CPA Quiz: Sec And Pcaob Independence Rules
20 questions · exam conditions
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Sec And Pcaob Independence RulesQuestion 1 of 20

A partner at a PCAOB-registered firm is the engagement partner for the audit of Skyline Energy, a public issuer. Midway through the audit, Skyline's chief financial officer offers the partner a position as vice president of finance, and the partner indicates interest and agrees to participate in interviews. What is the most appropriate course of action under SEC independence rules?

Continue the audit because independence is not affected unless the partner accepts the employment offer.
Immediately report the offer to the audit committee, remove the partner from the engagement, and consider whether the firm's independence has been impaired for the period after employment discussions began.
Continue the audit if the partner is not involved in making audit judgments related to areas overseen by the chief financial officer.
Continue the audit if the firm adds an engagement quality reviewer and documents safeguards consistent with AICPA nonissuer guidance.
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CPA Quiz

CPA Quiz: Sec And Pcaob Independence Rules

Practice Sec And Pcaob Independence Rules in CPA with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Sec And Pcaob Independence Rules, giving you a quick way to practice the rules, question types, and explanations that matter most for CPA.

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Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

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Question 1

A partner at a PCAOB-registered firm is the engagement partner for the audit of Skyline Energy, a public issuer. Midway through the audit, Skyline's chief financial officer offers the partner a position as vice president of finance, and the partner indicates interest and agrees to participate in interviews. What is the most appropriate course of action under SEC independence rules?

  1. Continue the audit because independence is not affected unless the partner accepts the employment offer.
  2. Immediately report the offer to the audit committee, remove the partner from the engagement, and consider whether the firm's independence has been impaired for the period after employment discussions began. (correct answer)
  3. Continue the audit if the partner is not involved in making audit judgments related to areas overseen by the chief financial officer.
  4. Continue the audit if the firm adds an engagement quality reviewer and documents safeguards consistent with AICPA nonissuer guidance.
Explanation: SEC independence rules require immediate action when audit team members enter employment discussions with an audit client, as this creates a self-interest threat that impairs independence. The engagement partner's expression of interest and agreement to interview for a position with Skyline Energy triggers the employment discussion provisions, requiring immediate removal from the audit. The correct answer (B) mandates reporting to the audit committee, removing the partner from the engagement, and evaluating whether independence was impaired for work performed after discussions began. Option A is incorrect because independence is impaired once employment discussions commence, not only upon acceptance. Option C is incorrect because limiting the partner's involvement in specific areas does not cure the pervasive self-interest threat. Option D is incorrect because AICPA nonissuer guidance is irrelevant for SEC registrants, and safeguards cannot cure employment discussion impairments. The critical principle is that employment discussions create an immediate independence impairment requiring removal from the audit and evaluation of whether prior work was compromised by the self-interest threat.

Question 2

A PCAOB-registered firm is negotiating the audit engagement letter for the audit of NovaFin, a public issuer. NovaFin proposes paying the audit fee only if the firm issues an unqualified opinion by a specified deadline, with a reduced fee if additional audit procedures are required. Based on SEC/PCAOB standards, which response is correct?

  1. Accept the arrangement because the fee is fixed unless the audit scope changes, which is consistent with a value-based pricing model.
  2. Accept the arrangement if the audit committee pre-approves it and the contingency is disclosed in the financial statements.
  3. Reject the arrangement because a fee contingent on the audit opinion or completion timing is a contingent fee that impairs independence for an issuer audit. (correct answer)
  4. Accept the arrangement because contingent fees are prohibited only for non-audit services, not for audit services.
Explanation: SEC rules explicitly prohibit contingent fee arrangements for audit services to issuers, where payment depends on the audit outcome or other conditions. The proposed arrangement making payment contingent on receiving an unqualified opinion by a deadline constitutes a prohibited contingent fee that impairs independence. The correct answer (C) correctly identifies this as a contingent fee violation because payment is tied to both the opinion type and completion timing. Option A is incorrect because the contingency on opinion type and timing, not scope changes, makes this a prohibited arrangement. Option B is incorrect because audit committee pre-approval cannot cure contingent fee prohibitions, and such arrangements need not be disclosed as they are simply prohibited. Option D is incorrect because contingent fees are prohibited for both audit and non-audit services to issuer clients. The fundamental principle is that audit fees must be fixed or determinable based on time and effort, not contingent on audit outcomes, to preserve independence and objectivity.

