PCAOB and SEC Rules of Independence

Summary

This session delves into the PCAOB and SEC independence rules, primarily focusing on auditors for publicly traded companies (issuers). Unlike AICPA rules, which target private company auditing, these regulations ensure auditors remain impartial and objective, a cornerstone of credible financial reporting. Key discussions include the PCAOB's role as an auditor's auditor, the criticality of auditor independence, prohibited and permissible services, tax service guidelines, the composition and role of audit committees, and issues such as partner rotation and employment relationships. Additionally, the session addresses potential impacts of opinion shopping on auditor independence and emphasizes ongoing communication with existing auditors when engaging new ones.

Highlights

• The differentiation between PCAOB/SEC and AICPA rules for auditor independence. 🔍
• A summary of prohibited services under Sarbanes-Oxley to ensure unbiased auditing. 📜
• Clarification on permissible tax services, requiring prior approval from audit committees. 📊
• The critical role of audit committees in maintaining auditor independence. 👥
• Explanation of the importance of partner rotation and its impact on objectivity. ✋
• Insight into the potential issues and resolutions related to opinion shopping. 💡
• Discussion on employment relationships and cooling-off periods to prevent ethical dilemmas. ⏳
• Details on mandatory fee disclosures to illustrate financial engagements and avoid undue influence. 💰

Key Takeaways

• PCAOB and SEC govern auditors of public companies, enforcing rigorous independence standards. 🏦
• Auditors must be perceived as independent by the general public to ensure trust and objectivity. 🕶️
• Certain non-audit services are prohibited to maintain auditor independence. 🚫
• Tax services can be provided by auditors, but require audit committee pre-approval. ✅
• Audit committees, composed of independent members, are essential in hiring and overseeing auditors. ⚖️
• Rotation of audit partners is required every five years to bring fresh perspectives. 🔄
• Partner and employment relationships require cooling-off periods to prevent conflicts of interest. 🛑
• Regular communication with predecessors is crucial to ensure objectivity and independence. 📞

Overview

In an insightful session, Farhat Lectures explores the rules of independence set by the PCAOB and SEC, focusing on public companies. These bodies enforce stricter guidelines than the AICPA for private companies, ensuring auditors maintain impartiality and objectivity in financial audits, which is essential for trust in public financial statements.

The discussion highlights prohibited non-audit services under Sarbanes-Oxley, disallowing auditors from offering additional services that could lead to potential biases, except tax services, which require audit committee clearance. It also stresses the role of audit committees in the independent hiring and supervision of auditors.

Furthermore, the session covers significant independence issues such as the necessity of audit partner rotation, the importance of resolving conflicts of interest, particularly concerning employment relationships and opinion shopping, and the requirement for disclosing financial relationships that may influence auditors' impartiality.

