Question

You are the Partner in Charge of a large metropolitan office of a regional public accounting firm. Two members of your professional staff have come to you to discuss problems that may affect the firm’s independence. Neither of these situations has been specifically answered by the AICPA Processional Ethics Division. Therefore, you must reach our own conclusions as to what to advise your staff members, and what actions, if any, are to be taken by the firm.

CASE 1: Don Moore, a partner in the firm, as recently moved into a condominium which he shares with his girlfriend, Joan Scott. Moore owns the condominium and pays all the expenses relating to its maintenance. Otherwise, the two are self-supporting. Scott is a stockbroker, and recently she has started acquiring shares in one of the audit clients of tis office of the public accounting firm. The shares are held in Scot’s name. At present, the shares are not material in relation to her net worth.

CASE 2: Mary Reed, a new staff auditor with the firm, has recently separated from her husband. Mary has filed for divorce, but the divorce cannot become final for at least five mots. The property settlement is being bitterly contested. Mary’s husband has always resented her professional career and has just used community property to acquire one share of common stock in each of the publicly owned companies audited by the office in Mary works.

For one case, you are to (Students with last names beginning A-L CASE 1, M-Z CASE 2, your reply should be on the opposing case):

1. Set forth arguments indicating that the firm’s independence has NOT been impaired.
2. Set forth arguments indicating that the firm’s independence HAS been impaired.
3. Express your personal opinion. Identify those arguments from pat (a) and (b) that you found most persuasive. If you believe that the firm’s independence has been impaired, make suggestion about how the problem might be resolved.

Answer 1

Case 1

a.

Moore and Scott are not married or related; they are merely friends. They have made no special commitments to one another, and therefore the relationship is not equivalent to that of a spouse. Substantial differences exist between their relationship and that of marriage. For example, their relationship does not create community property or rights of inheritance. Hence, the joint financial interests of marriage are not created merely by the couple's living together.

Given that the relationship is not equivalent to that of a spouse, Scott's investment cannot be considered "direct" from Moore's viewpoint. Scott, not Moore, makes the investment decisions and receives the benefits. The securities are held in Scott's name. Moore's interest, if any, must be considered only indirect. Hence, independence is not impaired as the investment is not material to the couple's combined net worth. A third party with knowledge of all of the facts would not conclude that an unacceptable risk to independence exists.

b.

The basic issue is appearance of independence to an informed third party. Many people view living together as essentially equivalent to marriage and would view Scott as a spousal equivalent. Thus, Moore's appearance of independence is impaired. Since he is a partner, this impairs the independence of the firm.

The Code of Professional Conduct states that to assess the effects of such a relationship on independence, the CPA must consider both actual ability to act independently, and whether a reasonable person aware of all the facts would consider the relationship to be equivalent to that of a spouse. As Moore and Scott are romantically linked and are living together, it is reasonable to assume that Moore's concern over Scott's financial well-being might come into conflict with his objectivity with respect to the audit client in which Scott has invested.

c. Note to instructor: Part (c) calls for a personal opinion. We offer our opinion only as a basis for discussion; it should not be used as a standard for evaluating students' responses.

The appearance of independence is a matter of judgment. We believe that many people will think that Moore participates directly in Scott's investment decisions, at least as they relate to Moore's audit clients. In addition, we think that "living together" tends to create a certain "joint financial interests," in which each partner has a vested interest in each other's solvency. Scott should be viewed as a spousal equivalent. Thus, we feel that Moore's independence has been impaired. To resolve this problem, either Scott must refrain from investing in the audit clients of Moore's firm, or the two must live separately.

Case 2

a. Because Mary is a staff auditor, while her independence would ordinarily be impaired through such direct financial interests, the independence of the firm would not if she is not a "covered member" under section A of Interpretation 101-1.

Alternatively, if one wishes to argue that she too is independent, article IV states that "A member in public practice should be independent in fact and appearance when providing auditing and other attestation services. Independence in appearance hinges on whether a reasonable person, having knowledge of all the facts including any safeguards, would conclude that an unacceptable threat to the CPA's independence exists. In this case, a reasonable person would not conclude that the minor holdings of Reed's husband would affect her independence of mental attitude.

The actions of Reed's husband clearly are vindictive. If such a situation is assumed to impair independence, a CPA's professional career could easily be held hostage in any marital disagreement. Also, the investment is not under Mary Scott's direct control. Hence, it should be considered an indirect investment, rather than direct. Since it is not material in amount, independence is not impaired. Finally, it is reasonable to assume that the firm would have safeguards to mitigate threats to independence.

b. Interpretation 101-1 specifically prohibits "any direct . . . financial interest" in an audit client by the CPA or his or her firm. Financial interests of a CPA's spouse are attributed directly to the CPA. The Code of Conduct does not recognize the degree of harmony within the marriage as relevant. Mary and her husband are married. Thus, his direct financial interest in her firm's audit clients impairs her independence. (The independence of the firm also will be impaired if she participates in the engagement.)

Also, since the investment is community property, Mary stands to benefit or lose as a direct result of fluctuations in the client's stock price. Materiality is not an issue with respect to direct financial interests.

c. In our personal opinion, it is unlikely that a third party with knowledge of all of the facts would conclude that there is an unacceptable risk to Mary’s independence.