Audit Committees and Auditor Independence
Office of the Chief Accountant
The Sarbanes-Oxley Act of 2002 mandates that audit committees be directly responsible for the oversight of the engagement of the company's independent auditor, and the Securities and Exchange Commission (the Commission) rules are designed to ensure that auditors are independent of their audit clients. The purpose of this brochure is to highlight certain Commission rules and other authoritative pronouncements relevant to audit committee oversight responsibilities regarding the auditor's independence. More information on this topic is available in the Commission's rules and on the Commission's web site at www.sec.gov/about/offices/oca/ocaprof.htm.
Audit committees should also be aware that the PCAOB has Ethics and Independence Rules Concerning Independence, Tax Services, and Contingent Fees.
General Standard of Auditor Independence
The Commission's general standard of auditor independence is that an auditor's independence is impaired if the auditor is not, or a reasonable investor with knowledge of all the facts and circumstances would conclude that the auditor is not, capable of exercising objective and impartial judgment on all issues encompassed within the audit engagement. To determine whether an auditor is independent under this standard an audit committee needs to consider all of the relationships between the auditor and the company, the company's management and directors, not just those relationships related to reports filed with the Commission. The audit committee should consider whether a relationship with or service provided by an auditor:
The Commission rules also address specific auditor independence issues, some of which are:
Specific Prohibited Non-audit Services
The auditor is prohibited from providing the following non-audit services to an audit client including its affiliates:
In addition to the specific prohibited services, audit committees should consider whether any service provided by the audit firm may impair the firm's independence in fact or appearance.
Pre-approval of Permitted Services
Subject to certain limited exceptions, the audit committee must pre-approve all permitted services provided by the independent auditor (i.e., tax services, comfort letters, statutory audits or other). The Commission rules include certain pre-approval requirements that the audit committee must follow. In addition, the audit committee should be informed about the services expected to be provided by the audit firm to understand whether the audit firm's independence will be impaired.
The audit committee should consider whether company policies and procedures require that all audit and non-audit services are brought before the committee for pre-approval.
Also, listing company standards require audit committees to pre-approve all audit, review and attest services regardless of whether the firm performing the services is the company's principal auditor.
Certain relationships between audit firms and the companies they audit are not permitted. These include:
Communications Between the Audit Committee and the Independent Auditor
Independence Standards Board Standard No. 1 requires that the auditor disclose to the audit committee in writing all relationships between the audit firm and the company that may reasonably be thought to bear on the audit firm's independence. Standard No. 1 also requires the auditor to confirm and discuss its independence with the audit committee. The audit committee should consider discussing the following issues with the auditor in regards to the firm's independence disclosure:
Change of Independent AuditorsThe auditor generally must be independent for the entire engagement period and the period covered by the financial statements being audited. Once this relationship is terminated, there is no continuing requirement for the auditor to remain independent. The auditor may generally re-issue its former opinions on the company's financial statements. However, if a restatement of the financial statements becomes necessary, the auditor must be independent to audit the restatement adjustments and re-issue its opinion. Further, if the Board is contemplating or plans a change in auditors, the audit committee must consider whether the prospective firm will be independent during the audit engagement period. That is, the prospective firm must cease all prohibited services and/or sever all prohibited relationships with the issuer prior to the beginning of the audit engagement period. Therefore, the audit committee should consider these issues before hiring a predecessor auditor or a prospective auditor to provide non-audit services to the company or its affiliates. Prospective firms can not audit financial statements of years that they were not independent.
Addressing Independence Issues
The audit committee should discuss and thoroughly investigate any potential independence impairments or issues. The audit committee should also consider seeking guidance from legal counsel, the auditor and the Office of the Chief Accountant (OCA).
Guidance on Consulting with OCA
Guidance on consulting with OCA is available at http://www.sec.gov/info/accountants/ocasubguidance.htm.