Chapters

• 00:00 - 00:30: Introduction to PCAOB and SEC Independence Rules This chapter introduces the differences in independence rules between PCAOB/SEC and AICPA, focusing on their application to auditors of public versus private companies.
• 00:30 - 02:00: Understanding Independence in Auditing This chapter focuses on the concept of independence in auditing, specifically for non-issuers, which are private companies following the AICPA guidelines.
• 02:00 - 03:30: Role of PCAOB and Its Origin The chapter discusses the role of the Public Company Accounting Oversight Board (PCAOB) and its origin. It touches on the dynamics of the audit process, highlighting the relationship between the auditor, the company being audited, and the third-party users of the financial statements. Although the company pays for the audit, the financial statements are intended for public use, necessitating trust in the auditor's impartiality and competence. The chapter emphasizes the importance of public perception and trust in the Certified Public Accountant (CPA) who conducts the audit.
• 03:30 - 05:30: Prohibitive Services for Auditors The chapter discusses the role of a Certified Public Accountant (CPA) and the importance of maintaining independence. It highlights the necessity for CPAs to be impartial and independent not only in their actions and thoughts but also in how they present themselves. The appearance of independence is as critical as actual independence, as any perception of advocacy or bias, even if unfounded, could undermine trust in their impartiality.
• 05:30 - 08:00: Tax Services and Other Non-Prohibitive Services The chapter discusses the role and importance of the Public Company Accounting Oversight Board (PCAOB). The PCAOB is described as an entity established to audit the auditors of public companies, ensuring that they conduct accurate and impartial audits, particularly following major corporate scandals like Enron and Worldcom. The necessity for such oversight arose because the auditing industry cannot be expected to audit itself without bias, especially in the case of public companies.
• 08:00 - 13:00: Audit Committee and Corporate Governance The chapter discusses audit frequencies for different entities, particularly focusing on the auditing schedules for companies auditing more or less than 100 publicly traded companies annually. It highlights the importance of understanding rules set by both the PCAOB and the SEC, as both bodies deal with public company regulations. A key point is the emphasis on auditor independence, which is deemed the cornerstone of effective auditing practices.
• 13:00 - 18:00: Ownership Interests and Financial Relationships The chapter covers the introduction of a new supplemental educational tool called 'forehead accounting lectures.com.' It is designed to assist with CPA exam preparation and supports accounting courses. The material aligns with major CPA review cores like Becker, Roger, Wiley, Gleim, and Miles. Additionally, the accounting courses are structured to match specific chapters and topics, consisting of lectures and multiple resources.
• 18:00 - 21:30: Shopping for Accounting Principles and Employment Relationships The chapter discusses various services that auditors are prohibited from performing during an audit to maintain their independence. This is to ensure compliance with Sarbanes-Oxley Act regulations, which are aligned with PCAOB (Public Company Accounting Oversight Board) standards. The chapter also provides practice activities including choice questions, true/false questions, and exercises for readers.
• 21:30 - 24:30: Partner Rotation Requirements The chapter delves into the impacts of the Sarbanes-Oxley Act and SEC regulations on auditor independence, focusing on partner rotation requirements. It details how these regulations restrict firms from offering certain non-audit services to their audit clients, such as financial system design, bookkeeping, appraisal, valuation, and actuarial services, to avoid conflicts of interest and ensure objectivity in audits.
• 24:30 - 30:00: Audit Committee Responsibilities and Knowledge Check The chapter discusses the responsibilities of an Audit Committee, particularly focusing on services that cannot be outsourced to external firms. These include management functions, broker services, investment advisories, banking services, and certain legal and expert services that are unrelated to audit as determined by PCOB regulations.

