INDEPENDENCE STANDARDS AND
BELOW COST AUDITS
Dr. Raymond Johnson, CPA
Professor of Accounting
Portland State University
Chair, Oregon Board of Accountancy
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Ethics and Strategic
Professional Issues Committee
 Gaylen Hansen, CPA, Chair

 Loss Audit Subcommittee
 Raymond Johnson, CPA, Subcommittee Chair
 Bobby Creech, CPA
 Rick David, CPA
 Gary Forte, Public Member
 Jeff Leiserowitz, CPA
 Kurt Kofford, CPA
 Larry Nunn, CPA
 Rona Shor, CPA
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Audits Below Cost
 “Below Cost Pricing” is an anti-
competitiveness issue with the FTC
 Brooks Act
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Threats and Safeguards Approach
 Recognized in AICPA Independence Conceptual
Framework
 Risk Based Approach to Independence
 Identify and evaluate threats to independence
 Implement safeguards such that it is not reasonable to
expect that the threat would compromise professional
judgment
 Recognized by International Ethics Standards Board
for Accountants
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Threats to Independence Posed by
Performing an Audit Below Cost
 Current trend in declining audit fees
 Red flag in Madoff audit
 Numerous articles about loss of independence in
mental attitude by auditing profession
 Baker (2005)
 Zeff (2003)
 Brewster (2003)
 Mautz (1988)
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Threats to Independence Posed by
Performing an Audit Below Cost
 When an auditor is intent on “buying” an
engagement, there is a threat of subordination of
judgment in order to retain the client.
 When the auditor relies on selling other services to
make up for the performing an audit below cost,
subordination of judgment may occur.
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Threats to Due Care and Compliance
with Professional Standards Posed by
Performing an Audit Below Cost
 When a fee is quoted below cost, a threat exists that it
may be difficult to perform the engagement and also
comply with applicable professional standards within
the time reasonably contemplated.
 When a fee is quoted below cost, a threat exists that
documentation requirements may not be met.
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Peer Review Considerations
 Tone at the top: acceptability of low balling regardless
of ethical consequences
 Engagement selection process with a focus on audit
below cost at a higher risk of noncompliance with
ethical standards
 Engagement reviews: Is it reasonable to assume that
given the actual hours on a below cost audit that
professional standards have been complied with?
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Anti-Trust Considerations
 There is considerable federal and state jurisprudence
explaining the “below cost” in antitrust and unfair
trade cases.
 There are also hundreds of state statutes and rules
currently applying the term to different areas of
commerce.
 Requiring a threats and safeguards approach should be
considered as an effort to stifle competitive bidding
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Committee Conclusion
 In principle, there is a presumption
that performing an audit, or other
attest services, below cost poses a
significant threat to independence, due
care, and compliance with professional
standards.
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Fees
 When entering into negotiations regarding audit
or other attest services a licensee may negotiate
any appropriate fee.
 The fact that one licensee may quote a lower fee
than another, or a licensee quotes a fixed fee, is not
itself unethical.
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Safeguards
The auditor may overcome the presumption that
performing an audit below cost poses a significant
threat to independence, due care, and compliance
with professional standards by putting the
following types of normal safeguards in place:
 Engagement quality reviews (e.g., concurring or second
partner review) and consultation with technical
specialists on issues of significant professional
judgment.
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Safeguards (continued)
 Adequate supervision and review of engagements
 Allocating appropriate time and assigning qualified
staff to do the engagement.
 Instituting an adequate system of quality control,
including approval of acceptance and continuance of
engagements by those responsible for managing the
auditing firm, preferably those that otherwise have no
participation in the audit
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States with Ethics Rules on
Audits Below Cost
North Carolina
 It is a discreditable act for a CPA or CPA firm to
knowingly offer to perform services below cost for
purposes of injuring or destroying competition
Texas
 Presumption of loss of independence when an attest
service is performed for less than the direct labor cost
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Potential Action Steps
1.
Develop professional standards that address the
threat to independence, due professional care and
compliance with professional standards of
performing attest services below cost.
2. Develop quality control standards that require a
firm’s systems of quality control to address the
inherent threats to independence, due professional
care, and compliance with professional standards
created by accepting and performing below cost
attest services.
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Potential Action Steps
3. Develop quality/compliance assurance (peer review)
standards to require, when selecting engagements
for review, appropriate consideration be given to
below cost engagements and the related ethical
threats
4. The Committee has drafted a rule, for discussion
purposes, with the hope that it will be considered
further by the NASBA UAA Committee as part of
uniform independence requirements.
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Discussion Questions
 Based on your experience in enforcement matters, is
performing an audit below cost a significant threat to
independence, due care and compliance with
professional standards?
 Is a threats and safeguards approach an appropriate
approach to addressing the below cost audits issue?
 Should below cost audits be addressed in the UAA as
part of uniform independence requirements?
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Discussion Questions
 After reviewing the proposed draft rule on Performing
Audits of Attest Engagements Below Cost are there
changes or clarifications that need to be made?
 Should NASBA address this issue comprehensively and
pursue changes to see that quality control standards
and peer review standards address the issue?
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