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entitled 'Government Auditing Standards:  Answers to Independence 
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By the Comptroller General of the United States:



July 2002:



GOVERNMENT AUDITING STANDARDS:



Answers to Independence Standard Questions:



GAO-02-870G:



Contents:



Questions Relating to Independence Standard Implemen-

tation and Transition:



Questions Concerning Certain Independence Standard Underlying 

Concepts:



Audit and Nonaudit Services:



Overarching Principles and Safeguards:



Significance/Materiality:



Management Functions:



Subject Matter of the Audit:



Personal Impairments:



Questions about Applying the Independence Standard in Specific Nonaudit 

Circumstances:



Bookkeeping Services:



Financial Statement Review and Basic 

Accounting Assistance:



Internal Audit Services:



Information Technology Services:



Work of Specialists:



Tax Services:



Budget Work:



Human Resource Services:



On January 25, 2002, we issued an amendment to Government Auditing 

Standards (1994 revision), Amendment No. 3, Independence, which 

substantially changed the previous standard to better serve the public 

interest and to maintain a high degree of integrity, objectivity, and 

independence for audits of government entities. While the new amendment 

deals with a range of auditor independence issues, the most significant 

change relates to the standards associated with nonaudit, or consulting 

services.



Understandably, we have received many inquiries about the new 

independence standard due to its significant effect on auditors in 

connection with audits of federal entities and funds and on those who 

have adopted or are otherwise required to use Government Auditing 

Standards. Indeed, when we issued the new standard, we indicated that 

we planned to subsequently provide further guidance in the form of 

questions and answers to assist in its implementation. Accordingly, 

this document responds to questions related to the independence 

standardís implementation time frame, underlying concepts, and 

application in specific nonaudit circumstances.



In making judgments on independence under Government Auditing Standards 

and applying the independence standardís principles and safeguards, 

audit organizations should take a ďsubstance over formĒ approach and 

consider the nature and significance of the services provided to the 

audited entity--the facts and circumstances. Before an audit 

organization agrees to perform nonaudit services, it should carefully 

consider the need to avoid situations that could lead reasonable third 

parties with knowledge of the relevant facts and circumstances to 

conclude that the auditor is not able to maintain independence in 

conducting audits. It is imperative that auditors always be viewed as 

independent in fact and appearance.



Importantly, when the independence standard was issued, we called for 

its provisions to be applicable to all audits for periods beginning on 

or after October 1, 2002. Because of the breadth of changes in the 

amendment and to allow additional time for the new independence 

standardís effective implementation, we are extending its effective 

date to be applicable to all audits for periods beginning on or after 

January 1, 2003.



Also, when we issued the new independence standard on January 25, 2002, 

we intended for audit organizations to begin their transition at that 

time. We have since found that some audit organizations affected by the 

new independence standard, particularly smaller audit organizations and 

those in remote locations, may not have become immediately aware of its 

issuance and that many audit organizations have raised implementation 

questions. Accordingly, we are providing the following guidance to 

audit organizations to use in transitioning to the new independence 

standard.



Nonaudit services that were completed prior to January 25, 2002, are 

exempt, or grandfathered, from the new independence standardís 

provisions. Also exempt are nonaudit services that were performed under 

a binding contract entered into, or that were initiated by a government 

audit organization, by June 30, 2002, provided the work is completed 

before June 30, 2003.



Also with the next update of Government Auditing Standards and based on 

the information this document provides, we plan several modifications 

to the independence standard. We will:



* expand paragraph 3.13, footnote 1, to fully recognize that auditors 

who are required to follow the new independence standard in conducting 

their audit work must also be aware of and comply with any applicable 

government ethics laws and regulations and any other ethics 

requirements (such as those of state boards of accountancy) associated 

with their activities;



* clarify paragraph 3.14, footnote 2, to specify that the independence 

standardís provisions related to using the work of specialists applies 

to external consultants and firms performing work for the audit 

organization; and:



* establish a requirement, in a new footnote to paragraph 3.26a, that 

an audit organization should obtain from an audited entityís management 

an acknowledgement in its management representation letter, which is 

required by Government Auditing Standards, of the role of an audit 

organization in drafting financial statements and notes and in 

converting cash-based financial statements to accrual-based financial 

statements, as well as managementís review, approval, and 

responsibility for the financial statements, related notes, and accrual 

adjustments.



This question and answer document was provided in draft for input to 

the Comptroller Generalís Advisory Council on Government Auditing 

Standards, and the major concepts were discussed with other interested 

parties. The council includes 21 experts in financial and performance 

auditing and reporting drawn from all levels of government, academia, 

private enterprise, and public accounting.



An electronic version of this document can be accessed at (http://

www.gao.gov/govaud/ybk01.htm). If you have any questions regarding this 

document or the independence standard, please contact Jeffrey C. 

Steinhoff, Managing Director, Financial Management and Assurance, at 

(202) 512-2600, or Marcia B. Buchanan, Assistant Director, Financial 

Management and Assurance, at (202) 512-9321.



David M. Walker

Comptroller General

of the United States:

Signed by David M. Walker:



[End of section]



Questions Relating to Independence Standard Implementation and 

Transition:



On January 25, 2002, we issued an amendment to Government Auditing 

Standards (1994 revision), Amendment No. 3, Independence. As provided 

in this amendment, the Government Auditing Standardsí second general 

standard is as follows:



In all matters relating to the audit work, the audit organization and 

the individual auditor, whether government or public, should be free 

both in fact and appearance from personal, external, and organizational 

impairments to independence.



Regarding this standard, GAO recognizes that audit organizations have 

the capability of performing a range of services for their clients. 

However, for audits that are required to be conducted under Government 

Auditing Standards, in certain circumstances it is not appropriate for 

an audit organization to perform both audit and selected nonaudit 

services for the same client. In these circumstances, an audit 

organization and/or an audited entity will have to make a choice as to 

which of these services an audit organization will provide.



When issued, the new independence standard provided for audit 

organizations to implement its provisions for all audits for periods 

beginning on or after October 1, 2002. Because of the breadth of 

changes related to the independence standard, this time frame is being 

extended. The independence standardís provisions are applicable to all 

audits for periods beginning on or after January 1, 2003.



Also, when we issued the new independence standard on January 25, 2002, 

we intended for audit organizations to begin their transition at that 

time. We have since found that some audit organizations affected by the 

new independence standard, particularly smaller audit organizations and 

those in remote locations, may not have become immediately aware of its 

issuance and that many audit organizations have raised implementation 

questions. Accordingly, we are providing the following guidance to 

audit organizations to use in transitioning to the new independence 

standard.



Nonaudit services that were completed prior to January 25, 2002, are 

exempt, or grandfathered, from the new independence standardís 

provisions. Also exempt are nonaudit services that were performed under 

a binding contract entered into, or that were initiated by a government 

audit organization, by June 30, 2002, provided the work is completed by 

June 30, 2003.



These matters are discussed in response to the following questions.



1. The new independence standard supersedes preexisting professional 

standards under which an audit organization could have performed 

certain nonaudit services, such as certain accounting entry and payroll 

processing activities, without impairing audit organization 

independence. Would performing such nonaudit services prior to the new 

standardís release on January 25, 2002, impair an audit organizationís 

independence?



No. If such services were performed prior to the new standardís release 

and they were in compliance with the then existing professional 

standards, an audit organizationís independence would not be impaired. 

Nonaudit services performed before January 25, 2002, are exempt, or 

grandfathered, from the application of the new standard.



2. On the date the independence standard was issued some audit 

organizations may have been under contract to provide both audit and 

nonaudit services. In that case, how should an audit organization make 

the transition to the new standard?



Contracts for nonaudit services that were signed prior to January 25, 

2002, (the date that the new standard was issued) will also be exempt, 

or grandfathered, provided the nonaudit work is completed by June 30, 

2003, and would not have violated preexisting professional standards. 

This transition period for already established contracts will provide 

an audit organization and an audited entity time to make other 

arrangements for conducting either the nonaudit services or the audit, 

if necessary.



3. How would this exemption apply to binding contracts for nonaudit 

services that may have been signed on or after January 25, 2002?



Originally, our intent was that any nonaudit service contract awarded 

on or after January 25, 2002, would not be exempt, or grandfathered. 

However, some audit organizations may not have understood this or were 

not aware of the standard when it was issued on January 25, 2002. To be 

fair to these audit organizations, we will exempt, or grandfather, all 

nonaudit services that were initiated, agreed to, or performed by June 

30, 2002, provided the work is completed by June 30, 2003.



4. Would a nonaudit service performed or initiated by a government 

audit organization on or after January 25, 2002, but by June 30, 2002, 

be similarly exempt, or grandfathered?



Yes, if the work is completed by June 30, 2003.



5. What about nonaudit services related to contracts that may be 

signed, or initiated by a government audit organization, from July 1, 

2002, through January 1, 2003?



The new independence standardís provisions would apply to these 

nonaudit service engagements.



6. Regarding a contract for nonaudit services that is exempt, or 

grandfathered, would an audit organizationís independence be affected 

if the contract was extended after June 30, 2002?