PCAOB and SEC Rules of Independence Transcription

• 00:00 - 00:30 hello and welcome to this session in which we will discuss the pcaob and the SEC Independence rules in the prior session we looked at the aicpa Independence rules what is the difference between the two when we discuss aicpa independence rule we are referring to Auditors that audit private companies when it comes to pcaob and the SEC we are dealing with Auditors that audit publicly traded companies which are called issuers issuers pcaob
• 00:30 - 01:00 non-issuers which are private aicpa remember Independence is the Cornerstone of auditing why because when when a CPA perform an audit there are three parties involved in this process we have the CPA themselves we have the company cpa1 company 2 and we have the users of financial statements three now the company or the client hires the CPA and actually pays the CPA to perform an
• 01:00 - 01:30 audit on the company the audit on the financial statements of the company however the intended users of the financial statements are a third party so although the company party 2 is paying the auditor which is party one party one is issuing financial statement to the public to the users of the financial statements who who's supposed to be the public now the users since they have no relationship with the auditor they have no no relationship with the CPA to trust the CPA they have to perceive
• 01:30 - 02:00 the CPA as impartial they have to trust that the CPA is independent they have to trust that the CPA is objective and the CPA must be independent in mind and appearance what does that mean it means they have to actually be independent in fact in mind and also when it comes to appearance they have to appear they have to look like they cannot be look as if they are advocating although they may not be advocating but the appearance alone might Hinder my
• 02:00 - 02:30 tarnished your Independence the pcaob is the audit of the Auditors so who audits the auditor the pcaob audit the Auditors that ordered two public companies why well the pcob came after the Enron Worldcom the frauds that took place and the government says the industry the CPA industry the auditing industry when it comes to public companies they cannot order themselves who are going to be
• 02:30 - 03:00 auditing them and they audit you once a year if you audit more than 100 publicly traded companies and otherwise once every three years if it's less than 100 publicly traded companies so in this session we're going to be looking at the rules that involve both the pcob and the SEC because they are they both deal with public companies when it comes to independence why do we have we worry about independence again Independence is the Cornerstone of auditing let's go ahead and get started before we proceed
• 03:00 - 03:30 any further I have a public announcement about my company forhat lectures.com forehead accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses my CPA material is aligned with your CPR view core such as Becker Roger Wiley gleam miles my accounting courses are aligned with your accounting courses broken down by chapter and topics my resources consist of lectures multiple
• 03:30 - 04:00 choice questions true false questions as well as exercises go ahead start your free trial today first thing we're going to look at prohibitive Services prohibitives means Services the the auditor cannot perform when they are performing an audit otherwise they would lose their independence their independence will be impaired and those rules are by sarbanes access when I say sarbanes actually what we say is the same thing as PC aob because the pcaob
• 04:00 - 04:30 is the creation of the sarbanes-axley act and also the SEC they have their own rules and they limit your services for companies that you are other things so those are non-audit services and those they cannot be they cannot be offered when you are performing an audit financial information system design and implementation bookkeeping and other accounting services appraisal or valuation Services Actuarial Services
• 04:30 - 05:00 internal audit Outsourcing management or Human Service functions anything that management you can do broker broker dealer investment advisor or investment banker service legal and expert Services unrelated to the audit or any other service that pcob determines by regulation is impermissible now in this list what's missing is tax and hopefully you notice this can we provide Tax Services well let's talk about the tax services
• 05:00 - 05:30 acts and other non-prohibitive services Tax Services can you prepare the tax return for the for example the corporate tax return for an audit client order state tax return well you can as long as you get the pre-approved by the audit committee who's the audit committee we're going to talk about the audit committee before shortly so as long as you can get the approval because Tax Services is not a prohibitive service so notice tax service is not one of these Services these Services that's it you
• 05:30 - 06:00 cannot perform however tax and stock Services is not prohibitive you need to get approval so if something not prohibited you must get approval tax for example now you cannot prepare the tax return for company Executives Who oversee the financial reporting simply put you can prepare the return for the company but you cannot be too friendly with the executives now you now you start to have a financial relationship with the executives you can't do that
• 06:00 - 06:30 no tax avoidance planning services so although you are preparing the return you are not helping them do planning planning is different than preparing the return specially aggressive planning planning is what planning is when you're trying to save the money well if you're trying to save the money you are advocating for the client you can no longer be independent you have to be in bed with them you have to be on the same page because the the goal here is to save money of course
• 06:30 - 07:00 legally nevertheless you're no longer independent CPA firm is not independent if the audit partner receives compensation for selling services to the client other than audit review and Atta Services also you cannot sell them because if you're trying to sell them you're trying to convince them and when you try to convince them well you might be subordinating your objectivity and Independence and what what else do you need to do you need to disclose an a proxy statement or the annual report the breakdown of fees
