Question

The Detroit accounting firm of Norman, Braverman, Potvin, and Benjamin, CPAs, has always had a cordial, but frequently contentious, relationship with its publicly traded audit client, Jay-Scott, Inc. Jay-Scott sells beverages and must collect a refundable deposit on every glass bottle and aluminum can sold. Lately, for instance, this audit client angrily accused the firm of “sabotage” for failing to allow it to record a portion of these refundable deposit collections as revenue transactions in the year of collection. According to the management of Jay-Scott, statistics prove that 20% of all deposits will be claimed by customers, and therefore, the forfeited deposits constitute immediate revenue. Jay-Scott, Inc. retains this accounting firm annually to perform both tax preparation services and its audit. When the CPA firm informed Jay-Scott that its fee for tax services was going to increase by 4% during the upcoming year, Warren Harris, the CEO of Jay-Scott, said, “That’s not being fair to you. You work hard, so let’s up that to a 30% increase.” Did this client violate SOX?

Answer 1

The Sarbanes-Oxley Act 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.

Audit committees should also be aware that the PCAOB has Ethics and Independence Rules Concerning Independence, Tax Services, and Contingent Fees. 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:

(a) creates a mutual or conflicting interest with their audit client;
(b) places them in the position of auditing their own work;
(c) results in their acting as management or an employee of the audit client; or
(d) places them in a position of being an advocate for the audit client.

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:

• Bookkeeping
• Financial information systems design and implementation
• Appraisal or valuation services, fairness opinions, or contribution-in-kind reports
• Actuarial services
• Internal audit outsourcing services
• Management functions or human resources
• Broker-dealer, investment adviser, or investment banking services
• Legal services and expert services unrelated to the audit

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.

In the given case, accounting firm and is having cordial relationship, but frequently contentious, relationship with its client . Lately, for instance, this audit client angrily accused the firm of “sabotage” for failing to allow it to record a portion of these refundable deposit collections as revenue transactions in the year of collection. According to the management of Jay-Scott, statistics prove that 20% of all deposits will be claimed by customers, and therefore, the forfeited deposits constitute immediate revenue. Jay-Scott, Inc. retains this accounting firm annually to perform both tax preparation services and its audit. When the CPA firm informed Jay-Scott that its fee for tax services was going to increase by 4% during the upcoming year, Warren Harris, the CEO of Jay-Scott, said, “That’s not being fair to you. You work hard, so let’s up that to a 30% increase.”

Conclusion: If it is established that a financial fraud has occurred then it is violation of SOX Act then Warren Harris, the CEO of Jay Scott will face the penalties and legal repercussions as prescribed in law.