Yes. On these contracts, extensions and change orders would be 

considered new contracts and viewed in light of the two overarching 

principles and safeguards.



7. On June 25, 2002, an audit organization was engaged to design and 

implement a financial system for an entity and the work is completed by 

June 30, 2003. Would this impair the independence of an audit 

organization to conduct the entityís financial statement audit for 

periods beginning after January 1, 2003?



No. An audit organizationís independence would not be impaired for 

nonaudit services that began, or were agreed to, by June 30, 2002, and 

are completed on or before June 30, 2003. However, as audit 

organizations enter into new contracts, or accept requests for 

additional nonaudit services, they should consider the overarching 

principles and the safeguards.



8. On June 25, 2002, an audit organization was engaged to design and 

implement an entityís accounting system, and the work is completed in 

November 2003. When would an audit organization be considered 

independent to perform the entityís financial statement audit?



In this case, an audit organization completed the nonaudit service 

engagement in November 2003, or after the transition period ended on 

June 30, 2003. Therefore, an audit organizationís independence to 

perform the entityís financial statement audits is impaired for as long 

as the entity uses the accounting system. The passage of time has no 

impact on the impairment unless the system is subsequently upgraded or 

redesigned to such an extent that it would be considered a new system. 

If that were to occur, the new standardís overarching principles would 

not be violated because an audit organization would not be auditing its 

own work.



9. In the above situation, would an audit organizationís independence 

be impaired if it were engaged to perform the nonaudit service after 

June 30, 2002, but before January 1, 2003, and the nonaudit services 

were completed by June 30, 2003?



An audit organizationís independence would be impaired. For a nonaudit 

service to be exempt, or grandfathered, an audit organization must have 

been engaged to perform the nonaudit service by June 30, 2002, and the 

related nonaudit work must be completed by June 30, 2003.



[End of section]



Questions Concerning Certain Independence Standard Underlying 

Concepts:



Before an audit organization agrees to perform nonaudit services, it 

should consider the need to avoid situations that could lead reasonable 

third parties with knowledge of the relevant facts and circumstances to 

conclude that the auditor is not able to maintain independence in 

conducting audits. The standard for nonaudit services is based on two 

overarching principles:



* Auditors should not perform management functions or make management 

decisions.



* Auditors should not audit their own work or provide nonaudit services 

in situations where the amounts or services involved are significant/

material to the subject matter of the audit.



For nonaudit services that do not violate the above principles, certain 

supplemental safeguards would have to be met. For example, (1) 

personnel who perform nonaudit services would be precluded from 

performing any related audit work, (2) an audit organizationís work 

could not be reduced beyond the level that would be appropriate if the 

nonaudit work was performed by another unrelated party, and (3) certain 

documentation and quality assurance requirements must be met.



We have received inquiries related to some of the concepts underlying 

the two overarching principles and the safeguards. We have been asked, 

for example, for further guidance regarding what constitutes a 

management function, significance/materiality, and the subject matter 

of the audit. This section provides information on a range of areas 

such as these.



Audit and Nonaudit Services:



10. Because of the significant and differing effects audit and nonaudit 

services can have on audit organization independence, how can an audit 

organization distinguish between them?



GAGAS define audit services as financial audits, attestation 

engagements, and performance audits. In nonaudit services, audit 

organizations perform tasks requested by management that directly 

support the entityís operations. Nonaudit services (1) are generally 

performed for the sole use and benefit of the entity requesting the 

work or (2) provide information or data to a requesting party without 

providing verification, analysis, or evaluation of the information or 

data and, therefore, the work does not usually provide a basis for 

conclusions, recommendations, or opinions on the information or data. 

The nature and scope of a nonaudit service is generally determined by 

agreement between an audit organization and an audited entity or by the 

requesting party. In contrast, the nature and scope of an audit is 

determined by an audit organization in order to satisfy the audit 

objectives.



11. The independence standard, paragraph 3.26, gives examples of 

nonaudit services that typically would not create an impairment to an 

audit organizationís independence. Is the provision of these services a 

safe harbor?



No. The examples in paragraph 3.26 are illustrative in nature. The 

facts and circumstances of each nonaudit service always need to be 

considered in light of the two overarching principles and the substance 

over form doctrine. If either of the principles would be violated, an 

audit organization and/or the audited entity need to decide whether an 

audit organization will provide the nonaudit service or perform the 

audit.



12. May staff members of an audit organization who provide nonaudit 

services convey to the audit organizationís audit engagement team 

information based on the knowledge gained about an audited entity and 

its operations?



Yes. The independence standard permits such knowledge sharing. The 

nonaudit service team may have specific understanding of an audited 

entityís internal controls that, for example, could be useful to the 

audit engagement team in planning the audit. Since the audit engagement 

team is required to obtain a sufficient understanding of internal 

controls to plan the audit and to determine the nature, timing, and 

extent of tests to be performed, the understanding that the nonaudit 

assignment team may have of an audited entityís operations can 

significantly assist in fulfilling this requirement. This information 

can be conveyed to the audit engagement team and documentation from the 

nonaudit team can be transferred for use by the audit engagement team; 

but the nonaudit service team cannot otherwise participate in the 

audit. However, the audit engagement team should be mindful that 

knowledge shared by the nonaudit service team cannot be used to reduce 

the audit work beyond the level that would be appropriate if the 

nonaudit work was performed by another unrelated party.



13. What circumstances can give rise to personal impairments to 

independence and how can an audit organization detect and prevent them?



The independence standard, in paragraph 3.15, presents examples of 

personal impairments to independence, including factors such as having 

a direct or a significant/material indirect financial interest in an 

audited entity or program. An audit organization and its staff members, 

including internal experts and specialists, need to be alert to 

possible impairments to staff member independence. To assist in this 

regard, an audit organization should have an internal quality control 

system (see paragraph 3.15) to help determine if its auditors and 

internal experts and specialists have any personal impairment to 

independence that could affect their impartiality or the appearance of 

impartiality on a given assignment.



14. If an audit organization is asked to evaluate a programís 

efficiency, can it perform this work as a performance audit (instead of 

as a consulting engagement) without impairing its independence to do 

further audits for the requesting entity?



This work could be done as either a performance audit or as a 

consulting engagement. If the work is performed in accordance with the 

GAGAS performance auditing standards, including the general, fieldwork, 

and reporting standards, the provisions of the independence standard in 

paragraphs 3.18 through 3.26 do not apply, and an audit organizationís 

independence would not be impaired. If performed as a consulting 

service, this work would be considered a nonaudit service. In that 

case, the independence standardís overarching principles must not be 

violated and the safeguards must be applied.



Overarching Principles and Safeguards:



15. As indicated previously, the new independence standard is 

principles-based. Is there a practical, impartial way for audit 

organizations to apply the overarching principles without the new 

standard being construed as rules-based?



Yes. Making decisions involving possible independence impairment 

related to audit and nonaudit services for the same audited entity will 

require reasonable judgment by audit organizations and auditors. In 

each case, the decision on whether independence is impaired is likely 

to rest on different factors, considering the nature of the nonaudit 

service and its significance/materiality to the subject matter of the 

audit. In other words, the facts and circumstances of the nonaudit 

service drive the judgment.



In addition, the audit organization should consider the totality of 

services provided to the audited entity in making reasonable judgments 

on independence. Overall, an audit organization should use a ďsubstance 

over formĒ approach in applying the principles and safeguards. For 

example, if in substance, the audit organization is effectively 

maintaining the official accounting records, the audit organization has 

violated the overarching principles and the express prohibition in 

paragraph 3.26a.



16. What is the potential impact on an audit organizationís 

independence if it provides nonaudit services?



Audit organizations that provide nonaudit services should consider 

whether providing these services creates an impairment, either in fact 

or appearance, that adversely affects its independence for conducting 

audits. If an audit organization provides a nonaudit service that would 

cause it to violate one or both of the overarching principles, an audit 

organization would not be considered independent in performing any 

related audit services to an audited entity. When a potential 

independence impairment may arise in subsequent audit work, an audit 

organization and/or an audited entity must decide which of the services 

(either audit or nonaudit) the audit organization will provide. It 

becomes a matter of choice.



17. If one office or unit of an audit organization performs a nonaudit 

service that would violate either of the two overarching principles for 

a particular audited entity with respect to subsequent audit work, 

could another of the audit organizationís offices or units perform the 

subsequent audit without being impaired?



No. When any one office or unit of an audit organization performs 

nonaudit services for an audited entity, it affects the entire audit 

organizationís independence as it relates to that entity.



We consider an audit organization to be (1) a federal, state, or local 

government organization that performs financial, attestation, and 

performance audits or (2) a form of organization permitted by state law 

or regulation that is engaged in the practice of public accounting. One 

office or unit of an audit organization is not differentiated from 

another. Consequently, each office or unit is considered to be part of 

the same audit organization rather than separate audit organizations. 

Therefore, it is of utmost importance for an audit organization to 

always be aware of nonaudit services performed across its offices or 

units.



18. An audit organization has put a firewall between its consulting and 

auditing units. Could the work of the consulting unit affect the audit 

organizationís independence to perform audits?



Yes. In this case, both units are still part of the same organization. 