• 07:00 - 07:30 for the past two years so how are you getting the fees from the client because as users we we want to know and this especially becomes important after Enron I'm going to tell you why in a moment how much you are you are getting for audit fees audit related fees tax fees and all other fees why is this relevant these days post surveyance actually for that matter because Enron when Enron was being audited by Arthur Anderson 25 million of the fees
• 07:30 - 08:00 that they were charging 25 million was four auditing services and 27 million was for consulting services so Arthur Anderson was receiving 27 million from Enron for consulting services and only 25 million for tax services so simply put what's going to happen is this well well Arthur Anderson was basically paying Enron a million dollar per week for tax and consulting services and because the
• 08:00 - 08:30 Consulting Services represented a larger portion of tax well they have some undue influence they can twist Arthur Anderson hands in agreeing with them on certain things so that's why you have to disclose how much are you getting paid for tax non-tax audit so on and so forth we mentioned in the slide that you have to get approval from the audit committee the audit committee is an important component of the corporate governance let's talk about the audit committee surveys Oxley legislation mandate the
• 08:30 - 09:00 establishment of an audit committee within a public company so what are we looking at here on the top you have the board of directors within that board of directors you want to have an audit committee this audit committee you have to have it for public companies this audit committee is the party that hires compensate and supervise the auditor remember the auditor is auditing the company the company is management you don't want management to hire the auditor you want someone else
• 09:00 - 09:30 you want the audit committee to hire the auditor to audit management although management technically is paying for the order but they don't hire the auditor this committee also holds the authority to resolve any conflict arising from financial reporting disagreement because between the company and the auditor so there's any disagreement you don't have to go to the company although they're paying you you go to the audit committee who's supposed to be independent in all significant finding discovered during the audit will have to be communicated
• 09:30 - 10:00 to the audit committee the audit committee as I mentioned must be independent the the composition of the audit committee could be three five seven members they have to be independent it must be exclusively compromised of members who have no affiliation with the company's management that's why they want those are the people you're going to go to when you find an issue with management also the audit committee includes at least one individual that possess expertise and financial matters AKA you
• 10:00 - 10:30 know a CPA will suffice now who are the covered member who are the people who they should be very careful when conducting an audit for a public company very careful in terms of Independence well in any individual that possess the ability to impact the audit and their immediate families who are they well people on the front line members of the audit engagement team individuals holding position capable of influencing those the people on the line
• 10:30 - 11:00 basic the staff the senior the manager the partner you know people and the firm's hierarchy partners and managers offering more than 10 hours of non-audid service to the client and partners within the office of the principal partner responsible for overseeing the audit engagement simply put partners and managers within that office there are providing more than 10 hours none other services none other services is tax services for example now what are some the
• 11:00 - 11:30 rise that we have to to deal with those issues are very similar to the aicpa issues so sometimes I'm going to say this is just like the aicpa the Assumption here is you looked at the aicpa otherwise go ahead and look at the aicpa and dependence roles we're going to look at ownership interest and financial interests partner rotation conflict arising from employment relationship and shopping for accounting principles I have partnered rotation twice which is called opinion shopping starting with
• 11:30 - 12:00 ownership ownership interest just like aicpa covered members cannot have any direct ownership whether that material or not simply put just like aicpa no direct no direct ownership indirect ownership it depends on the materiality so for direct ownership materiality is not an issue for indirect ownership materiality is an issue loans can you get a loan from if you're
• 12:00 - 12:30 auditing a bank well similar to the AI CPA rules normal lending procedures that's fine if you have a collateral that's fine can you have a savings or checking account at that institution yes as long as it's less than the FDIC protection amount the federal Insurance federal Federal Deposit Insurance Corporation in other words you have no interest to fudge the numbers for the bank because the money that you have in the bank is protected by the government credit card balance you can have that
• 12:30 - 13:00 with that bank less than ten thousand dollars how about if you received stocks from gift or inheritance they're called they're called unsolicited ownership seldom you have 30 days to get rid of them you will be in good shape shopping for accounting principle could impair Independence and what what does that mean what does it mean shopping for accounting principle or shopping for an opinion here and sometime the client which is this the the the the company that you're auditing they may seek guidance from a different CPA regarding
• 13:00 - 13:30 some issues some accounting principle issue and here's what happens sometime the company might be happy with that new opinion so in the event that the client decide to switch auditor following the given advice the newly engaged CPA might uncover fresh information that necesses necessitate a revision in their position so they went from they left auditor a they want to auditor B so let's just letter Than A and B let's assume their current auditor is PwC and they went to KPMG and they asked KPMG
