Chapter 10 Fee Issues

Chapter 10 — Fee issues What types of fee arrangements between my firm and an attest client are prohibited? Two types of fee arrangements—contingent fees and commissions—are prohibited if the arrangement involves certain attest clients, even though the fee is not related to an attest service. A contingent fee is an arrangement whereby no fee is charged unless a specified result is attained or the amount of the fee depends on the results of your firm’s services. Some examples of contingent fees are your firm: • receives a finder’s fee for helping a client locate a buyer for one of your client’s assets. • performs a consulting engagement to decrease a client’s operating costs. The fee is based on a percentage of the cost reduction the client achieves as a result of your service. The following are exceptions: • fees fixed by a court or other public authority. • in tax matters, fees based on the results of judicial proceedings or the findings of governmental agencies. A commission is any compensation paid to you or your firm for recommending or referring a thirdparty’s product or service to a client or recommending or referring a client’s product or service to a third party. The following are examples of commissions: • if you or your firm refers a client to a financial planning firm that pays you a commission for the referral • if you or your firm sells accounting software to a client and receives a percentage of the sales price (a commission) from a software company • iIf you or your firm refers a non-client to an insurance company client that pays you a percentage of any premiums subsequently received (a commission) from the non-client Commissions or contingent fee arrangements with a client are not allowed if your firm also provides one of the following services to the client: • An audit of financial statements • A review of financial statements • A compilation of financial statements if a third party (for example, a bank or an investor) will rely on the financial statements, and the report does not disclose a lack of independence • An examination of prospective financial statements You may have commission and contingent fee arrangements with persons associated with a client, such as officers, directors, and principal shareholders, or with a benefit plan that is sponsored by a client (that is, the plan itself is not an attest client). For example, you may receive a commission from a non-client insurer if you refer an officer of an attest client to the insurer, and the officer purchases a 42 policy. Even though this situation is permitted, you are still required to tell the officer in writing that you received a commission for making the referral. Note: State boards of accountancy and state societies also may have more restrictive regulations regarding fee arrangements, as well as specific disclosure requirements. PCAOB Rule 3521, Contingent Fees (AICPA, PCAOB Standards and Related Rules, Select Rules of the Board), prohibits you and your firm from providing any service or product to a SEC audit client for a contingent fee or commission or receiving from the audit client, directly or indirectly, a contingent fee or commission. Although the PCAOB’s definition of contingent fees was adapted from the SEC’s definition, the PCAOB rule eliminates the exception for fees in tax matters if determined based on the results of judicial proceedings or the findings of governmental agencies. In addition, the PCAOB rule specifically indicates that the contingent fees cannot be received directly or indirectly from an issuer that is an audit client. When are referral fees permitted? Paragraph .04 of the “Commissions and Referral Fees Rule” (ET sec. 1.520.001) provides an exception for referral fees for recommending or referring a CPA’s services to another person or entity. That is, you may receive a fee for referring a CPA’s services to any person or entity, or if you are a CPA, you may pay a fee to obtain a client. You must inform the client in writing if you receive or pay a referral fee. Is independence affected when an attest client owes the firm fees for professional services the firm has already provided? If an attest client owes your firm fees for services rendered more than one year ago, your firm’s independence is considered impaired. It does not matter if the fees are related to attest services; what matters is that the attest client has an outstanding debt with the firm. This is the case even if the attest client has given you a note receivable for these fees. The SEC generally expects payment of past due fees before an engagement has begun, although a short-term payment plan may be accepted if the SEC audit client has committed to pay the balance in full before the current year report is issued.1 Does being compensated for selling certain services to clients affect my independence? The AICPA rules do not specifically address this issue. 1 The exception generally has been applied only to engagements to audit a client’s financial statements included in its annual report, not in a registration statement. 43 The SEC prohibits audit partners from being directly compensated for selling nonattest services to issuers that are audit clients. The SEC believes that such financial incentives could threaten an audit partner’s objectivity and that the appearance of independence could be affected by such compensation arrangements.2 The rule does not prevent an audit partner from sharing in profits of the audit practice or overall firm. It also does not preclude the firm from evaluating a partner based on factors related to the sale of nonaudit services to issuers (for example, the complexity of engagements or overall management of audit or nonaudit engagements). Does it matter if a significant proportion of my firm’s fees come from a particular attest client? Paragraph .16 of the “Conceptual Framework for Independence” interpretation (ET sec. 1.210.010) states that a self-interest threat may exist if a “member or his or her firm relies excessively on revenue from a single