Therefore, the independence standardís overarching principles and 

safeguards would apply.



19. If an audit organization sells its consulting unit to another firm 

or the consulting unit was spun off as an independent entity, what 

would be the affect on the audit organizationís independence to perform 

audits?



In addressing independence matters under the new independence standard, 

an audit organization cannot do indirectly what it cannot do directly. 

If an audit organization has totally divested itself of the consulting 

unit--that is, it does not have any direct financial interest in the 

consulting unit and/or control over its work--an audit organizationís 

independence to perform audits would not be impaired by subsequent 

nonaudit services provided by its former consulting unit.



However, if the audit organization retains any direct financial 

interest in its former consulting unit, the audit organizationís 

independence would be impaired by any work done by the consulting unit 

that would violate an overarching principle had the audit organization 

done the nonaudit service itself. Likewise, if an audit organization 

has a direct financial interest in any other entity that provides 

consulting services, an audit organizationís independence would be 

impaired by work done by this other entity in the same manner as it 

would be for a consulting unit that it sold or spun off. These 

situations exemplify the application of the substance over form 

doctrine and why it is always important for an audit organization to 

think of its work in that context.



20. In the above circumstance, what about the audit organizationís 

independence with regard to nonaudit services its former consulting 

unit performed before it was sold or spun off?



For these prior services, unless the nonaudit service provided by the 

audit organizationís former consulting unit was exempt, or 

grandfathered, from the independence standard, the audit organizationís 

independence would be affected in the same way it would have been 

affected if the consulting unit were still under the ownership and 

control of the audit organization.



21. Is an audit organizationís independence affected by an affiliation 

with a team, consortium, or partnering arrangement with other 

organizations?



Affiliations such as these would not, in and of themselves, cause an 

impairment to independence. Any impairment to the audit organizationís 

independence would depend on the specific facts and circumstances of 

its involvement as they relate to the overarching principles. 

Specifically, an audit organization would need to consider its specific 

work, role, and financial interest in order to assure that it does not 

impair its independence by violating the overarching principles and it 

complies with the safeguards, as applicable.



22. The senior leadership or partners of an audit organization 

establish a new entity, separate and apart from the audit organization 

that provides nonaudit or consulting services. The senior leadership or 

partners of the audit organization own and/or control the new entity. 

Since the audit organization itself does not have a direct financial 

interest in or control of the new entity, what would be the effect on 

the audit organizationís independence to perform audits?



As stated previously, under the new independence standards, an audit 

organization cannot do indirectly what it cannot do directly. Under the 

arrangement described in the question, applying the substance over form 

doctrine, the audit organization would be impaired by any work done by 

this new entity that would have violated an overarching principle had 

the audit organization done the work itself.



In this case, the senior leadership or partners of the audit 

organization would clearly have a substantial vested interest in the 

work of the new entity and its success. In substance, the audit 

organization would be attempting to do through the new entity what it 

could not do itself and still maintain its audit independence. An audit 

organization must always be careful to ensure that it is independent 

both in fact and appearance. A reasonable third party would most 

certainly question this relationship as being one of form over 

substance to the extent the new entity was doing work that would impair 

audit independence if done by an audit organization.



23. If an audit organization performs a nonaudit service that results 

in an impairment to its independence at one federal agency, would this 

impairment extend to other federal agencies as well?



No. However, there is a caveat. Generally, if an audit organization has 

an impairment to independence related to one particular governmental 

agency--whether at the federal, state, or local level--an audit 

organizationís independence is not impaired with respect to other 

governmental agencies, as long as the two agencies are separate 

entities.



At the federal level, for example, the Department of Health and Human 

Services (HHS) and the Social Security Administration (SSA) are 

separate entities. Therefore, if an audit organization provides HHS 

nonaudit services, it would not affect an audit organizationís 

independence as it related to audits at SSA.



An exception to this example would be created if the subject matter of 

the audit involved any areas where the work of HHS and SSA may overlap 

or where one of these organizations may be providing services to the 

other. These situations could result in the nonaudit service being 

material to the audit objectives and an audit organization auditing its 

own work, which would violate an overarching principle. Accordingly, 

the audit organization needs to be alert for such situations and, 

applying the substance over form doctrine, ensure that it does not 

violate the overarching principles and applies the safeguards.



24. If an audit organization does consulting work involving the 

valuation of a material line item for the financial statements of a 

particular bureau within a major department, is the audit organization 

independent to conduct the bureauís financial statement audit?



No. The audit organization would not be independent to conduct the 

bureauís financial statement audit because the nonaudit service would 

be significant/material to the subject matter of audit, which would 

violate the overarching principle that audit organizations should not 

audit their own work.



25. In the above situation, would the audit organization be independent 

to conduct the departmentís financial statement audit?



It would depend on the materiality of the bureau-level line item at the 

department level. If the valuation were significant/material to the 

departmentís financial statements, the audit organizationís 

independence would be impaired in connection with the department as 

well. On the other hand, if the valuation is not material/significant 

to the departmentís financial statements, the audit organizationís 

independence is not impaired and it could perform the audit of the 

department, provided it complies with the safeguards. 



26. How would an audit organizationís independence be affected if it 

provides nonaudit services to an entity that provides a central 

service, such as payroll processing, to support each of a departmentís 

entities and other departments as well?



An audit organization would apply the independence standardís 

overarching principles and safeguards as discussed in the previous 

response. In the example cited in this question, the audit 

organizationís independence could be impaired to perform audits for the 

department and its components, as well as other federal agencies, when 

personnel costs or payroll operations are significant/material to the 

subject matter of the audit. At the federal level, for example, the 

Department of Agricultureís (USDA) National Finance Center provides 

payroll services for USDAís components and for many other departments 

and agencies.



27. What routine activities can an audit organization provide without 

impairing its independence and requiring it to apply the safeguards?



The independence standard, paragraph 3.23, lists several routine 

activities that are always viewed as not significant/material to the 

subject matter of the audit and that an audit organization can provide 

without impairing independence provided the audit organization does not 

make management decisions or perform management functions. For example, 

an audit organization can provide routine advice to an audited entity 

and its management to assist in activities such as establishing 

internal controls or implementing audit recommendations, can answer 

technical questions, and/or provide training. Other examples of 

activities that the audit organization can be involved with that are 

considered routine include providing tools and methodologies, such as 

best practice guides, benchmarking studies, and internal control 

assessment methodologies; collaborating with others to strengthen 

professional standards; developing audit methodologies; and providing 

legal/accounting opinions or other assistance to a legislative body. 

The decision to follow the audit organizationís advice remains with 

management of the audited entity.



28. A federal government office of inspector general has as its mission 

both audit and investigative functions and is required to follow 

Government Auditing Standards for audits. When a federal inspector 

general undertakes an investigation, is it considered an audit or a 

nonaudit service for purposes of applying the independence standard?



When a federal office of inspector general undertakes an investigation, 

it is considered to be neither an audit nor a nonaudit service and 

GAGAS does not apply.



29. Would the previous answer apply if the federal inspector general 

performed an inspection using the Presidentís Council on Integrity and 

Efficiency standards?



Yes.



30. Would the safeguards apply if an audit organization provides a 

nonaudit service that may not be a routine activity, but involves only 

a de minimis amount of time to perform?



An audit organization always must ensure that the nonaudit service does 

not violate the overarching principles. If the overarching principles 

are not violated, then the safeguards must be considered.



In applying the safeguards and for reasons of efficiency and 

practicality, if the nonaudit service involves a total of 40 hours or 

fewer as it relates to a specific audit engagement, the safeguard 

associated with precluding personnel who provided the nonaudit service 

from performing related audit work would not be required. The other 

safeguards in paragraph 3.25, though, would apply.



Auditors and audit organizations need to consider related services that 

may have been performed under separate contracts or separate 

engagements in applying the de minimis criteria, and they should not 

inadvertently or purposely perform related services under separate 

contracts or engagements in a manner that would circumvent the 

safeguards. Related nonaudit services need to be considered together in 

determining the overall time involved in performing the services.



In applying the safeguards, audit organizations need to be able to 

articulate why the nonaudit service should be considered as a separate, 

unrelated service to other nonaudit services being provided. Substance 

over form is paramount, and ďunbundlingĒ of services should not be used 

as a means to circumvent an impairment to independence. This situation 

would be considered a serious violation of the GAGAS independence 

standard and could cast doubt on the integrity of the audit 

organization.



31. If an audit organization provides a nonaudit service that has no 

relationship whatsoever to any ongoing or planned future audit work, 

would all of the safeguards apply?



No. If the nonaudit service has no relationship whatsoever to either 

ongoing or planned audits under GAGAS, then the safeguards concerned 

with (1) precluding personnel who provided the nonaudit service from 

performing related audit work (paragraph 3.25c), and (2) reducing the 

scope of related audit work (paragraph 3.25d) would not be applicable.



At the same time, in deciding whether to provide a nonaudit service, 

government audit organizations should consider their broad audit 

responsibilities and any legislative or other requirements that would 

limit their ability to decline to provide future audit work, as 

discussed in paragraph 3.24. While a nonaudit service may have no 

relationship to current or planned audits, it could affect the 

independence of the audit organization to perform future audit work. 

