owners on a personal basis. Would these services be subject to Interpretation 101-3? 9. A CPA performs the audit of a company. The client deposits money into the CPA firm’s account. The account is totally separated from that of the firm’s money and other accounts. The client is a signer on the account and is able to make transfers and write checks from the account. The CPA only transfers money to vendors of the client when the client requests and formally approves. Would this service be permitted under Interpretation 101-3? 10. A review client of a CPA has a pile of invoices indicating the purchase date and purchase price of all of its fixed assets. The CPA compiles the information into an Excel spreadsheet creating a fixed assets schedule with formulas to calculate monthly depreciation on the assets. Would this service impair independence under Interpretation 101-3? 
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