attest client.” In addition, the “Integrity and Objectivity Rule” (ET sec. 1.100.001) and the “Objectivity and Independence” principle (ET sec. 0.300.050) discuss in broad terms that members should be alert for relationships that could diminish their objectivity and independence in performing attest services. The significance of a client to a member (or the member’s firm), measured in terms of fees, status, or other factors, may diminish a member’s ability to be objective and maintain independence when performing attest services. To address this issue, firms should consider implementing the following policies and procedures to identify and monitor significant clients to help mitigate possible threats to a member’s objectivity and independence: a. Policies and procedures for identifying and monitoring significant client relationships, including the following: i. Considering client significance in the planning stage of the engagement. ii. Basing the consideration of client significance on firm-specific criteria or factors that are applied on a facts and circumstances basis (see the following section, “Factors to Consider in Identifying Significant Attest Clients”). iii. Periodically monitoring the relationship. What constitutes periodic is a matter of judgment, but assessments of client significance that are performed at least annually can be effective in monitoring the relationship. During the course of such a review, a client previously deemed to be significant may cease to be significant. Likewise, clients not identified as significant could become significant whenever factors the firm considers relevant for identifying significant clients arise. (For example, additional services are contemplated.) b. Policies and procedures for helping mitigate possible threats to independence and objectivity, including the following: 2 Accounting firms with 10 or fewer partners and 5 or fewer audit clients that are issuers, as defined by the SEC, are exempt from this rule. 44 i. Assigning a second (or concurring) review partner who is not otherwise associated with the engagement and who practices in an office other than those who perform the attest engagement attest engagement ii. Subjecting the assignment of engagement personnel to approval by another partner or manager iii. Periodically rotating engagement partners iv. Subjecting significant client attest engagements to internal firm-monitoring procedures v. Subjecting significant client attest engagements to pre-issuance or post-issuance reviews or to the firm’s external peer review process The most effective safeguards a firm can employ will vary significantly, depending on the size of the firm; the way the firm is structured (for example, whether highly centralized or departmentalized); and other factors. For example, smaller firms (particularly those with one office) tend to be simpler and less departmentalized than larger firms. Generally, their processes will be less formal and involve fewer people than those of larger firms. Further, the firms’ managing partners may engage in frequent and direct communications with the firms’ partners and professional staff on attest client matters and be personally involved in staff assignments. Larger firms draw from a sizeable and diverse talent pool. In those firms, partners who are not affiliated with the engagement (or client service office or business unit) can choose a second (or concurring) review partner from outside the office to perform the attest engagement. Midsized or regional firms may have aspects of both their smaller and larger counterparts, such as combining the ability to choose second review partners from an office other than the attest client service office while maintaining a relatively close connection to specific attest client relationships. Factors to consider in identifying significant attest clients The following are both qualitative and quantitative factors that can reveal a significant attest client: • The size of the attest client, in terms of the percentage of fees or the dollar amount of fees versus total revenue of the engagement partner, office, or practice unit of the firm3 • The significance of the client to the engagement partner, office, or practice unit of the firm in light of the following: • o The amount of time the partner, office, or practice unit devotes to the engagement o The effect on the partner’s stature within the firm due to the partner’s relationships with the attest client o The manner in which the partner, office, or practice unit is compensated o The effect that losing the attest client would have on the partner, office, or practice unit The importance of the attest client to the firm’s growth strategies (for example, the firm is trying to gain entry into a particular industry) 3 Assessing an attest client’s significance at the business or practice unit level may be a more meaningful measure for firms that structure their practices along industry lines (such as health care or financial services). 45 • The stature of the attest client, which may enhance the firm’s stature (for example, the firm is trying to gain entry into a particular industry) • Whether the firm also provides services to related parties (for example, also provides professional services to affiliates or owners of the attest client) • Whether the engagement is recurring Judgment is necessary to determine whether an attest client is significant to the firm, office, practice unit, or partner of the firm. Firms will vary considerably in terms of the degree to which they consider some factors to be more pertinent than others. Gauges that relate to each relevant level within a firm (for example, firm, geographic region, office, or practice unit) may be useful but will likely be different for various levels within the firm. In general, if a firm derives more than 15 percent of its total revenues from one SEC audit client or group of related clients, independence may be impaired because this may cause the firm to be overly dependent on the client or group of related clients. 46