For this reason, the other safeguards in paragraph 3.25 would apply. 

While a nongovernment audit organization also should consider its 

future commitments for audit services, as discussed in paragraph 3.24, 

it may be in a better position to decline to perform a future audit 

than a government audit organization. 



Significance/Materiality:



32. The independence standard uses the terms ďsignificantĒ and 

ďmaterial.Ē Are these terms synonymous?



Yes. Government Auditing Standards cover financial statement audits, 

where ďmaterialĒ is typically used, and performance audits, where the 

term ďsignificantĒ is typically used. Importantly, both terms involve 

the consideration of both quantitative and qualitative elements.



33. In determining significance/materiality, should an audit 

organization consider the cumulative nature of related nonaudit 

services?



Yes. Each nonaudit service should be considered in light of other 

previous or current nonaudit services. When considered in isolation, 

each nonaudit service may not be deemed significant/material; but when 

such services are considered cumulatively, they could be deemed 

significant/material and, therefore, impair auditor independence. This 

is one reason why it is important for an audit organization to document 

its nonaudit services and have the ability to track these services.



Management Functions:



34. As related to nonaudit services, what would constitute a management 

function?



This question can best be responded to by illustrating several types of 

situations that would typically constitute management functions. These 

include:



* serving as a member of an entityís management decision-making 

committee or on its board of directors (although participating as an 

observer or nonvoting ex-officio member is permitted under paragraph 

3.23),



* making policy decisions affecting the direction and operations of 

entity programs,



* supervising entity employees,



* developing entity programmatic policies,



* authorizing entity transactions, or:



* maintaining custody of entity assets (unless the assets are in the 

custody of an investigative unit and, under its statutory authority, 

are being held as evidence in a investigation).



It would be important that audit organizations ensure that the audited 

entity understands its responsibility for the substantive outcomes of, 

and is in a position to make an informed judgment on, the results of an 

audit organizationís nonaudit service. Audit organizations should 

carefully consider the evidence required by paragraph 3.25e that, in 

fact, the management-level individual designated to oversee the 

nonaudit service has the necessary qualifications to conduct the 

oversight needed.



35. If an individual auditor has a management responsibility related to 

an audited entity or is responsible for making decisions that could 

affect the audited entityís operations or its programs, can the audit 

organization retain its independence to audit the entity?



No. Making management decisions or having responsibility for managing 

the entity would violate one of the overarching principles. Were an 

individual auditor to perform management functions or make a management 

decision, the independence of the entire audit organization would be 

impaired.



Subject Matter of the Audit:



36. For a performance audit, what does the phrase ďsubject matter of 

the auditĒ mean? What does this phrase mean for a financial statement 

audit?



For performance audits, the subject matter of the audit is defined by 

the audit objectives, and it is generally limited to the program, 

activity, or operation under review. For financial statement audits, 

the subject matter of the audit is determined by the audit objectives 

as well, and can vary among audits. If the financial statement audit 

objective is to express an opinion on the financial statements taken as 

a whole, then the subject matter of the audit is the financial 

statements taken as a whole. If the financial statement audit objective 

is to express an opinion on each material unit within a state and local 

government, the subject matter of the audit is each material unit.



Personal Impairments:



Paragraph 3.13 states that auditors need to consider three general 

classes of impairments to independence--personal, external, and 

organizational--and provides a footnote indicating the need to also 

follow other codes of professional conduct. With the next Government 

Auditing Standards update, we will expand footnote 1 as follows:



Auditors who are required to follow the new independence standard in 

conducting their audit work must also be aware of and comply with any 

applicable government ethics laws and regulations and any other ethics 

requirements (such as those of state boards of accountancy) associated 

with their activities. For example, federal auditors need to be aware 

of and comply with the requirements associated with the Office of 

Government Ethics. Also, government and nongovernment auditors who are 

certified public accountants should follow the code of professional 

conduct of the state board with jurisdiction over the practice of the 

public accountant and the audit organization, as applicable, and if a 

member of the American Institute of Certified Public Accountants 

(AICPA), the AICPA code of professional conduct.



37. Paragraph 3.13, footnote 1, covers the need for nongovernment 

auditors to also follow certain codes of professional conduct. What 

about government auditors?



As noted above, we plan to expand paragraph 3.13, footnote 1, to cover 

government auditors as well. Also, we reiterate that all auditors who 

are required to follow the new independence standard in conducting 

their audit work must also be aware of and comply with any applicable 

government ethics laws and regulations and other requirements (such as 

those of state boards of accountancy) associated with their activities.



38. Under paragraph 3.25c of the independence standard, an audit 

organizationís personnel who provide nonaudit services are precluded 

from planning, conducting, or reviewing audit work related to the 

nonaudit service. What work is covered in planning, conducting, and 

reviewing audit work?



As discussed in GAGAS:



* Planning includes determining audit objectives, scope, and 

methodology; establishing criteria to evaluate matters subject to 

audit; and coordinating the work of other audit organizations. This 

excludes individuals whose roles are limited to gathering information 

used in planning the audit. (In this regard and as previously 

discussed, a nonaudit service team can convey knowledge to an audit 

engagement team.):



* Conducting includes performing audit tests and procedures necessary 

to accomplish the audit objectives in accordance with GAGAS.



* Reviewing includes examining the audit work and/or the report 

contents and substance to determine whether the audit objectives have 

been accomplished and the evidence supports the reportís technical 

content and substance prior to issuance.



39. If an individual audit staff memberís involvement in the nonaudit 

service, in fact and appearance, was insignificant, would paragraph 

3.25c preclude the audit staff from planning, conducting, or reviewing 

the audit work related to the nonaudit service?



No. In applying the substance over form doctrine to the facts and 

circumstances presented, the audit staff memberís independence would 

not be impaired.



40. If a staff member of an audit organization participated in an 

audited entityís policy-making responsibilities through previous 

employment with an audited entity, can they work on audits of the 

entity?



It would depend on the subject matter of the audit and time that has 

lapsed since the staff member participated in the policy-making. If the 

situation described involves policies--such as those covering an 

audited entityís financial reporting--that directly relate and are 

significant/material to the subject matter of the audit--such as a 

financial statement audit--it would constitute a personal impairment to 

the individual staff memberís independence. The auditor needs to be 

free from this personal impairment for ďa cooling-offĒ period before 

being allowed to work on audits involving this subject matter. Footnote 

5 (at paragraph 3.15c) states that the auditor needs to be free from 

this impairment for the period covered by the activity under audit, 

including any financial statements being audited, and for the period in 

which the audit is being performed and reported. In most cases, this 

means that individual staff members should recluse themselves of 

involvement with the audit for 2 years. However, this situation would 

not impair an audit organizationís independence to perform a financial 

statement audit for an audited entity.



41. Does the engagement-team concept apply to all financial, business, 

and employment relationships of an audit organization?



Yes. The independence standard, in footnote 7 to paragraph 3.17, 

provides that ďauditors participating in the audit assignment, 

including those who perform review of the report, and all others within 

an audit organization who can directly influence the outcome of the 

audit, need to be free from personal impairments.Ē Although this 

footnote specifically applies to paragraph 3.17, the engagement-team 

concept applies to all financial, business, and employment 

relationships discussed in paragraph 3.15.



42. As set out in paragraph 3.15g, personal impairment includes 

ďseeking employment with an audited organization during the conduct of 

the audit.Ē Can this personal impairment be mitigated through removing 

the individual from the engagement?



Yes. See paragraph 3.17.



43. What elements are needed in an internal quality control system over 

audit organization independence? If an audit organization is small, 

does the internal quality control system need to be as elaborate as 

that described in paragraph 3.16?



As discussed in paragraph 3.32 of Government Auditing Standards, the 

nature and extent of an audit organizationís internal quality control 

system depends on a number of factors, such as the audit organizationís 

size, the degree of operating autonomy allowed its personnel and its 

audit office, the nature of its work, its organizational structure, and 

appropriate cost-benefit considerations. Thus, the systems established 

by individual organizations will vary as will the need for, and the 

extent of, their documentation of the systems. However, each audit 

organization should prepare appropriate documentation to demonstrate 

compliance with policies and procedures to identify personal 

impairments to independence. For a small audit organization, this need 

not be elaborate. The substance over form doctrine is paramount in 

applying all key elements of this independence standard.



44. If the head of, or other individual employed by a government audit 

organization is included by statute as a member of an oversight board, 

such as one that is responsible for administering a governmental 

entityís pension system, can the audit organization still audit the 

program?



In paragraph 3.13, the standard states that in situations in which a 

government auditor, because of a legislative requirement or for other 

reasons, cannot decline to perform the work, the auditor can still 

perform and report on the audit. However, the impairment should be 

reported in the scope section of the audit report. In the disclosure, 

auditors can consider addressing the following issues: (1) the cause of 

the impairment, (2) the mandate to do the audit, and (3) any 

compensating actions taken to minimize the impairment.



45. Would the previous answer be different if a government auditor were 

required by statute to provide any nonaudit services that might 

otherwise violate the overarching principles?