Question 3

You are the engagement partner for the integrated audit of an issuer (SEC registrant). During annual independence confirmations, you learn that a manager assigned to the engagement owns $2,500 of the issuer's common stock in a brokerage account and acquired it two months before fieldwork began. Under SEC and PCAOB independence rules, which action should the auditor take regarding independence?

  1. Continue the engagement because the holding is immaterial to the manager and disclose the interest to those charged with governance
  2. Require the manager to dispose of the stock and continue the engagement because the interest was held before the audit started
  3. Remove the manager from the engagement and have the manager dispose of the stock; evaluate whether the firm's independence was impaired and whether the audit report can be issued (correct answer)
  4. Apply only the AICPA conceptual framework and implement safeguards (e.g., an additional review) to reduce the threat to an acceptable level
Explanation: SEC and PCAOB independence rules prohibit covered persons, including engagement team members, from having direct financial interests in issuer audit clients during the professional engagement period. The key facts are that the manager, a covered person, acquired and holds a direct investment in the issuer's stock before fieldwork began, creating a self-interest threat. Choice C aligns with SEC guidance by requiring removal of the manager, disposal of the stock, and evaluation of any impairment to the firm's independence and audit report issuance. Choice A is incorrect because immateriality does not permit continued holdings under SEC rules, and disclosure alone is insufficient; choice B is wrong as pre-existing holdings still impair if not divested; choice D is incorrect because the AICPA framework does not supersede stricter SEC/PCAOB rules for issuers. To apply professional judgment, auditors should identify all covered persons and their financial interests annually, ensuring immediate remediation for any violations. A decision rule is to assess whether the interest existed during any part of the audit period and evaluate if safeguards can retroactively mitigate the threat.

Question 4

An engagement team member on the audit of an issuer has a credit card issued by a bank that is also the issuer audit client. The card has a $3,000 balance that is paid in full each month, and the terms are standard for the general public. Based on SEC/PCAOB standards, which response is correct?

  1. Independence is impaired because any lending relationship with an issuer audit client is prohibited
  2. Independence is generally not impaired for consumer credit under normal terms and immaterial amounts, but the firm should evaluate the specific facts and applicable SEC lending exceptions (correct answer)
  3. Independence is impaired unless the team member closes the account before year-end
  4. Independence is not affected because credit cards are nonfinancial relationships
Explanation: SEC independence rules provide exceptions for normal consumer lending relationships with issuer clients, such as credit cards, if terms are standard and amounts immaterial. The key facts are the $3,000 balance, monthly full payment, and public terms. Choice B is correct per SEC guidance, allowing such relationships with evaluation. Choice A is incorrect as not all lending is prohibited; choice C is wrong because closure is unnecessary if compliant; choice D is incorrect since credit cards are financial relationships. For judgment, assess materiality and terms against exceptions. A rule is to permit only grandfathered or immaterial consumer loans under normal conditions.

Question 5

Your firm audits an issuer and is asked to provide internal audit outsourcing by performing ongoing testing of controls and reporting results to management throughout the year. Management states it will "own" the internal audit function but wants the firm to execute the work program and determine which locations to test. Which action should the auditor take regarding independence?

  1. Accept the engagement because internal audit outsourcing is permitted if management receives the reports
  2. Decline because performing management functions such as determining the internal audit plan and executing ongoing internal audit activities would impair independence for an issuer audit (correct answer)
  3. Accept if the firm uses different personnel than the external audit team and the audit committee pre-approves the service
  4. Accept because internal audit services are prohibited only when fees are contingent
Explanation: SEC and PCAOB rules prohibit auditors from assuming management functions, such as executing internal audit plans, for issuer clients to avoid self-review threats. The key facts are the firm's role in determining the plan, testing locations, and ongoing execution despite management's 'ownership' claim. Choice B is correct per SEC guidance, as this impairs independence by placing the auditor in a management role. Choice A is incorrect as report receipt does not prevent impairment; choice C is wrong because separate personnel and pre-approval cannot authorize prohibited services; choice D is incorrect since contingency is irrelevant to the management function prohibition. For judgment, distinguish between advisory and operational roles in internal audit. A decision rule is to decline if the service involves decision-making or execution typically reserved for management.

Question 6

A senior associate on the audit of an issuer informs the engagement partner that the associate's spouse has accepted a position as the issuer's controller, which is a financial reporting oversight role. The associate is scheduled to begin interim testing next week. How should the auditor address this independence threat under SEC and PCAOB rules?

