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Independence Standards and Below Cost Audits. Dr. Raymond Johnson, CPA Professor of Accounting Portland State University Chair, Oregon Board of Accountancy. Ethics and Strategic Professional Issues Committee. Gaylen Hansen, CPA, Chair Loss Audit Subcommittee

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slide1

Independence Standards and Below Cost Audits

Dr. Raymond Johnson, CPA

Professor of Accounting

Portland State University

Chair, Oregon Board of Accountancy

ethics and strategic professional issues committee
Ethics and Strategic Professional Issues Committee
  • Gaylen Hansen, CPA, Chair
  • Loss Audit Subcommittee
  • Raymond Johnson, CPA, Subcommittee Chair
  • Bobby Creech, CPA
  • Rick David, CPA
  • Gary Forte, Public Member
  • Jeff Leiserowitz, CPA
  • Kurt Kofford, CPA
  • Larry Nunn, CPA
  • Rona Shor, CPA
audits below cost
Audits Below Cost
  • “Below Cost Pricing” is an anti-competitiveness issue with the FTC
  • Brooks Act
threats and safeguards approach
Threats and Safeguards Approach
  • Recognized in AICPA Independence Conceptual Framework
  • Risk Based Approach to Independence
    • Identify and evaluate threats to independence
    • Implement safeguards such that it is not reasonable to expect that the threat would compromise professional judgment
  • Recognized by International Ethics Standards Board for Accountants
threats to independence posed by performing an audit below cost
Threats to Independence Posed by Performing an Audit Below Cost
  • Current trend in declining audit fees
  • Red flag in Madoff audit
  • Numerous articles about loss of independence in mental attitude by auditing profession
    • Baker (2005)
    • Zeff (2003)
    • Brewster (2003)
    • Mautz (1988)
threats to independence posed by performing an audit below cost1
Threats to Independence Posed by Performing an Audit Below Cost
  • When an auditor is intent on “buying” an engagement, there is a threat of subordination of judgment in order to retain the client.
  • When the auditor relies on selling other services to make up for the performing an audit below cost, subordination of judgment may occur.
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Threats to Due Care and Compliance with Professional Standards Posed by Performing an Audit Below Cost
  • When a fee is quoted below cost, a threat exists that it may be difficult to perform the engagement and also comply with applicable professional standards within the time reasonably contemplated.
  • When a fee is quoted below cost, a threat exists that documentation requirements may not be met.
peer review considerations
Peer Review Considerations
  • Tone at the top: acceptability of low balling regardless of ethical consequences
  • Engagement selection process with a focus on audit below cost at a higher risk of noncompliance with ethical standards
  • Engagement reviews: Is it reasonable to assume that given the actual hours on a below cost audit that professional standards have been complied with?
anti trust considerations
Anti-Trust Considerations
  • There is considerable federal and state jurisprudence explaining the “below cost” in antitrust and unfair trade cases.
  • There are also hundreds of state statutes and rules currently applying the term to different areas of commerce.
  • Requiring a threats and safeguards approach should be considered as an effort to stifle competitive bidding
committee conclusion
Committee Conclusion
  • In principle, there is a presumption that performing an audit, or other attest services, below cost poses a significant threat to independence, due care, and compliance with professional standards.
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Fees
  • When entering into negotiations regarding audit or other attest services a licensee may negotiate any appropriate fee.
  • The fact that one licensee may quote a lower fee than another, or a licensee quotes a fixed fee, is not itself unethical.
safeguards
Safeguards

The auditor may overcome the presumption that performing an audit below cost poses a significant threat to independence, due care, and compliance with professional standards by putting the following types of normal safeguards in place:

  • Engagement quality reviews (e.g., concurring or second partner review) and consultation with technical specialists on issues of significant professional judgment.
safeguards continued
Safeguards (continued)
  • Adequate supervision and review of engagements
  • Allocating appropriate time and assigning qualified staff to do the engagement.
  • Instituting an adequate system of quality control, including approval of acceptance and continuance of engagements by those responsible for managing the auditing firm, preferably those that otherwise have no participation in the audit
states with ethics rules on audits below cost
States with Ethics Rules on Audits Below Cost

North Carolina

  • It is a discreditable act for a CPA or CPA firm to knowingly offer to perform services below cost for purposes of injuring or destroying competition

Texas

  • Presumption of loss of independence when an attest service is performed for less than the direct labor cost
potential action steps
Potential Action Steps
  • Develop professional standards that address the threat to independence, due professional care and compliance with professional standards of performing attest services below cost.
  • Develop quality control standards that require a firm’s systems of quality control to address the inherent threats to independence, due professional care, and compliance with professional standards created by accepting and performing below cost attest services.
potential action steps1
Potential Action Steps
  • Develop quality/compliance assurance (peer review) standards to require, when selecting engagements for review, appropriate consideration be given to below cost engagements and the related ethical threats
  • The Committee has drafted a rule, for discussion purposes, with the hope that it will be considered further by the NASBA UAA Committee as part of uniform independence requirements.
discussion questions
Discussion Questions
  • Based on your experience in enforcement matters, is performing an audit below cost a significant threat to independence, due care and compliance with professional standards?
  • Is a threats and safeguards approach an appropriate approach to addressing the below cost audits issue?
  • Should below cost audits be addressed in the UAA as part of uniform independence requirements?
discussion questions1
Discussion Questions
  • After reviewing the proposed draft rule on Performing Audits of Attest Engagements Below Cost are there changes or clarifications that need to be made?
  • Should NASBA address this issue comprehensively and pursue changes to see that quality control standards and peer review standards address the issue?