No. The answer would be the same, as paragraph 3.13 covers all 

situations of this nature. In instances where a government audit 

organization is required by law to perform a nonaudit service and 

cannot decline to perform the work, it must ensure that the related 

audit report clearly makes the necessary disclosures, to ensure the 

situation is transparent to the reader of the audit report. However, if 

the statutorily required nonaudit service is a routine activity, as 

delineated in paragraph 3.23, that would not violate an overarching 

principle, applying the substance over form concept, disclosure in the 

audit report would not be necessary.



[End of section]



Questions about Applying the Independence Standard in Specific Nonaudit 

Circumstances:



The independence standard recognizes that audit organizations may 

encounter many different circumstances or combinations of circumstances 

that could result in an impairment to independence. At the same time, 

the standard in paragraph 3.23 recognizes that audit organizations can 

provide routine advice and answer technical questions without violating 

the two overarching principles or having to comply with the 

supplemental safeguards. The standard also provides examples of how 

certain nonaudit services are to be treated in determining audit 

independence.



The answers to the following questions provide further guidance to 

assist in implementing the independence standard in certain specific 

nonaudit circumstances.



Bookkeeping Services:



Several questions have been raised regarding an audit organizationís 

development of draft financial statements and notes and other 

bookkeeping services. Before responding to those questions, in the next 

Government Auditing Standards update, we plan to add the following 

requirement as a footnote after the first sentence in paragraph 3.26a.



If an audit organization has prepared draft financial statements and 

notes and performed the financial statement audit, it should obtain 

from the audited entityís management an acknowledgement in its 

management representation letter, required by Government Auditing 

Standards, the audit organizationís role in this regard and entity 

managementís review, approval, and responsibility for the financial 

statements and related notes. Likewise, if the audit organization 

converts cash-based financial statements to accrual-based financial 

statements, it should obtain from the audited entityís management an 

acknowledgement in its management representation letter the audit 

organizationís role in reflecting accruals and entity managementís 

review, approval, and responsibility for the accrual adjustments.



46. Can an audit organization be involved in preparing a trial balance 

and draft financial statements and notes without impairing its 

independence to audit the financial statements? Can audit engagement 

team members perform these activities?



Maintaining the audited entityís books and records is the 

responsibility of its management. Accordingly, management is 

responsible for ensuring that these books and records adequately 

support the preparation of financial statements in accordance with 

generally accepted accounting principles and that records are current 

and in balance.



If an audit organization were asked to prepare a trial balance, the 

audit organization would not impair its audit independence if the 

preparation of the trial balance was purely technical in nature. The 

trial balance should be based on managementís chart of accounts, and 

the audited entityís management must take responsibility for the trial 

balance. In other words, the preparation of the trial balance is a 

matter of formatting the chart of accounts into a trial balance. Work 

involving more than the technical formatting of the trial balance would 

impair independence because the audit organization would be performing 

a management function, which would violate an overarching principle.



The audit organizationís preparation of draft financial statements and 

note disclosures from a trial balance provided by entity management (or 

prepared by the audit organization as described above), which the 

management of the audited entity then reviews and approves, would not 

impair the auditorís independence (see paragraphs 3.26 and 3.26a). This 

work is considered technical assistance and as part of the audit. The 

audit organization must be careful not to make management decisions, 

and management of the audited entity must have the knowledge to 

evaluate and approve the draft financial statements and notes and take 

responsibility for them.



Further, the audit engagement team that prepared the trial balance and 

draft financial statements and notes could also perform the financial 

statement audit. The audit organization must comply with all other 

safeguards in paragraph 3.25. Also, the management representation 

letter, required by auditing standards, should acknowledge the audit 

organizationís role in preparing the trial balance and draft financial 

statements and related notes, and managementís review, approval, and 

responsibility for the financial statements and related notes.



Likewise, auditors can convert cash-based financial statements to 

accrual-based financial statements, as long as management is in the 

position to make informed judgments to review, approve, and take 

responsibility for the appropriateness of the conversion. In providing 

this service, the audit team that proposed the accruals could also 

perform the financial statement audit since this service is in 

substance the same as proposing adjusting or correcting entries as long 

as management makes the decision on accepting the entries. Similarly, 

as stated above, the management representation letter should also 

acknowledge the audit organizationís role in reflecting accruals and 

managementís review, approval, and responsibility for the accrual 

adjustments.



It is important to reiterate that the answer to this question is 

conditioned on the audit organization starting with appropriate books 

and records that balance and the audited entity having knowledgeable 

management. Where this is not the case, the audit organization must be 

careful not to cross the line of making managementís decisions or 

performing management functions and find itself in a position where 

reasonable third parties with knowledge of the relevant facts and 

circumstances could conclude that the auditor has, in effect, 

maintained the audited entityís books or records and, therefore, has 

impaired its independence to conduct the financial statement audit.



47. The AICPA defines the compilation of financial statements as 

presenting in the form of financial statements information that is the 

representation of management without undertaking to express any 

assurance on the statements. This definition acknowledges that the 

audit organization might find it necessary to perform other accounting 

services to compile the financial statements, such as adjusting the 

books of accounts or consulting on accounting matters. Can an audit 

organization provide a compilation service without impairing 

independence to audit subsequent period financial statements?



Yes. Compilations are generally performed to periodically supply 

financial information in an understandable format, such as quarterly 

financial statements. Similar in substance to drafting financial 

statements and notes, the compilation of financial information would 

not impair the audit organizationís independence as long as it does not 

make management decisions and management of the audited entity has the 

knowledge to evaluate and approve the compilation and to take 

responsibility for it. Also, the team that performed the compilation 

could perform the financial statement audit as long as the audit 

organization complies with the other safeguards in paragraph 3.25.



Similar to our answer to the previous question regarding the 

preparation of draft financial statements and notes, we reiterate that 

our answer is conditioned on the audit organization starting with 

appropriate books and records and the audited entity having 

knowledgeable management. Therefore, the audit organization was able to 

perform the compilation without having to reconstruct the books and 

records, and the audited entityís management was in a position to take 

responsibility for the compilation.



48. Paragraph 3.26a of the independence standard states that 

independence is impaired if the audit organization maintains or 

prepares an audited entityís basic accounting records or maintains or 

takes responsibility for basic financial or other records that an audit 

organization will audit. What is considered to be an entityís basic 

accounting records and basic financial or other records?



Basic accounting and financial records are considered to be source 

documents or originating data evidencing transactions have occurred 

(for example, purchase orders, payroll time records, and customer 

orders). Such records would also include an audited entityís general 

ledger and subsidiary records, or equivalent. Supporting schedules are 

not considered to be basic accounting or financial records, as long as 

management has made all the decisions in key areas regarding these 

supporting schedules. An example of a supporting schedule is a 

depreciation schedule, which the next question discusses further.



49. Can an audit organization assist an audited entityís management in 

preparing depreciation schedules without impairing its independence to 

perform the financial statement audit?



Yes, as long as the audited entityís management has determined such key 

factors as the method and rate of depreciation and the salvage value of 

the assets. If the audit organization makes these decisions, it has 

violated an overarching principle. To not impair its independence, the 

audit organizationís service must be limited to calculating the 

depreciation, and the audited entityís management must take 

responsibility for the depreciation schedules. The audit organization 

must take care that the extent of its work does not cross the line and 

place it in a position where reasonable third parties with knowledge of 

the relevant facts and circumstances could conclude that the auditorís 

independence is impaired. Also, given the nature of this nonaudit 

service, the audit organization would not have to apply the safeguard 

precluding personnel who provided the nonaudit services from auditing 

their own work. However, the remaining safeguards in paragraph 3.25 

would apply.



50. If the audit organization posts transactions coded by the audited 

entityís management, would the audit organizationís independence be 

impaired to perform the financial statement audit?



Yes. Paragraph 3.26a specifically addresses the posting of 

transactions, whether coded by management or not, to an entityís 

financial records or to other records that subsequently provide data to 

an entityís financial records. An audit organization cannot provide 

this service without impairing its independence to perform the 

financial statement audit.



51. An audit organization arrives at an audited entity for the first 

day of fieldwork and finds that the last quarterís cash receipts and 

disbursements and other transactions have not been recorded. To assist 

the audited entity in updating its financial records, the audit 

organization agrees to prepare and post all transactions to the general 

ledger based on the audit organizationís professional judgment. Would 

the audit organizationís independence be impaired to perform the 

financial statement audit?



Yes. The audit organization would be posting transactions to the 

audited entityís general ledger, which impairs its independence as 

discussed in paragraph 3.26a.



52. An audited entity provides an audit organization with a record of 

all cash receipts and cash disbursements made during the period. The 

audit organization (1) determines the appropriate classification of 

each transaction based on the available information (such as payee and 

description), (2) posts current-year transactions to the prior-year 

adjusted balance sheet and then determines necessary adjustments to 

convert the financial information to the accrual basis of accounting, 

and (3) uses this adjusted information to draft financial statements, 

which are reviewed with and approved by an audited entity. In this 

case, would an audit organizationís independence be considered impaired 

to perform the financial statement audit?



