AUDITOR INDEPENDENCE, PROFESSIONAL SKEPTICISM, AND ... ?· picpa educators conference presented by francine mckenna july 19, 2013 auditor independence, professional skepticism, and auditors’ obligations when

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  • P I C P A E D U C A T O R S C O N F E R E N C E

    P R E S E N T E D B Y F R A N C I N E M C K E N N A

    J U L Y 1 9 , 2 0 1 3




    Morning Keynote: The Ethics of Auditor Independence and an Auditors Public Duty The Auditors Public Duty A Review of Auditor Independence Including Some Less Often

    Discussed Provisions Professional Skepticism Recent Data Updates

    Lunch Address: Auditor Independence, Skepticism, and Fraud: Case Studies and Examples A Review of Professional Skepticism In The Standards and In

    Regulator Comments The Auditors Obligations Regarding Fraud and Other Illegal Acts Case Studies Resources


    The Ethics of Auditor Independence and An Auditors Public Duty


    The auditors client is the shareholder and investor in the company, not the companys management. By certifying the public reports that collectively depict a

    corporations financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporations creditors and stockholders, as well as to the investing public. This public watchdog function demands that the accountant maintain total independence from the client at all times, and requires complete fidelity to the public trustUnited States v. Arthur Young & Co., 465 U.S. 805 (1984)U.S. Supreme Court


    Keep telling yourself: Im a professional! We are always hearing these days about how law has become a business. Becoming a partner leads to even greater exposure to the business side of private practice, from preparing bills to generating new clients, all of which are very important to keeping the lights on in the office, so to speak. But, the last time I checked, lawyers were not MBAs We are part of an honorable tradition that counsels and guides the uninitiated, our clients, through what can seem like a morass of confusing laws and regulations. We are trusted to regulate ourselves and also keep the pipes clean, by questioning and challenging the processes and guidelines that define how disputes are resolved, all with the goal of making them as transparent and fair as possible. We are more than hired guns even when our clients tell us otherwise Legal Times By Brian Corcoran Letter to a New Partner


    The largest four firms have reported for fiscal 2012, approximately $109 billion in revenue worldwide and counted between 150,000 and 200,000 employees and partners each on a worldwide basis.

    Auditors are paid by the companies they audit, like ratings agencies are paid by bond issuers.

    By comparison, an October survey by American Lawyer of the top 100 global law firms published revenues, even for the top ten that were much more modest. The combined revenues of the top fifty global law firms, $55 billion, equals about half of what the largest four global audit firms report. The combined revenues of the top ten largest global law firms, approximately $20 billion, are still less than the reported revenues of the smallest of the global audit firm, KPMG.


    Insider Trading By Public Accounting Firm Professionals Client confidentiality breach compounded by, perhaps,

    violation of financial interest rules

    Auditors/Audit Engagements Scott London KPMG - Tipper Tom Flanagan Deloitte Tipper and Trader

    Other Firm Professionals James Gansman EY - Tipper Arnie McClellan Deloitte Inadvertent Tipper PwC Transaction Services Staff - Traders


    Audit firm leadership denies responsibility for the serious legal and ethical transgressions of very senior partners by characterizing them as rogues. Tom Flanagan was a Deloitte Vice Chairman. Deloitte lost no clients, endured no fines or sanctions for, by their

    admission, hundreds of breaches of their policies and procedures by a 38-year veteran of the firm in a leadership position that had responsibility for relationships with prestigious Fortune 500 clients.

    Deloitte escaped criticism and sanctions because they claim this Vice Chairman duped the firm.

    Scott London of KPMG was a partner in charge of audit for Southern California responsible for all the audits in the region, hundreds of partners and thousands of staff.


