How to Establish Independence with Auditing Clients
When deciding whether to accept an auditing engagement, you must judge your independence and objectivity. If your audit firm lacks independence or objectivity, you can’t accept the engagement. Independence and objectivity are closely related attributes that you need as an auditor. You and your firm have to be independent in both fact and appearance.
Here are examples of situations that can lead to an actual or perceived lack of independence:
Someone at the CPA firm has an immediate family member working for or with the potential client.
You’re put in the position of auditing your own work. You can’t prepare the financial statements you’re auditing.
You or your audit firm has served in a management capacity with the potential client within the past few years or has provided appraisal, actuarial, or valuation services to the client:
Appraisal services consist of evaluating the value of the business or any of its assets.
An example of an actuarial service would be defining and creating pension and retirement plans for the potential client.
Valuation services may consist of coming up with a balance sheet value for intangible assets such as patents and trademarks.
You or your firm has a direct or material indirect financial interest in the potential client. Direct interests are substantial, such as you, your immediate family, or your partner owning stock in the company, or your firm having a loan to or from the potential client. An example of a material indirect circumstance is if you have a financial interest with an entity associated with the client. For example, you have an interest in an estate, trust, or investment vehicle such as a mutual fund.
Too large a percentage of your firm’s overall revenue is coming from the same client. This situation creates at least a perceived lack of independence, because your firm has a very good reason to issue a favorable report — you don’t want to lose the revenue!
This list is not exhaustive, of course. The key is that the auditor must be unbiased and avoid any engagements that may lead users of the financial statements to question the auditor’s independence. And although you must be independent, gauging firm independence isn’t a decision you have to make until you reach the level of senior manager or partner at an auditing firm.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
