Chapter 2 Applying the Rules Attest Client and Affiliates

Chapter 2 — Applying the rules: Attest client and affiliates Do I need to remain independent from just my attest client or from other entities as well? Although we think of our attest clients as the entity for which we are performing an attest engagement, in some instances, you will need to remain independent from other entities. The code requires you to remain independent of affiliates of any financial statement attest client. A financial statement attest client is considered to be any entity whose financial statements are audited, reviewed, or compiled when the member’s compilation report does not disclose a lack of independence. If the engaging entity is not also the attest client, the member needs to determine if the engaging entity is an affiliate for which the member needs to remain independent. If the engaging entity does not meet the definition of an affiliate, the member needs to determine if there are threats to the member’s compliance with regards to the “Integrity and Objectivity Rule” (ET sec. 1.100.001) and the “Conflicts of Interest for Members in Public Practice” interpretation (ET 1.110.010) with respect to the engaging entity. If threats exist, then the member needs to comply with this rule and interpretation. What entities are considered affiliates of my financial statement attest client? The “Client Affiliates” interpretation (ET sec. 1.224.010) of the “Independence Rule” (ET sec. 1.200.001) requires that when a client is a financial statement attest client, members should apply the “Independence Rule” and related interpretations applicable to the financial statement attest client to their affiliates. This interpretation does not apply to affiliates of state and local government clients. See “State and Local Government Affiliates” below. The following entities will need to be considered affiliates of your financial statement attest client: a. An entity (for example, subsidiary, partnership, or LLC) that a financial statement attest client can control. b. An entity in which a financial statement attest client or an entity controlled by the financial statement attest client has a direct financial interest that gives the financial statement attest client significant influence over such entity and is material to the financial statement attest client. c. An entity (for example, parent, partnership, or LLC) that controls a financial statement attest client when the financial statement attest client is material to such entity. d. An entity with a direct financial interest in the financial statement attest client when that entity has significant influence over the financial statement attest client, and the interest in the financial statement attest client is material to such entity. e. A sister entity of a financial statement attest client if the financial statement attest client and sister entity are each material to the entity that controls both. 4 f. A trustee that is deemed to control a trust financial statement attest client that is not an investment company. g. The sponsor of a single employer employee benefit plan financial statement attest client. h. Any entity, such as a union, participating employer, or a group association of employers, that has significant influence over a multiemployer employee benefit plan financial statement attest client and the plan is material to such entity i. The participating employer that is the plan administrator of a multiple employer employee benefit plan financial statement attest client. j. A single or multiple employer employee benefit plan sponsored by either a financial statement attest client or an entity controlled by the financial statement attest client. All participating employers of a multiple employer employee benefit plan are considered sponsors of the plan. k. A multiemployer employee benefit plan when a financial statement attest client or entity controlled by the financial statement attest client has significant influence over the plan and the plan is material to the financial statement attest client. l. An investment adviser, a general partner, or a trustee of an investment company financial statement attest client (fund) if the fund is material to the investment adviser, general partner, or trustee that is deemed to have either control or significant influence over the fund. When considering materiality, members should consider investments in, and fees received from, the fund. What do I do if a financial statement attest client’s affiliates can’t be identified? If after expending your best efforts to obtain the information to identify the affiliates of a financial statement attest client, you are unable to do so, all the following steps must be taken: • Discuss the matter, including the potential effect on independence, with those charged with governance. • Document the results of the discussion with those charged with governance. • Document the efforts taken to obtain the information to identify the affiliates of the financial statement attest client. • Obtain written assurance from the financial statement attest client that it is unable to provide the member with the information necessary to identify its affiliates. What if my financial statement attest client is acquired after I begin the engagement? Although the interpretation requires members to apply the independence provisions applicable to their financial statement attest clients to any affiliates, it was determined that an exception was necessary when a financial statement attest client is acquired while you are performing an attest engagement. The exception would only be applicable if the attest engagement covers periods prior to the acquisition and provided you will not continue to perform financial statement attest services to the acquirer. 5 Are there any other exceptions to the affiliate rules? It was also deemed appropriate that members need not apply the independence provisions applicable to their financial statement attest clients to any affiliates in several other situations. The first situation involves loans and applies to all affiliates. The code currently prohibits a covered member from making a loan to, or having a loan from, an individual who is an officer, a director, or a 10 percent or more owner of an attest client. If this provision were applied to affiliates any time a member had a loan to or from an individual, especially one that is only an investor and not in a position of governance, the member would need to take steps to ensure the individual was not in one of these positions at an affiliate. Accordingly, the exception concludes that only when the covered member has knowledge that the individual is in such a position with an affiliate of a financial statement attest client, the covered member should be required to consult the “Conceptual Framework for Independence” interpretation (ET sec. 1.210.010), because without knowledge, the familiarity, undue influence, and financial self-interest threats would be at an acceptable level. The second, third, and fourth exceptions may not be applied by those described as an affiliate under (a) or (b); rather, they may only be applied to those described as an affiliate under (c)–(l) above. The second exception involves the provision of prohibited nonattest services (that is, nonattest services that would impair a member’s independence). Specifically, when it is reasonable to conclude that the prohibited nonattest services do not create a self-review threat because the results of the nonattest services will not be subject to financial statements attest procedures, and any other threats that are created by the provision of the nonattest service (for example, management participation threats) that are not at an acceptable level