Two recent articles (“Imagine This,” and “Something Every Manager Should Know”) on proposed auditor independence rules generated several questions and comments, suggesting that some very direct follow-up is warranted.

To recap, the AICPA (American Institute of CPAs) has proposed modified independence standards for all CPAs performing review or audit services that would likely prohibit them from “preparing financial statements.” The present state of the industry is that management companies generally perform monthly accounting services resulting in production of a balance sheet and income statement that are for internal management use only and are not intended to be presented in accordance with GAAP (Generally Accepted Accounting Principles). “Preparing financial statements” goes a step further by ensuring the financial statements are in accordance with GAAP by making any necessary cash-to-accrual conversion; making year-end tax accrual; and adding footnotes, cash flow statement, and reserve disclosures.

At the heart of this issue is the fact that the HOA industry, as it has operated for many years, has generally not understood or recognized the difference between audit/review services and other accounting services. To put this into the framework recognized by the AICPA:

1. a)Audit and review services are “attest” services, because the independent CPA is “attesting” to work performed by his client (the association).
2. b)Making a cash-to-accrual conversion, making year-end tax accrual, preparing income tax returns, and “preparing financial statements” (the act of adding footnotes, a cash flow statement, and reserve disclosures to management-prepared financial statements) are all considered “non-attest” services, because the CPA is involved in the act of creating information, not attesting to what another person has done. These are considered management functions.

Performance of these “nonattest” services is considered to impair the independence of the CPA because they are management functions. The proposed rules shift the burden of performing these services back to the association / management company.

Here are various questions / comments I've received:

1. 1)I don’t understand why this is even an issue; the CPA has always performed this work.  See comments above
   
2. 2)Are these independence rules effective now? No, they’re proposed rules, but are worth exploring because of the potential significant impact on the HOA industry.
3. 3)Can the AICPA really be serious about this? Yes, these independence issues have been discussed for decades, and the discussion is trending towards more strict interpretations. The Ethics Committee meeting in January 2013 was the first time this issue has come up for a formal vote.
4. 4)What is the current status of these rules? Unknown. While public comments appear to strongly support the proposed rules, the committee referred it back to the “study group” for further consideration. The proposed rules were not adopted as was anticipated by many, but they were also not defeated. We need to wait to see what action the committee takes in the future, probably within the next year.
5. 5)Why is the AICPA proposing these rules? In a word – Enron. The 2000 audit failure known as Enron was a watershed moment in the accounting profession. Pressure from congress forced AICPA to adopt more stringent standards or else face being completely eliminated from the standards-setting process. These proposed independence standards are the most recent manifestation of that process.
6. 6)Are you just trying to scare us with these articles? No, I’m trying to provide advance warning of what is very likely coming your way in the near future. I could have waited until after the new standards were effective, but that may not have provided enough warning for management companies to amend their contracts to provide necessary protection.
7. 7)Does the AICPA have any idea how disruptive their proposed rules are to the HOA industry? No, nor would they care. In the context of the larger business community, the HOA industry is not even a blip on the radarThe AICPA is targeting small (nonpublic) business with these proposed rules, but has cast a very wide net that is also catching the HOA industry.
8. 8)I followed the links provided in the second article and read that under the proposed rules an auditor’s independence would not be automatically compromised by the act of “preparing financial statements.” So why are you making such a big deal of this? That statement does exist in AICPA commentary, but is not part of the proposed standard. Unfortunately, the auditor would be held to assessing the “cumulative effect” of nonattest services provided. Within the HOA industry, it is not simply a matter of preparing the financial statements, but also usually performing a cash to accrual conversion, calculating the tax provision, summarizing reserve disclosures, and preparing the tax return. That’s a lot of “cumulative effect,” likely way too much for an auditor to attempt to justify as being within an acceptable range of services and still maintain independence. To put this in perspective, it was only a couple of years ago that the AICPA took the position that the single act of preparing the association’s tax return would impair independence. AICPA later backed off that position.

Additional independence issues come into play from prior standards issued by the AICPA. As an example, if the CPA is required to make “too many” adjusting journal entries, he runs the risk of compromising independence by having performed a “management” function. In other words, if the accounting records as presented for audit are not “clean” and free from error, then the CPA is deemed to be performing an accounting (as opposed to an audit) service, and is potentially no longer independent. Unfortunately, there is no “bright line” test to determine “too many.” It is a matter of judgment.

Another standard requires that the association must have someone (staff, management company staff, or a board or finance committee member) who is able to understand and properly record the CPA’s adjusting entries. If that person does not exist, this again raises the question of the auditor’s independence.

It’s not really fun to write about these topics, as they’re technical, boring, and in most people’s eyes, something that they shouldn’t have to know about, since that’s the auditor’s job. Unfortunately, the impact of these rules shifts the burden to those individuals responsible for the association’s accounting, and away from the independent CPA.