Question

Management has the responsibility of accurately preparing financial statements when communicating with investors and creditors. Another group, auditors, serves an independent role by helping to ensure that management has in fact appropriately applied GAAP in preparing the company's financial statements. Auditors examine (audit) financial statements to express a professional, independent opinion. The opinion reflects the auditors’ assessment of the statements’ fairness, which is determined by the extent to which they are prepared in compliance with GAAP. Suppose an auditor is being paid $1,000,000 by the company to perform the audit. In addition, the company plans to pay the auditor $500,000 over the next year for business consulting advice and another $200,000 for preparing its tax returns. The auditor and management of the company have always shared a friendly relationship, which partly explains the company's willingness to give the auditor additional work for $700,000.

Questions:

1. Summarize your case.

2. What is the dilemma?

3. What is the ethical solution?

4. What would you do if you are faced with the dilemma?

Answer 1

Summary:

Independence of the Auditor might be at stake. SEC and PCAOB has set certain rules and guidelines to not let Auditor take up non audit services to the client. In the given scenario, the Independence of the Auditor might be at stake as the Auditor has the business proposal awaiting for the next finacial year. It is recommended to take prior approval from Audit committee. And to disclose any business transaction with auditor in the annual reports to keep the shareholders notified about the facts.

Business consultancy service:

Business consultancy services is prohibited to be taken up by the Auditor.

Tax returns preparation:
The Sarbanes-Oxley Act of 2002 enumerated certain prohibited services and relationships that are deemed to impair an auditor’s independence, including bookkeeping, financial information systems design and implementation, appraisal and valuation services, actuarial services and internal audit services. Notably absent from the list are tax services.

As a general rule, auditor-provided tax services don’t raise independence issues, so long as the company’s audit committee approves the arrangement. But that doesn’t mean the arrangements are always permissible. Even though tax services aren’t prohibited, they may violate SEC auditor independence rules if they create a conflict of interest — for example, if an auditor developed tax strategy results in sanctions against the company or some other legal liability. Under SEC rules, auditor independence may also be impaired if the auditor is placed in the position of auditing his or her own work or serving as an audit client’s advocate.

Also, the Public Company Accounting Oversight Board (PCAOB) prohibits auditors from providing tax services under certain circumstances. For example, tax services aren’t permitted if the auditor receives a commission or contingent fee for such services, advises the company regarding certain confidential or “aggressive” tax transactions, or provides tax services to someone in a financial oversight role with the company.

It is to be noted that the restriction by SEC and PCAOB pertains only to the financial year to which the audit pertains and not anytime after the Auditor-client relation terminates.

However proper vigilance must be exercised by the auditor and the Audit Committee to maintain Auditor’s independence.