Revised Rules Require More Scrutiny Regarding Independence– January 22, 2013 by Jenna Santisi

Does your auditor prepare your bank reconciliations, or did your most recent audit have to be completed in an unreasonable time frame? The independence issues these types of activities may create for your auditors will now be under closer scrutiny based on the recent revision of the Government Accountability Office’s (GAO) Yellow Book. That may mean enduring more questions from your auditors regarding independence issues for any financial audits or attestation engagements conducted for periods on or after December 15, 2012.

The Yellow Book revision established a “conceptual framework” for making independence determinations based on each situation’s unique facts and circumstances. Auditors must identify potential threats to independence, evaluate the significance of those threats and apply safeguards to eliminate any resulting risks.

There are seven broad categories of threats to independence that auditors are required to evaluate when they’re identified. Auditors must evaluate these threats both individually and in the aggregate:

1. Self-interest
2. Self-review
3. Bias
4. Familiarity
5. Undue influence
6. Management participation
7. Structural

Once a threat is identified, the auditor must determine whether the threat relates to a non-audit service, specific types of which are prohibited by this latest Yellow Book revision. Non-audit services, which auditors frequently provide to smaller entities, can include preparing financial statements, journal entries other than proposed entries and reconciliations. However, these services are not considered to impair independence if the entity being audited assumes all management responsibilities; designates an individual who has suitable skills, knowledge or experience to oversee the service; evaluates the results of the service and accepts responsibility for the results of the service. An example of a non-audit service that would impair independence is if the auditor determined or changed journal entries, account codes or classifications for transactions, or other accounting records for the entity without obtaining management’s approval. If your auditor provides any type of non-audit services, be prepared to have a discussion with them about independence.

If the auditor identifies any significant threats to independence, safeguards must be identified and applied. Safeguards are controls designed to eliminate, or reduce to an acceptable level, threats to independence. In some cases, multiple safeguards may be necessary.

Auditors must document the threats and resulting safeguards. In certain situations, the auditor may be able to rely on safeguards that the organization has implemented. In this scenario, be prepared to answer more questions than usual to identify any safeguards present that may alleviate the situation. After safeguards are applied, their effectiveness must be evaluated. If the applied safeguards did not eliminate an unacceptable threat or reduce it to an acceptable level, independence would be considered impaired and new auditors would be needed.

Contact Jenna Santisi at for more information.

This communication is for information only, and any action should only be taken after a detailed review of the specific situation and appropriate consultation.

Notwithstanding that these materials do not constitute legal, accounting or other professional advice, as may be required by United States Treasury Regulations and IRS Circular 230, you should be advised that these materials are not intended or written to be used, and cannot be used by you or any other person, for the purpose of avoiding penalties that may be imposed under federal tax laws. No written statement contained in these materials may be used by any person to support the promotion or marketing of or to recommend any federal tax transaction(s) or matter(s) addressed in these materials, and any taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor with respect to any such federal tax transaction matter.