  1. Allow the associate to continue working because the spouse is not in the issuer's audit committee
  2. Remove the associate from the engagement immediately and evaluate whether independence was impaired during any period the spouse held (or accepted) the role (correct answer)
  3. Continue the associate on the engagement but add an engagement quality reviewer to mitigate the threat
  4. Apply only AICPA family member guidance because PCAOB rules do not address spouse employment relationships
Explanation: SEC and PCAOB independence standards consider close family members' employment in financial reporting oversight roles as impairing the auditor's independence due to familial self-interest threats. The key facts are the spouse's new controller position and the associate's role on the engagement team, making the associate a covered person. Choice B aligns with SEC rules by requiring immediate removal and evaluation of impairment during any overlapping period. Choice A is incorrect because SEC rules apply to any financial oversight role, not just audit committee positions; choice C is wrong as additional reviews cannot safeguard against familial employment impairments; choice D is incorrect since PCAOB incorporates SEC rules, which are stricter than AICPA for family relationships in issuers. In professional judgment, promptly document and communicate such relationships to firm leadership. A decision framework is to assess if the family member's role involves authority over accounting or reporting, necessitating team member exclusion.

Question 7

While serving as engagement partner on the audit of an issuer, you receive an unsolicited offer to become the issuer's chief accounting officer and begin discussions with management about compensation and start date. Fieldwork is ongoing and the audit report has not been issued. What is the most appropriate course of action under SEC independence rules?

  1. Continue leading the audit as long as you do not participate in final opinion formation
  2. Immediately report the offer to the audit committee, remove yourself from the engagement, and ensure appropriate procedures are performed to address potential independence impairment (correct answer)
  3. Continue on the engagement until the audit report is issued, then resign from the firm to join the issuer
  4. Accept the offer and remain on the engagement if an additional partner reviews your work as a safeguard
Explanation: SEC independence rules prohibit auditors from engaging in employment discussions with issuer clients during the audit engagement period, as this creates adverse interest and familiarity threats. The key facts are the ongoing fieldwork, unissued report, and active discussions about joining as chief accounting officer. Choice B is correct per SEC guidance, requiring immediate reporting, removal, and procedures to address potential impairment. Choice A is incorrect as partial participation still impairs; choice C is wrong because resignation must occur before discussions; choice D is incorrect since additional reviews cannot mitigate employment negotiation threats under SEC rules. For judgment, auditors should halt all client interactions upon receiving offers and consult ethics resources. A rule is to treat any employment dialogue during the engagement as an immediate independence violation requiring remediation.

Question 8

A PCAOB-registered firm audits the financial statements of VertexApps, Inc., an SEC-registered issuer. During the year under audit, the firm also provided bookkeeping services by posting journal entries and preparing the trial balance used to generate the financial statements. Which action should the auditor take regarding independence?

  1. Continue as auditor because bookkeeping is permissible if management approves all entries and the firm does not authorize transactions.
  2. Continue as auditor if the firm uses separate personnel for bookkeeping and the audit committee pre-approves the service.
  3. Conclude independence is impaired because providing bookkeeping services to an issuer audit client is a prohibited non-audit service under SEC rules. (correct answer)
  4. Continue as auditor because the prohibition applies only when the auditor prepares source documents, not when posting entries.
Explanation: SEC rules explicitly prohibit auditors from providing bookkeeping services to issuer audit clients, including posting journal entries and preparing trial balances. These services are considered prohibited non-audit services because they place the auditor in a management role and create a self-review threat when auditing the financial statements. The correct answer (C) recognizes that providing these bookkeeping services impairs independence for the issuer audit. Option A is incorrect because management approval does not cure the prohibition against bookkeeping services for issuers. Option B is incorrect because using separate personnel and obtaining audit committee pre-approval cannot overcome the absolute prohibition. Option D is incorrect because the prohibition encompasses all bookkeeping activities, including posting entries prepared by others. The key principle is that bookkeeping services are categorically prohibited for issuer audit clients to prevent auditors from auditing their own work and assuming management responsibilities.

Question 9

A PCAOB-registered firm audits the financial statements of HarborSoft, Inc., an SEC-registered issuer. The firm's tax department proposes representing HarborSoft in a tax court proceeding that involves a material uncertain tax position reflected in the financial statements under audit. Based on SEC/PCAOB standards, which response is correct?