are eliminated or reduced to an acceptable level by the application of safeguards, members should not be prohibited from providing these services to entities described as an affiliate under (c)–(l). This exception does not apply to those entities described as an affiliate under (a) or (b). The third exception involves subsequent employment at an affiliate. The code (that is, the “Subsequent Employment or Association With an Attest Client” interpretation [ET sec. 1.279.020]) requires the application of specific safeguards when a former partner or employee becomes employed at an attest client in a key position. Under the interpretation, if no exception were provided, these safeguards would need to be applied when a former partner or employee becomes employed or associated with an affiliate in a key position. It was determined that it is not necessary to apply these safeguards to entities described as an affiliate under (c)–(l) if the individual’s position does not allow the individual to be in a key position with respect to the financial statement attest client. Again, this exception does not apply to those entities described as an affiliate under (a) or (b). The fourth exception involves immediate family members and close relatives who are employed at those entities described as an affiliate under (c)–(l). Similar to the third exception previously described, covered members need only be concerned with employment positions their immediate family members and close relatives have with such affiliates when these positions put them in a key position with respect to the financial statement attest client at those defined as an affiliate under (a) and (b). The final exception involves a covered member that is part of the attest engagement team or is an individual in a position to influence the attest engagement, or the firm itself, having a lease with an entity described as an affiliate under (c)–(l) that does not meet the requirements of the “Leases” interpretation (1.260.010) during the period of professional engagement. The covered 6 member should use the “Conceptual Framework for Independence” to evaluate threats to the member’s independence and apply safeguards to mitigate threats that are not at an acceptable level. Is there any additional guidance to help me understand how to apply the affiliate definition and related interpretation? The ethics division issued a nonauthoritative frequently asked questions (FAQ) document, “Application of the Independence Rules to Affiliates of Employee Benefit Plans.” The FAQ document is designed to help you better understand how the definitions and guidance provided in the “Client Affiliates” interpretation apply to affiliates of employee benefit plans subject to the Employee Retirement Income Security Act. Is there a visual aid to help me understand the affiliate definitions? We created a visual aid to help explain how the first five entities, (a)–(e) identified in the affiliate definition, could be related to Entity Z, the financial statement attest client. The letters used in the visual aid correspond with the letters used in the affiliate definition. 7 Is there an executive summary of the interpretation? Tick mark key P: The independence provisions contained in the AICPA Code of Professional Conduct should be applied to this affiliate. PS: A member may have a loan to or from an individual who is an officer, a director, or a 10 percent owner of an affiliate; however, if the covered member has knowledge of the individual’s relationship with the affiliate, he or she should consult the “Conceptual Framework for Independence” interpretation (ET sec. 1.210.010). A: The firm will have to apply safeguards outlined in paragraph .02 of the “ Subsequent Employment or Association With an Attest Client” interpretation (ET sec. 1.279.020), if the former employee is in a key position at the affiliate. Even if position is a non-key position, when considering employment, the individual must report the consideration to the appropriate person in the firm and be removed from the engagement. R: Immediate family members and close relatives of a covered member may be employed at an affiliate, as long as their position does not put them in a key position with respect to the financial statement attest client. NSA: Services are permitted if not subject to audit; see the second exception for details. N/A: The relationship is not applicable. Affiliate definitions Affiliate A: Entity that a financial statement attest client can control. Affiliate B: An entity in which a financial statement attest client or an entity controlled by the financial statement attest client has a direct financial interest that gives the financial statement attest client significant influence over such entity and is material to the financial statement attest client. Affiliate C: An entity that controls a financial statem ent attest client when the financial statement attest client is material to entity. Affiliate D: An entity with a direct financial interest in the financial statement attest client when that entity has significant influence over the financial statement attest client, and the interest in the financial statement attest client is material to such entity. Affiliate E: Sister entity of a financial statement attest client if the financial statement attest client and sister are material to the entity that controls both. Affiliate F: Trustee that is deemed to control a trust financial statement attest client that is not an investment company. Affiliate G: Sponsor of a single employer employee benefit plan financial statement attest client. Affiliate H: Union or participating employer having significant influence over a multiple or multiemployer employee benefit plan financial statement attest client. Affiliate I: Employee benefit plan sponsored by either a financial statement attest client or an entity controlled by the financial statement attest client. Affiliate J: Investment adviser, general partner, and trustee of an investment company financial statement attest client (the fund) if the fund is material to the investment adviser, general partner, or trustee, and they are deemed to have either control or significant influence over the fund. 8 Is independence different for state and local government affiliates? In the AICPA code the entity’s basic financial statements include the government-wide financial statements, the fund financial statements, and other entities disclosed in the notes to the basic financial statements. Some of the entities that should be included are related organizations, joint ventures, jointly governed organizations, and component units of another governments with characteristics of a joint venture or jointly governed organization. When a member audits the basic financial statements, the member must be independent of all of the organizations whose financial statements are included in the basic financial statements as described previously unless the member explicitly states reliance on another auditors’ reports. If the member has an immediate family member that holds a key position in an entity included in the basic financial statements during the period of professional engagement or during the period covered by the financial statements, then the member would not be independent. If the member is not the auditor of the basic financial statements, but instead audits one of the entities included in the basic financial statements, the member does not have to be independent of the entities that the member does not audit. If the member has an immediate family member that holds a key position in in the primary government during the period of professional engagement or during the period covered by the financial statements, then the member would not be independent. 9