    The Independence Standard (SEC Final Rule 10/12/01) Independence generally is understood to refer to a mental state of objectivity and lack of bias. The amendments retain this understanding of independence and provide a standard for ascertaining whether the auditor has the requisite state of mind. The first prong of the standard is direct evidence of the auditor's mental state: independence "in fact." The second prong recognizes that generally mental states can be assessed only through observation of external facts; it thus provides that an auditor is not independent if a reasonable investor, with knowledge of all relevant facts and circumstances, would conclude that the auditor is not capable of exercising objective and impartial judgment.


    AICPA Auditor Independence Section 201 Sarbanes-Oxley Act Prohibited services Audit Committee pre-approval Additional disclosures Permitted non-audit tax services Audit partner rotation Audit partner compensation Auditor/Client revolving door Auditor/Audit Committee communication

    An AICPA/SEC Independence Rule Comparison


    These AICPA Independence Interpretations of Rule 101 have no specific corresponding SEC rules: Interpretation 101-4 Honorary directorships and trusteeships of not-

    for-profit organization. Interpretation 101-6 The effect of actual or threatened litigation on

    independence Interpretation 101-10 The effect on independence of relationships

    with entities included in the governmental financial

    Relationships. Interpretation 101-11 Modified application of Rule 101 for certain engagements to issue restricted-use reports under the

    Statements on Standards for Attestation Engagements. Interpretation 101-14 The effect of alternative practice structures on the applicability of independence rules.


    Section 201 Sarbanes-Oxley Act Prohibited Services (Internal audit, systems design and

    implementation, bookkeeping, etc.) Audit Committee Pre-approval Additional Disclosures Permitted Non-audit Tax Services KPMG GE EY and HP, News Corp, Walmart EY UK on country-by-country reporting EY tax lobbying for audit clients

    Audit partner rotation 7/2 to 5/5 plus concurring partner) Reality Scott London & Skechers

    Audit partner compensation Auditor/Client revolving door Auditor/Audit Committee Communication


    Section 201 other topics Perception versus reality of roles, no oversight, audit takes a back seat. The rapid rise in the growth of non-audit services has increased the economic incentives for the auditor to preserve a relationship with the audit client, thereby increasing the risk that the auditor will be less inclined to be objective. October 12, 2001 SEC Final Rules. Deloitte Standard Chartered ban Deloitte JPM Foreclosure Reviews PwC Ally/ResCap foreclosure reviews Deloitte Marin County SAP implementation Deloitte Kabul Bank KPMG due diligence HP acquisition of Autonomy KPMG, EY due diligence CAT acquisition of ERA, Chinese company PwC Thomson Reuters tax software alliance EY tax lobbying for audit clients Auditors and corporate investigations (EY Lehman case)


    Business Alliances Rule 2-01 (b) of Regulation S-X (17 CFR 210.2-01.),

    amended under SOx to enhance auditor independence after the Enron/Arthur Andersen, provides the standard used to judge a business relationship between a company and its auditor orservices provided to an audit client: Does the relationship create a mutual or conflicting interest

    between the accountant and the audit client?

    Examples: EY PeopleSoft, PwC Thomson Reuters, Deloitte Autonomy/HP


    PCAOB Staff Audit Practice AlertNo. 10, Maintaining and Applying Professional Skepticism in 12/4/12 PCAOB standards define professional skepticism as an

    attitude that includes a questioning mind and a critical assessment of audit evidence, and it is essential to the performance of effective audits under Board standards.

    The PCAOB continues to observe instances in which circumstances suggest that auditors did not appropriately apply professional skepticism in their audits.

    Alert focuses on the importance of professional skepticism, the appropriate application of professional skepticism in audits, and certain important considerations for audit firms' quality control systems.



    It seems auditors have never been skeptical enough An examination of SEC Enforcement Actions 1987-1997

    found 60% of enforcement actions related to a lack of professional skepticism. Beasley et al. (2001)

    PCAOBs 2008 review of first four years of inspections of eight largest accounting firms found deficiencies attributable, at least in part, to lack of professional skepticism when performing audit procedures and performing audit tests.



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