• 13:30 - 14:00 about their opinion the KPMG gave them an opinion about about an accounting principle so KPMG is the new auditor well they were happy with the with their opinion they said okay thank you very much PWC now we're gonna hire KPMG because we liked what they told us now once KPMG got on board they find out that there are more information more facts and circumstances that their initial opinion was not 100 accurate it
• 14:00 - 14:30 was accurate based on the information that they had at that point what would happen What would KPMG the new CPA now okay this could lead to a potential compromise of their independence because the new CPA provided an opinion without being fully aware of all the relevant details so it's essential what should KPMG have done what should KP mg have done they should have talked to PWC they should have talked to the PWC to just kind of consult the CPA firm and establish communication with them the
• 14:30 - 15:00 current auditor because they might give you more information about the situation and if the well obviously have to get the client's permission if the client don't allow you then you have to be very careful and whether you want to take them as a as a client or not okay so this action is crucial to gather all the relevant fact before forming a judgment matter of fact as a future CPA it is a future auditor stay away from giving an answer on the spot always you want to take a look at
• 15:00 - 15:30 additional fact additional circumstances always qualify your answer this is the answer but always that's the case this is the answer but under different circumstances this is not the same answer okay this approach means communicating with the current auditor will minimize the practice of seeking multiple opinion to manipulate outcomes because why are they asking me for this what for this information if they already have an auditor we want the second opinion that's fine give them a second opinion after you consult with
• 15:30 - 16:00 the current auditor no problem employment relationship very similar to the aicpa hiring former members of the audit team within the audit client organization gives rise to Independence issue so if you hired you know an auditor they switch team well there's an independence issue in order to transition into roles such as chief CEO controller Chief Financial Officer Chief accounting officer or comparable position can can encounter conflict conflict of interest the SEC says well
• 16:00 - 16:30 you have to have what's called a cooling off period okay basically you have to just wait a year well can you be hired you can be hired but you should not be working in key financial reporting position Maybe work in marketing for a year then they can take you back and put you in in each in the financial reporting position otherwise the employment relationship is similar to the AI CPA rules partner rotation what does that mean it means
• 16:30 - 17:00 the lead partner and the concurrent audit partner they have to step away from the engagement every five years so you can be on the engagement for five years then as a partner not as a firm as a partner you have to leave wait five years come back and you could be the partner on that engagement for five years initially it was the firm have to leave and there was a lot of disagreement that will uh well a few let the firm go then they need to hire a new firm there's a learning curve it takes time it costs money therefore what they
• 17:00 - 17:30 agreed on well the lead auditor and the partner will have to leave every five years basically bring new partner new sets of eyes let's take a look at this multiple choice questions from Farhat lectures which of the following statement is true so one statement is true regarding the audit Committee of public company so since one is true one is true three must be false so it's easier to spot the false statement okay let's take a look at option A most audit
• 17:30 - 18:00 committee are made up of three to five directors who are part of the company's management most all the Committees they could be form of three to five directors they can be directors who are part of the company management no way they cannot be part of the company's management directors means it's just a title I'm not saying director for the company if those directors are part of the company that's a No-No as well simply put the audit committee cannot have any relationship with management
• 18:00 - 18:30 and what make this answer incorrect false is part of the company's management we can cross a that's easy B the audit committee should have at least two independent members oh no no no not at least two the audit committee all the members should be independent okay so B is out because they all need to be independent the audit committee is responsible for the oversight of the work order of the auditor who's appointed by management well the audit committee is responsible
• 18:30 - 19:00 for the oversight of the work of the auditor up to this point 100 correct who's appointed by management not at all management cannot appoint the auditor C is out by process of elimination D is the answer let's make sure it is the answer the audit committee should include at least one member who is a financial expert yes at least one member and we say CPA because we take pride in our work CPA is a financial expert so one person is a financial expert at least one person of a financial expert they
• 19:00 - 19:30 all have to be independent but at least one person is a financial expert independent means they have no relationship with the company in other words they are working objectively they have no financial interest in the outcome of the audit of your audit opinion otherwise if they are then again the independence is violated the whole purpose of this audit is to make sure we give an objective opinion what should you do now go to forehead lectures look at additional mcqs true false that's going to help you whether you are
• 19:30 - 20:00 an accounting student or a CPA exam candidate invest in yourself good luck study hard and of course stay safe