  1. Provide the representation because tax services are generally permissible for audit clients if pre-approved by the audit committee.
  2. Decline the representation because acting as an advocate for the issuer in a tax court proceeding creates an advocacy threat that impairs independence for the issuer audit. (correct answer)
  3. Provide the representation if the litigation relates to a prior year and the audit team is not involved in evaluating the uncertain tax position.
  4. Provide the representation because advocacy impairments apply only to nonissuer audits under AICPA standards.
Explanation: SEC rules prohibit auditors from acting as advocates for issuer audit clients in any legal proceedings, including tax court proceedings. Representing HarborSoft in tax court would place the firm in an advocacy position defending positions that affect the financial statements under audit, creating both advocacy and self-review threats. The correct answer (B) correctly identifies that this representation impairs independence because it creates an unacceptable advocacy threat. Option A is incorrect because while many tax services are permissible with pre-approval, advocacy in legal proceedings is specifically prohibited regardless of audit committee approval. Option C is incorrect because the prohibition applies regardless of which year is involved or whether the audit team evaluates the position, as the firm cannot advocate for positions it must independently evaluate. Option D is incorrect because advocacy prohibitions apply to both issuer and nonissuer audits, though specific rules may vary. The key principle is that auditors cannot serve as advocates for audit clients in legal proceedings, as this fundamentally conflicts with the objectivity required for independent auditing.

Question 10

An audit partner at a PCAOB-registered firm is leading the integrated audit of AlphaTech, Inc., a publicly traded issuer. During the engagement acceptance process, the partner learns that their spouse owns 500 shares of AlphaTech held in a brokerage account under the spouse's name, and the shares were acquired before the audit period. Under SEC and PCAOB independence rules, which action should the auditor take regarding independence?

  1. Continue the audit because the spouse's investment is not in the auditor's name and was acquired before the engagement period.
  2. Continue the audit if the partner documents the interest and implements additional engagement quality review procedures as a safeguard.
  3. Withdraw from the engagement unless the spouse disposes of the shares before the firm issues the audit report and the firm evaluates whether independence was impaired during the audit period. (correct answer)
  4. Continue the audit because SEC independence rules permit direct financial interests held by immediate family members if the amount is not material to the spouse.
Explanation: SEC independence rules prohibit covered members and their immediate family members from having any direct financial interest in an audit client, regardless of materiality. The spouse's ownership of 500 shares of AlphaTech stock constitutes a direct financial interest that impairs independence because spouses are considered immediate family members under SEC rules. The correct answer (C) requires withdrawal from the engagement unless the spouse disposes of the shares before the audit report is issued, and the firm must evaluate whether independence was impaired during the period the shares were held. Option A is incorrect because the timing of acquisition and ownership name are irrelevant when immediate family members hold direct financial interests. Option B is incorrect because safeguards cannot cure direct financial interest violations for immediate family members. Option D is incorrect because SEC rules contain no materiality exception for direct financial interests held by immediate family members. The key principle is that direct financial interests by covered members or their immediate family members create an absolute prohibition that can only be remedied through disposal of the interest.

Question 11

A PCAOB-registered firm audits the financial statements of BrightRetail Corp., an SEC-registered issuer. Management asks the audit firm to design and implement BrightRetail's new revenue recognition controls within its financial reporting system, and then to audit the effectiveness of those controls as part of the integrated audit. Based on SEC/PCAOB standards, which response is correct?

  1. Accept the engagement because the firm may design and implement internal controls if management takes responsibility for the system.
  2. Decline the requested non-audit service because designing and implementing internal controls over financial reporting would place the auditor in a management role and impair independence. (correct answer)
  3. Accept the engagement if the audit committee pre-approves the service and the firm uses separate personnel from the audit team.
  4. Accept the engagement because this is permissible under AICPA independence rules for nonissuers when safeguards are applied.
Explanation: SEC rules specifically prohibit auditors from designing or implementing internal control systems for issuer audit clients because these activities place the auditor in a management role. Designing and implementing revenue recognition controls within the financial reporting system would require the auditor to make management decisions about control objectives, risk assessment, and control activities. The correct answer (B) recognizes that this service impairs independence regardless of any safeguards because the auditor would essentially be auditing their own work during the integrated audit. Option A is incorrect because management's acceptance of responsibility does not cure the independence impairment when the auditor performs prohibited non-audit services. Option C is incorrect because audit committee pre-approval and personnel separation cannot overcome the prohibition against designing and implementing internal controls. Option D is incorrect because AICPA nonissuer rules are irrelevant for SEC registrants, which must follow the more restrictive SEC/PCAOB standards. The fundamental principle is that auditors cannot perform management functions or audit their own work, and designing internal controls clearly violates both prohibitions.