Yes. Determining the appropriate classification of receipts and 

disbursements, in substance, would be the same as maintaining/preparing 

an audited entityís basic accounting records. Likewise, posting current 

year transactions to the prior yearís balance sheet has the same affect 

as posting transactions to the audited entityís financial records. As 

discussed in paragraph 3.26a, activities such as these would impair an 

audit organizationís independence to perform the financial statement 

audit.



53. An audited entity provides its cash receipts and disbursements 

journals to the audit organization, which, as part of its financial 

statement audit, proposes adjusting entries to convert from a cash 

basis to an accrual basis of accounting. The audited entityís 

management, which has requested the conversion, reviews, approves, and 

posts the entries and has sufficient knowledge and ability to take 

responsibility for them. Would the audit organizationís independence be 

considered impaired for the financial statement audit?



No. An audit organization could perform these activities as part of a 

financial statement audit without impairing its independence, provided 

management of the audited entity is in a position to evaluate and take 

responsibility for results of the conversion. As with the answers to 

the earlier question related to converting financial statements from a 

cash to an accrual basis, this answer assumes that the cash receipts 

and disbursements journals only have to be converted and do not have to 

be reconstructed to such an extent that the audit organization, in 

substance, would be maintaining or preparing the audit entityís basic 

accounting records. Also, similarly to previous answers, the management 

representation letter should acknowledge the audit organizationís role 

in the conversion and managementís review, approval, and responsibility 

for the conversion.



54. A small audited entityís sole accountant suddenly leaves due to an 

emergency situation, and it asks an audit organization to provide a 

temporary staff person until a new accountant is hired. If the staff 

person that the audit organization assigns to provide this assistance 

is not part of the audit engagement team and the audit organization 

complies with all of the required safeguards, would its independence be 

considered impaired on a financial statement audit?



First, an emergency situation should be a rare and cataclysmic event 

that is unexpected and has a severe adverse impact on the audited 

entity. Second, the audit organization would have to document that, 

under the circumstances, the audited entity had no other viable option 

to address the emergency, such as hiring temporary help to carry them 

over. The audit organization should ensure that the audited entity 

understands the need to exhaust all other viable options and that the 

audit organization should be viewed as the last resort.



Considering the caveats included in the question and assuming that this 

represents the rare case where there is no other viable option, an 

audit organization could provide this emergency service for a short 

time (no longer than 1 month) without impairing its independence, as 

long as it included in its audit report the circumstances related to 

the emergency situation and makes clear its role and the safeguards 

taken. 



55. An audited entity asks an audit organization to assist with 

implementing GASB Statement 

No. 34, Basic Financial Statements--and Managementís Discussion and 

Analysis--for State and Local Governments. Would an audit 

organizationís independence be impaired?



It would depend on the nature of the assistance provided. GASB 

Statement No. 34 significantly changed the state and local governmental 

financial reporting model by redefining the general-purpose external 

financial statements and by requiring a new section on Managementís 

Discussion and Analysis and that all capital assets, including 

infrastructure assets, be reported in the financial statements. An 

audit organization could provide the type of services covered under the 

independence standard in paragraph 3.23--such as providing routine 

advice, explaining technical requirements, and providing training--

without impairing its independence. Generally, such assistance relating 

to an audit organizationís knowledge and skills would be considered 

routine and not impair audit independence.



However, if an audit organization is asked to perform work that goes 

beyond routine advice, this work needs to be considered in light of the 

overarching principles and the safeguards. This would be the case, for 

example, if an audit organization were asked to perform extensive 

valuation services (such as may be related to an audited entityís 

infrastructure assets or to prepare an audited entityís Managementís 

Discussion and Analysis.



56. If an audit organization arrives at an audited entity to perform a 

financial statement audit and finds that bank account reconciliations 

were not performed during the year, can the audit organization perform 

this service without impairing independence?



It would depend on the facts and circumstances. Reconciling cash 

balances to bank statements or related records is an internal control 

that is the responsibility of entity management. In deciding whether to 

provide this nonaudit service, the audit organization must consider the 

overarching principles and the safeguards, applying the substance over 

form doctrine. If the extent of an audit organizationís efforts in 

assisting the audited entity is extensive, which would seem to be the 

case in this situation, an audit organization needs to consider whether 

its efforts, in fact, constitute performing a management function. 

Also, the audit organization needs to consider the materiality of cash 

to the financial statements and whether management has the knowledge to 

evaluate and approve the auditorís work.



57. Over the last few years, the U.S. Department of Housing and Urban 

Development (HUD) has introduced a number of electronic filing 

requirements for financial information for public housing authorities 

and multifamily housing projects. HUD will soon introduce new 

electronic filing requirements for the lender community. Would 

independence be considered impaired if an audit organization assists an 

entity in making the electronic submission? What if the transmitted 

amount was material to the financial statements?



No. This would be considered a routine byproduct of the audit and is 

permissible irrespective of the materiality of the transmitted amount 

and without applying the safeguards.



Financial Statement Review and Basic Accounting Assistance:



58. Can an audit organization perform review services without impairing 

its independence to audit the financial statements?



The AICPA defines review of financial statements as performing inquiry 

and analytical procedures that provide the auditor with a reasonable 

basis for expressing limited assurance that there are not material 

modifications that should be made to the financial statements for them 

to be in conformity with the generally accepted accounting principles 

(GAAP) or, if applicable, with an other comprehensive basis of 

accounting. In performing a review, the auditor performs limited audit 

procedures to provide a basis for providing negative assurance on the 

presentation of financial statements in accordance with GAAP.



The AICPA has separate standards for review services and does not 

consider them audit services. Consistent with the AICPA standards, the 

GAGAS independence standard does not consider review services as an 

audit. However, under GAGAS, a review does have characteristics similar 

to a limited scope audit; for example, (1) the auditor exercises 

professional judgment in determining the specific procedures to apply 

in order to provide negative assurance on the presentation of the 

financial statements in accordance with GAAP, (2) the results of the 

review are for parties in addition to management of the audited entity, 

and (3) management is responsible for the basic financial records and 

the financial statements that the audit organization will review.



Considering the above similarities and applying the substance over form 

doctrine, a review will be treated as if it is an audit for the purpose 

of determining audit independence. Therefore, the audit organization 

could conduct both a review of the entityís financial statements for a 

given period, such as a calendar quarter, and then subsequently audit 

the entityís year-end financial statements, without having an 

impairment to its independence as long as the audit organization 

ensures that the review services do not involve a level of work so 

extensive that it gives an appearance that the audit organization, in 

substance, is maintaining an entityís books. In other words, the 

audited entity must have adequately maintained books and records to 

support its financial statements and management that has the knowledge 

to evaluate and approve any adjustments or corrections that the auditor 

proposes in order to provide the limited assurance on the financial 

statements.



Conversely, if the audit organization encounters a situation where the 

entity does not have adequately maintained books and records, and the 

audit organization is expected to, in effect, reconstruct the existing 

books and records and develop financial statements to review, the 

independence of the audit organization would be impaired to conduct the 

year-end financial statement audit. In substance, it would be auditing 

its own work, which violates an overarching principle. Further, it 

could be viewed that the audit organization was performing a management 

function or making management decision in order to produce the 

financial statements which would violate an overarching principle as 

well.



59. What if an audited entityís records are in disarray and require 

hundreds of correcting/adjusting entries? Would an audit organization 

be impaired at a certain point if it proposes so many correcting/

adjusting entities that it is taking heroic efforts to be able to 

express an opinion?



Footnote 11 in paragraph 3.26a does not place a limit on the number or 

dollar value of adjusting or correcting entries that an audit 

organization can propose as a result of its audit as long as management 

makes the decision on accepting these entries. Nonetheless, this 

question demonstrates a situation where applying sound judgment and the 

substance over form doctrine are critical. If the extent of an audit 

organizationís efforts in proposing correcting/adjusting entries is 

extraordinary, an audit organization needs to consider whether its 

efforts, in fact, constitute substantially maintaining the records that 

are being audited. It is important for the audit organization to avoid 

any situation that could lead reasonable third parties with knowledge 

of the relevant facts and circumstances to conclude that the auditor is 

substantially maintaining or reconstructing the records to be audited.



Audit organizations and audited entities have several options to 

consider when they encounter a situation in which the magnitude of 

adjustments and corrections that need to be made, in substance, 

constitute maintaining the records to be audited. The audit 

organization can suggest the audited entity engage a different audit 

organization, a bookkeeping service, or temporary assistance to clean 

up the accounting records before the audit begins or the audit 

organization could elect to clean up the entityís records and decline 

to do the audit.



60. Regarding footnote 11 in paragraph 3.26a, are other nonaudit 

services, such as drafting disclosures for bond offering statements, 

considered to be routine byproducts resulting from the performance of 

the audit and, thus, covered by the footnote?



No. Footnote 11 does not extend to any services beyond proposing 

adjusting and correcting entities. Other nonaudit services need to be 

considered in light of the overarching principles and the safeguards.



61. Is an audit organizationís independence to perform a financial 

statement audit impaired if it assists a client in converting its 

financial statements to address new accounting principles?



