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AICPA’s new state and local government client affiliates independence guidance

June 29, 2021 Article 2 min read
Authors:
Dawn Stark Katie Thornton Michelle Watterworth

The AICPA has adopted a revised independence interpretation that impacts state and local governments (SLGs). Our experts offer an overview and share resources for SLGs to understand and implement the guidance.

Close-up view of a wooden podium and microphone.State and local governments, take note: The AICPA  Professional Ethics Executive Committee has adopted a revised independence interpretation under the Independence Rule (ET sec. 1.224.020). The revised interpretation impacts entities defined in the AICPA Code of Professional Conduct as a State and Local Government (SLG). SLGs include any entity required to follow Government Accounting Standards Board (GASB) standards, including governments, higher education institutions, K-12 school districts, governmental healthcare organizations, and certain other entities if they follow GASB accounting standard.

What does the revised interpretation mean to my SLG organization?

Auditor independence is a shared responsibility between your organization and your organization’s audit firm. To ensure auditor independence, your auditors likely will need your help to perform an initial evaluation under these new standards and will also likely need your continuing assistance to meet the new rules.

What’s new?

The new independence interpretation defines four types of affiliates that require auditor independence.

These four types of affiliates have been defined by the AICPA as follows:

  • Type I – Entity included in your financial statements where your audit firm does not make reference to another auditor in the opinion.
  • Type II – Entity included in your financial statements where your audit firm makes reference to another auditor, and this entity is material, and you have more than minimal influence over this entity’s accounting/financial reporting.
  • Type III – A material excluded entity for which your organization has more than minimal influence over their accounting/financial reporting. A material excluded entity is one that is required by the applicable financial reporting model (GASB) to be included in your organization’s financial statements but has been excluded.
  • Type IV – An investment held by you or your type I affiliate(s) where either:
    • Control exists and the investment isn’t trivial or clearly inconsequential to your financial statements.
    • Significant influence exists and the investment is material to your financial statements.

Of these four types of affiliates defined by the guidance above, Type I entities already require independence, and type III entities rarely occur, particularly where state laws require full compliance with generally accepted accounting principles. The largest impact, therefore, will be to SLG’s with affiliates that are defined as type II and type IV entities.

But I thought auditor independence was an auditor issue?

The auditor independence frameworks required by both the AICPA and GAO do require auditors to monitor and comply with the independence regulations. That said, organizations that hire audit firms must also be concerned with the issue. Governmental organizations’ governing bodies play a critical role in financial reporting, hold a unique position in monitoring auditor independence, and are responsible for the oversight of the independent auditor.

Although most audit firms are rigorous in monitoring and enforcing these independence requirements, it is important that governments be aware of them as well.

Although most audit firms are rigorous in monitoring and enforcing these independence requirements, it is important that governments be aware of them as well.

What should I do now?

The revised interpretation is effective for years beginning after Dec.15, 2021.  Since the interpretation is effective as of the first day of the year of required adoption, you’ll need to work together with your audit firm to identify entities that qualify as your affiliates to ensure auditor independence evaluations are completed in a timely manner. 

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