Question 12

A senior manager on the engagement team is assigned to the audit of OceanBio, Inc., a publicly traded issuer. The senior manager's sibling is OceanBio's controller and prepares significant accounting estimates that are subject to audit. How should the auditor address this independence threat under SEC and PCAOB independence rules?

  1. Remove the senior manager from the engagement and evaluate whether any prior work performed by the senior manager must be reperformed to address a potential independence impairment. (correct answer)
  2. Continue the engagement because a sibling is not considered an immediate family member under SEC independence rules.
  3. Continue the engagement if the senior manager signs an annual independence confirmation and the relationship is disclosed to management.
  4. Continue the engagement because the controller is not a member of the audit committee and therefore is not in a financial reporting oversight role.
Explanation: SEC independence rules define immediate family members to include siblings when the audit team member can influence the audit, creating an independence impairment when the sibling holds a key position at the audit client. The senior manager's sibling serving as controller who prepares significant accounting estimates creates a direct threat to independence because the senior manager would be auditing their sibling's work. The correct answer (A) requires removing the senior manager from the engagement and evaluating whether prior work must be reperformed, as independence may have been impaired from the point the relationship began affecting the audit. Option B is incorrect because siblings are considered immediate family members under SEC rules when the auditor is in a position to influence the audit. Option C is incorrect because disclosure and independence confirmations cannot cure this type of structural independence impairment. Option D is incorrect because the controller position involves significant influence over financial reporting, regardless of audit committee membership. The key principle is that family relationships in financial reporting positions create unacceptable threats that require removal from the engagement team.

Question 13

A PCAOB-registered firm audits the financial statements of MetroMed, Inc., an SEC-registered issuer. The lead engagement partner has served in that role for the past five consecutive years, and the firm plans to retain the same partner for the upcoming audit. Based on SEC/PCAOB standards, which response is correct regarding partner rotation?

  1. Retain the partner because partner rotation is a best practice but not required if an engagement quality review is performed annually.
  2. Retain the partner because SEC partner rotation applies only to audits of nonaccelerated filers.
  3. Rotate the lead engagement partner off the engagement after five years and apply the required time-out period before the partner can return in that role. (correct answer)
  4. Retain the partner if the audit committee pre-approves an exception to the rotation requirement due to specialized industry expertise.
Explanation: SEC rules mandate partner rotation for issuer audits, requiring the lead engagement partner to rotate off after five consecutive years of service. The partner who has served for five years has reached the maximum tenure and must rotate off the engagement, followed by a five-year cooling-off period before returning as lead partner. The correct answer (C) properly applies the five-year rotation requirement and references the mandatory time-out period. Option A is incorrect because partner rotation is mandatory, not a best practice, and engagement quality review does not substitute for rotation requirements. Option B is incorrect because SEC partner rotation rules apply to all issuers regardless of filer status. Option D is incorrect because audit committees cannot grant exceptions to mandatory partner rotation requirements, even for specialized expertise. The fundamental principle is that mandatory partner rotation promotes independence by ensuring fresh perspectives and preventing excessive familiarity threats that develop over extended tenure.

Question 14

A small PCAOB-registered firm performs the audit of DeltaCloud, Inc., a publicly traded issuer. DeltaCloud's audit and permissible audit-related services represent 22% of the firm's total annual revenues, and firm leadership is concerned about the appearance of economic dependence. How should the auditor address this independence threat under SEC and PCAOB independence rules?