It would depend on the nature of the assistance. An audit 

organizationís independence to perform financial statement audits for 

the entity would not be impaired, if it provided routine advice as 

described in paragraph 3.23. However, beyond routine advice, an audit 

organization would need to consider the two overarching principles and 

the safeguards before agreeing to perform this nonaudit service.



62. Following up on the previous question, to what extent can an audit 

organization assist the client in redesigning its financial accounting 

system to implement new accounting principles?



The answer is the same as above. Again, routine advice, as described in 

paragraph 3.23, would not impair the audit organizationís independence. 

However, beyond routine advice, which would probably be the case in 

this situation, the organization would need to consider the overarching 

principles and the safeguards, applying the substance over form 

doctrine.



For example, if the nonaudit service is to redesign an accounting 

system, independence would be impaired if the changes were material to 

the financial statements. If the changes would not be material, an 

audit organization must comply with the safeguards and the additional 

requirements in paragraph 3.26e concerning information technology 

advisory services.



63. A local government contacts an audit organization to perform an 

agreed-upon procedures engagement involving a golf courseís revenues, 

of which the local government receives 25 percent under a revenue 

sharing arrangement. Can the audit organization perform this engagement 

without impairing its independence to perform financial statement 

audits of the golf course and of the local government?



Yes. This engagement can be performed without impairing an audit 

organizationís independence to perform financial statement audits, or 

any other audits, of either the golf course or the local government 

because, under GAGAS, an agreed-upon procedures engagement is an audit.



64. Regarding indirect cost proposals or cost allocation plans, how the 

new independence standard compare to provisions of U.S. Office of 

Management and Budget (OMB) Circular

A-133, Audits of State, Local Governments and Non-Profit Organizations?



The underlying concepts are different. OMB sets a specific dollar 

threshold above which an audit organization would be precluded from 

performing the financial statement audit, while the new independence 

standard applies a principles-based approach to establishing audit 

organization independence to perform the audit.



OMB Circular A-133, section 305(b), prohibits an audit organization 

that prepares an indirect cost proposal or a cost allocation plan from 

being selected to perform the audit that is required when the indirect 

costs recovered by the auditee during the prior year exceeded $1 

million. Under OMB Circular A-133, this prohibition applies to the 

base-year used in preparing indirect cost proposals or cost allocation 

plans and any subsequent years in which the resulting indirect cost 

agreements or cost allocation plans are used to recover costs. The 

$1 million threshold applies regardless of materiality.



The new auditor independence standard addresses audit organization 

independence to prepare indirect cost proposals or cost allocation 

plans in terms of the two overarching principles: Is this work material 

to the financial statements and is the audit organization performing a 

management function or making a management decision?



65. Following up on the prior question, what if an amount over $1 

million was not significant/material to the subject matter of the 

audit?



Preparing indirect cost proposals over $1 million that are not material 

to the financial statements and for which the audit organization is not 

performing a management function or making a management decision would 

not impair the audit organizationís independence to perform the 

financial statement audit under GAGAS. OMB Circular A-133 would though, 

prohibit the audit organization from doing so. Conversely, if an 

indirect cost proposal of

$1 million or less is material to the financial statements, the audit 

organizationís independence would be impaired under GAGAS because it 

would be in violation of an overarching principle.



Internal Audit Services:



66. If an audited entity does not have an internal audit operation and 

engages an audit organization to perform internal audit services, would 

the audit organizationís independence be impaired to also serve as the 

external auditor?



Yes. Internal audit is considered a management function and, for 

external audit organizations, would impair independence by violating an 

overarching principle. This would impair the independence of external 

audit organizations to perform not only the entityís financial 

statement audit but also performance audits.



67. Why, then, are an entityís internal audit organization and internal 

audit function not considered to have an impairment to independence?



Under paragraphs 3.30.5 and 3.30.6, internal audit organizations and 

the internal audit function can be presumed to be free from 

organizational impairments to independence when reporting internally to 

management if the head of the internal audit organization is (1) 

accountable to the head or deputy head of the entity, (2) required to 

report the results of an audit organizationís work to the head or 

deputy head of the entity, and (3) located organizationally outside the 

staff or line management function of the unit under audit. If an 

internal audit organization meets these criteria and care is taken to 

avoid personal or external impairments to independence, it is 

independent under GAGAS to report objectively to the entityís 

management.



Information Technology Services:



68. An audited entity purchases a commercial accounting package and 

asks an audit organization to provide advice on setting up the chart of 

accounts and the financial statement format. Would the audit 

organizationís independence be considered impaired?



No. Under paragraph 3.23, advice related to an audit organizationís 

knowledge and skills would generally be considered routine and is 

permitted. However, the decision to follow an audit organizationís 

advice must remain with an audited entityís management. Likewise, an 

audit organization needs to limit its involvement to providing advice. 

If an audit organization becomes responsible for the design, 

development, or installation of the accounting system, or for its 

operation, an audit organizationís independence would be impaired for 

any subsequent financial statement audit or any other audit where the 

accounting system would be significant/material to the audit 

objectives. This level of involvement would clearly violate the 

overarching principles that audit organizations should not audit their 

own work and should not provide nonaudit services that involve 

performing management functions or making management decisions.



69. A not-for-profit audited entity purchases software for a 

nonaccounting membership database, which it asks an audit organization 

to install. The audit organization is also asked to provide assistance 

in customizing the membership reports the system generates and to 

conduct initial training. Would the audit organizationís independence 

be considered impaired?



The impact on an audit organizationís independence depends on an 

audited entityís use of the database and the audit organizationís audit 

objectives. For example, if the membership database is used to bill 

members for dues and dues revenue is material to the entityís financial 

statements, the audit organizationís independence would be impaired. 

Also, if the audit objectives focused on the adequacy of membership 

information, or on the related system, independence would be impaired 

since this nonaudit service would be significant/material to the audit 

objectives.



In contrast, independence would not be impaired for a financial 

statement audit if, in this example, the membership system is used only 

for purposes that are not relevant or material to the preparation of 

the financial statements and assuming the audit organization has not 

performed any management functions or had not made any management 

decisions. Also, the safeguard on precluding personnel who provided the 

nonaudit service from performing related audit work (paragraph 3.25c) 

would not apply in this case because the nonaudit service would have no 

relationship to the objectives of the financial statement audit.



Under provisions of paragraph 3.23, an audit organization could provide 

the training associated with the new system without impairing its 

independence to perform either audit or imposing the safeguards. 

However, if asked to do a performance audit to evaluate the adequacy of 

the training, the audit organizationís independence would be impaired.



70. If an audit organization does all the work associated with 

installing an off-the-shelf accounting system except for ďpushing the 

button,Ē is the audit organizationís independence impaired for the 

financial statement audit?



Yes. An audit organizationís independence would be impaired in 

connection with a financial statement audit. Because the accounting 

system is significant/material to the subject matter of the audit, 

applying the substance over form doctrine, this service would violate 

the overarching principle that an audit organization should not audit 

its own work.



71. To follow up on the previous question, what if an audit 

organization was auditing the effectiveness of a particular program as 

a performance audit?



In that case, the audit organizationís independence would not be 

impaired if data from the accounting system were not significant/

material to the objectives of the performance audit. However, the audit 

organization should comply with the safeguard to document its rationale 

that the overarching principles have not been violated.



If the data from the accounting system were significant to the subject 

matter of a performance audit, which might well be the case for 

financial information, independence would be impaired for the 

performance audit as well.



72. A firm provides training on certain off-the-shelf accounting 

packages. Does installing include training?



No. As defined by paragraph 3.23, training is a separate category and 

will not impair audit organization independence. Paragraph 3.23 permits 

an audit organization to provide training without impairing its 

independence or triggering application of the safeguards.



73. If an audit organization develops or designs accounting or other 

financial systems software, can the audit organization sell the 

software to audit clients without impairing the audit organizationís 

independence to audit the clientís financial statements? What if an 

audit organization significantly modifies computer software that the 

audit client has purchased from another firm or off the shelf?



In both cases, the answer would be no. Since the financial systems 

described in these questions are significant/material to the subject 

matter of the audit, an audit organization would not be independent to 

perform the financial statement audit because it would violate the 

principle of auditing its own work.



74. An audit organization has been asked by an entity for advice on a 

particular n accounting software package. Would providing such advice 

impair the audit organizationís independence to audit the entityís 

financial statements?



No. If an audit organization is asked to provide advice regarding 

particular software packages, this is considered routine advice under 

paragraph 3.23. An audit organization may provide the audited entity 

its opinion on various software packages based on its experience with 

and knowledge of the effectiveness of these packages at other 

organizations and based on its knowledge of the audited entityís needs.



Further, if the audit organization is asked to recommend a package 

based on its knowledge of the audited entityís needs, it should attempt 

to point out two or more packages that could be used. Recommending only 

one package could create the appearance of an independence impairment. 

Finally, if the audit organization is asked to analyze a particular 

accounting software package, as long as the work is performed as a 

performance audit under GAGAS, the audit organizationís independence 

would not be impaired to audit the financial statements.