  1. Conclude independence is impaired because SEC rules prohibit any audit client from exceeding 10% of firm revenues.
  2. Conclude independence is not impaired solely due to fee concentration, but communicate with the audit committee and evaluate whether the relationship creates a reasonable appearance of lack of independence. (correct answer)
  3. Accept a contingent fee arrangement for the audit to reduce the upfront burden on the issuer and mitigate dependence.
  4. Conclude independence is not an SEC/PCAOB issue because fee dependence is addressed only in AICPA nonissuer guidance.
Explanation: While SEC rules do not specify a bright-line percentage for fee dependence, significant client concentration creates threats to independence in appearance that must be evaluated and communicated. A single client representing 22% of firm revenues raises concerns about economic dependence that could affect the auditor's objectivity or create a reasonable perception of compromised independence. The correct answer (B) recognizes that while independence may not be automatically impaired, the firm must communicate with the audit committee and evaluate whether the relationship creates an appearance issue. Option A is incorrect because SEC rules contain no specific 10% threshold for fee concentration. Option C is incorrect because contingent fees are prohibited for all audit services to issuers. Option D is incorrect because fee dependence is a concern under both SEC/PCAOB and AICPA standards, though specific thresholds may differ. The key principle is that economic dependence, even without technical violation, can create appearance issues requiring evaluation, disclosure, and potential mitigation strategies.

Question 15

A PCAOB-registered firm is engaged to audit the financial statements of GreenTransit, Inc., a publicly traded issuer. Before the engagement begins, the firm learns it has an outstanding loan receivable from GreenTransit related to an equipment financing arrangement entered into two years ago, with a remaining balance that is not material to the firm. How should the auditor address this independence issue under SEC and PCAOB independence rules?

  1. Proceed with the audit because loans are permitted when they are immaterial to the auditor and were entered into before the audit engagement.
  2. Proceed with the audit if the firm discloses the loan to management and documents that it does not affect the auditor's objectivity.
  3. Conclude independence is impaired due to a creditor relationship with the audit client and do not accept (or withdraw from) the issuer audit unless the relationship is eliminated consistent with SEC independence requirements. (correct answer)
  4. Proceed with the audit because this is primarily an AICPA independence matter and PCAOB standards do not address lending relationships.
Explanation: SEC independence rules prohibit lending relationships between auditors and their audit clients, with very limited exceptions that do not apply to equipment financing arrangements. The firm's loan receivable from GreenTransit creates a creditor-debtor relationship that impairs independence regardless of materiality to the firm. The correct answer (C) properly concludes that independence is impaired and the firm must eliminate the relationship or decline/withdraw from the engagement. Option A is incorrect because loans between auditors and audit clients are generally prohibited regardless of materiality or timing. Option B is incorrect because disclosure cannot cure prohibited financial relationships with audit clients. Option D is incorrect because SEC/PCAOB standards explicitly address and prohibit lending relationships with audit clients. The fundamental principle is that financial relationships creating mutual interests between auditors and clients, such as loans, are incompatible with independence and must be eliminated before accepting or continuing an issuer audit engagement.

Question 16

A small firm audits an issuer and the issuer's audit and audit-related fees represent 18% of the firm's total revenues for the year. No partner has a financial interest in the issuer, and all services are pre-approved by the audit committee. How should the auditor address this independence threat under SEC and PCAOB rules?

  1. Conclude independence is impaired because SEC rules prohibit any client exceeding 10% of firm revenues
  2. Conclude independence is not automatically impaired, but evaluate and address the self-interest threat (e.g., governance communication and firm-level safeguards) consistent with SEC/PCAOB independence requirements (correct answer)
  3. Conclude independence is not an issue because fee dependency is relevant only under AICPA standards for nonissuers
  4. Continue the engagement without further consideration because audit committee pre-approval eliminates the threat
Explanation: SEC and PCAOB independence rules address fee dependency as a potential self-interest threat but do not automatically impair independence based on a revenue percentage threshold for issuers. The key facts are the 18% revenue concentration, lack of partner interests, and audit committee pre-approval. Choice B is correct as it requires evaluation and safeguards like governance communication per PCAOB guidance. Choice A is incorrect because SEC has no strict 10% rule for impairment; choice C is wrong as fee dependency applies to issuers under SEC/PCAOB; choice D is incorrect since pre-approval alone does not eliminate the need to assess threats. For judgment, quantify fee reliance and implement firm-level reviews. A framework is to apply the conceptual framework, documenting threats and safeguards for significant client concentrations.

Question 17

A firm audits an issuer. The issuer's chief executive officer offers the engagement partner two tickets to a sold-out sporting event valued at $900 total as a thank-you for "working hard this year." The partner has not yet accepted. How should the auditor address this independence threat under SEC/PCAOB rules?

  1. Accept because gifts do not affect independence if they are not cash
  2. Accept if the partner reimburses the issuer for the face value after the event
  3. Decline because accepting a gift of more than clearly insignificant value from an issuer audit client creates an independence impairment or at least an unacceptable threat under SEC/PCAOB requirements (correct answer)
  4. Accept if the audit committee is notified and approves the gift in writing
Explanation: SEC and PCAOB rules restrict gifts from issuer clients to auditors, prohibiting those exceeding insignificant value to maintain appearance of independence. The key facts are the $900 tickets offered as thanks, not yet accepted. Choice C is correct per SEC guidance, creating an unacceptable threat. Choice A is incorrect as non-cash gifts can still impair; choice B is wrong because reimbursement does not prevent initial threat; choice D is incorrect since approval cannot waive gift restrictions. For judgment, evaluate gift value and intent. A rule is to decline gifts over trivial amounts, documenting all offers.

Question 18

A firm audits an issuer. The issuer asks the firm to prepare the issuer's financial statements and related footnote disclosures from the trial balance and to draft the Form 10-K, with management planning to "review and sign." Based on SEC/PCAOB standards, what is the most appropriate course of action under SEC independence rules?

  1. Accept because drafting financial statements is permissible if management reviews and accepts responsibility
  2. Decline because preparing financial statements and drafting SEC filings for an issuer audit client is a prohibited non-audit service that impairs independence (correct answer)
  3. Accept if the audit committee pre-approves and the work is performed after year-end fieldwork
  4. Accept if the firm limits its work to formatting and proofreading only
Explanation: SEC and PCAOB prohibit auditors from preparing financial statements or originating data for issuer clients, as this creates self-review threats and impairs independence. The key facts are the firm's role in preparing statements from the trial balance and drafting the 10-K, with only management review. Choice B is correct per SEC Rule 2-01, deeming this a banned bookkeeping service. Choice A is incorrect as management responsibility does not permit the service for issuers; choice C is wrong because pre-approval cannot authorize prohibited acts; choice D is incorrect since even limited work like formatting can impair if it involves preparation. For judgment, assess if the service generates auditable data. A rule is to limit assistance to technical advice, avoiding any origination of financial information.

Question 19

A firm audits an issuer. The issuer proposes that the audit firm will receive a success fee if the issuer completes a debt refinancing, because the firm's advisory group will help prepare lender presentations and negotiate terms. The firm would still issue the audit report. Based on SEC/PCAOB standards, which response is correct?

  1. Accept because the success fee relates to financing, not the audit opinion
  2. Accept if the success fee is separately contracted and the audit committee pre-approves it
  3. Decline because contingent fees and certain broker-dealer/investment banking type services for an issuer audit client can impair independence (correct answer)
  4. Accept if a separate affiliate performs the advisory work and the audit team is not involved
Explanation: SEC rules prohibit contingent fees and investment advisory services that promote issuer clients' financing, due to self-interest and advocacy threats. The key facts are the success fee for refinancing assistance, including presentations and negotiations. Choice C is correct per SEC guidance, impairing independence. Choice A is incorrect as financing ties still create contingencies; choice B is wrong because pre-approval cannot allow contingents; choice D is incorrect since affiliates are part of the firm. For judgment, scrutinize advisory for promotional elements. A rule is to ensure fees are non-contingent and services do not involve underwriting.

Question 20

Your firm audits an issuer. A tax partner proposes representing the issuer in an IRS examination and negotiating directly with the IRS agent on the issuer's behalf. The amounts involved are material, and the matter could lead to a significant uncertain tax position. Which action should the auditor take regarding independence?

  1. Provide the representation because tax services are always permissible for issuer audit clients
  2. Decline because acting as an advocate for the issuer in a material tax dispute can impair independence under SEC/PCAOB rules (correct answer)
  3. Provide the representation if the audit committee pre-approves and the engagement letter states management remains responsible
  4. Provide the representation only if the external audit team is not informed of the outcome
Explanation: SEC and PCAOB rules restrict advocacy services, such as representing issuer clients in material tax disputes, to avoid adverse interest threats. The key facts are the material IRS examination, direct negotiation, and potential uncertain tax position. Choice B aligns with SEC guidance by declining to prevent impairment from advocacy roles. Choice A is incorrect as not all tax services are permissible if they involve advocacy; choice C is wrong because pre-approval and responsibility statements do not mitigate; choice D is incorrect since audit team separation is irrelevant. In judgment, assess if the service positions the auditor as an advocate. A framework is to limit tax work to compliance and planning, avoiding representational roles in disputes.