Work of Specialists:



Paragraph 3.14 of the new independence standard presents requirements 

related to using the work of specialists and footnote 2 elaborates on 

the types of specialists and organizations to which the requirements 

apply. Several questions have been raised regarding this footnote 

information. With the next Government Auditing Standards update, we 

will clarify footnote 2 as follows:



This section applies to external consultants and firms performing work 

for the audit organization and includes, but is not limited to, 

actuaries, appraisers, attorneys, engineers, environmental 

consultants, medical professionals, statisticians, and geologists.



75. Would paragraph 3.14 apply when using the work of specialists who 

perform work under a contract with the audited entity?



No, because the specialists are under contract to the audited entity 

and not to the audit organization. While paragraph 3.14 would not 

directly apply to these specialists, if the audit organization used 

this work, it generally would need to assess the specialistsí 

capability to perform the work and the reliability of their data. In 

doing so, an audit organization would need to assure itself of the 

qualifications and independence of the firm under contract with the 

audited entity and then whether the specialists who actually performed 

the work are qualified and independent. An audit organization would 

consider any professional standards the specialists followed in 

conducting their work, especially whether they followed standards 

requiring independence.



76. What if the specialists are employed by the audited entity?



In this case, paragraph 3.14 would not directly apply to these 

specialists. The work of these specialists would be considered in the 

same way as information gathered from an audited entityís management.



77. What if the specialists are under contract with the audit 

organization?



The requirements of paragraph 3.14 apply to these specialists. An audit 

organization must determine that the firm under contract is independent 

of the audited entity and then assess the specialistsí capability to 

perform the work and report results impartially. In conducting this 

assessment, an audit organization should provide the specialists with 

the GAGAS independence requirements and obtain representations from the 

specialists regarding their independence from the activity or program 

under audit. Further, an audit organization would need to assure itself 

of the validity of these specialistsí work, as presented above.



78. What if the specialists are employed by the audit organization?



Audit organizations employ specialists, such as attorneys, actuaries, 

and statisticians, to assist on individual engagements. The 

independence requirements for specialists are the same as for auditors. 

Specialists employed by the audit organization are required to consider 

the three general classes of impairments to independence--personal, 

external, and organizational--as would any audit staff member. They are 

also required to consider the independence standardís principles and 

safeguards as an auditor would in performing any nonaudit service.



As described in paragraph 3.16, an audit organization should have 

internal quality control system requirements to identify personal 

impairments and determine compliance with GAGAS independence 

requirements. These requirements should extend to the specialists it 

employs.



79. If pension expense or liability is material to an audited entityís 

financial statements, can an audit organization perform the valuation 

of the plan and be independent to audit the entityís financial 

statements?



No. An audit organization would be auditing its own work, which is also 

material to the subject matter of the audit, and thus, would violate an 

overarching principle.



80. Following up on the previous question, can an audit organization 

provide advice to an audited entity on methodologies it can use in 

developing the valuation of the plan without impairing its 

independence?



Yes. This would be allowed under paragraph 3.23.



Tax Services:



81. An entity asks an audit organization to prepare tax returns or for 

advice on deposits due to a taxing authority. Would these types of tax 

services impair an audit organizationís independence to perform the 

entityís financial statement audits?



No. These types of tax services generally would be considered routine 

advice under paragraph 3.23. The overarching principles would not be 

violated, and an audit organization would not be required to apply the 

safeguards.



82. Would tax structuring also be considered to be routine advice under 

paragraph 3.23?



No. An audit organization would have to ensure that providing these tax 

services would not impair its independence by violating one of the 

overarching principles and must apply the safeguards, as applicable.



83. Can an audit organization assist its clients in preparing Internal 

Revenue Service (IRS) form 990, ďReturn of Organization Exempt From 

Income Tax,Ē without impairing its independence to audit the entities? 

Can audit engagement team members perform this activity?



Yes. This type of activity would be considered routine advice under 

paragraph 3.23. The overarching principles would not be violated, and 

an audit organization would not be required to apply the safeguards. 

This means that the audit engagement team could prepare such tax forms 

for the audited entity.



84. Under 5 U.S.C. 500, certified public accountants (CPA) have a 

statutory right to represent taxpayers before IRS as long as the CPAs 

meet certain conduct standards. Would an audit organizationís 

independence for performing financial statement audits be considered 

impaired if it represents an audited entity in IRS matters, such as in 

an IRS audit or in obtaining IRS rulings or other agreements?



No. These services, which are prescribed in law, would not impair 

independence for a financial statement audit. However, if an audit 

organization were engaged to perform a performance audit of tax 

compliance, its work to represent the audited entity before IRS would 

impair the audit organizationís independence since it would be auditing 

its own work.



Budget Work:



85. An audit organization provides assistance to a small municipal 

government that is preparing its annual operating budget by analyzing 

budget proposals or to a legislative body by analyzing budget requests 

submitted to it in the budget process. Would an audit organizationís 

independence be considered impaired?



No, as long as the work is done under the performance audit standards 

in GAGAS. If these services are limited to analyzing budget proposals, 

this work could be considered a type of performance audit consistent 

with paragraph 2.7 of GAGAS.



86. If an audit organization were asked to assist an audited entity in 

preparing its annual budget, would the independence standard be 

violated? The audited entityís board has the power to accept or reject 

the budget.



It would depend on the type or nature and degree of assistance an audit 

organization is asked to provide and the nature of any subsequent audit 

work it is asked to perform. Preparing an annual budget is a management 

function and involves making management decisions, which an audit 

organization must avoid to remain independent. However, if the 

assistance involves assessing the budget execution as a baseline for 

preparing the current budget, this work would qualify as a performance 

audit under GAGAS as long as the work is done in accordance with the 

performance audit standards.



87. An audit organization is engaged to assist a governmental entity in 

assessing program or policy alternatives, such as forecasting program 

outcomes under various assumptions or analyzing various opportunities 

for privatizing certain of its functions. Would an audit organizationís 

independence be considered impaired?



No. As long as the work is done under the performance audit standards, 

the audit organizationís independence would not be impaired. In 

performing engagements of this nature, an audit organization would 

always need to exercise caution that it does not perform any management 

functions or make any management decisions. If these services are 

limited to assessing program or policy alternatives, it could be 

considered a performance audit consistent with paragraph 2.7 of GAGAS. 

Under a performance audit, an audit organization can make 

recommendations, but management has the responsibility for determining 

action to be taken based on an audit organizationís work.



88. What if the audit organization wishes to perform the work described 

in the previous questions under the AICPAís consulting standards and to 

not follow the performance audit standards in GAGAS?



The audit organization would have to apply the overarching principles 

and safeguards since it has elected to do this work as a nonaudit 

service. This is not a matter of form over substance, since the 

performance audit standards in GAGAS are for a different purpose and 

are considerably more rigorous than the AICPAís consulting standards. 

Performing audit services under GAGAS would not impair an audit 

organizationís independence, whereas performing nonaudit services can 

impair independence if either of the overarching principles is violated 

or if the safeguards are not adhered to.



89. An audit organization is engaged to identify ways that an audited 

entity can improve services and cut costs. The audit organization 

studies the entity, interviews personnel from various departments, and 

ultimately makes recommendations for management to consider. Would the 

audit organizationís independence be considered impaired?



Under GAGAS, such work would qualify as a performance audit. If done 

under the performance audit standards, this service would not impair 

independence. However, if such services were performed as a nonaudit 

service (for example, as a consulting service that does not follow 

GAGAS), the services would be subject to the overarching principles and 

required safeguards.



90. Can audit organizations assist clients with strategic planning 

without impairing audit organization independence?



It would depend on the nature of the assistance. An audit organization 

may provide routine advice under paragraph 3.23 in assisting the 

audited entityís management in using strategic planning tools and 

methodologies, providing training, and answering technical questions 

without impairing audit independence.



However, preparing an audited entityís strategic plan would normally 

involve performing a management function that requires making 

management decisions. Thus, if an audit organization were to prepare or 

substantially prepare the strategic plan, it would violate the 

overarching principles and impair its independence to perform audits of 

the audited entity.



Human Resource Services:



91. Is auditor independence impaired if an audit organization is asked 

for its opinion on the qualifications of a specific individual for a 

particular key position at an audited entity?



No. This would qualify as routine advice under paragraph 3.23. If an 

audited entity asks about the qualifications of a particular individual 

for a specific position, an audit organization can respond without 

impairing its independence or having to apply the safeguards.



92. What if the audit organization instead is asked to recommend 

individuals for a particular position?



The audit organization can suggest individuals for the audited entity 

to contact for consideration without impairing the audit organizationís 

independence as long as it provides more than one name for a particular 

position. However, as discussed in paragraph 3.26f, if an audit 

organization recommends a single individual for a specific key position 

or conducts an executive search or recruiting program for an audited 

entity, the audit organizationís independence would be impaired.



Therefore, audit organizations should advise their clients to also 

consider other sources of information about potential candidates for 

financial management executive positions or accounting and other 

positions that may have a key role or substantially influence matters 

that may be the subject matter of an audit. In this regard, audit 

organizations should be aware of the potential for future independence 

impairments arising from human resource services they may provide to 

audited entities.



[End of Section]



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