By Christopher S. Johnson, CPA

For those nonprofit organizations receiving public funding in the form of grants, service contracts or certain loans, and required to have an annual audit in accordance with Government Auditing Standards, AKA the Yellow Book, recent revisions in those standards could impact future audit procedures and services provided by your auditors.

The 2011 Yellow Book was released in December of 2011 and supersedes the 2007 revision. As has been done in the past, the Government Accounting Office (GAO) issued a Summary of Major Changes in connection with the new release. Here’s where it gets interesting – of the eight bullet points in the Summary of Major Changes, five pertain to auditor independence standards. This compares to one of seven in 2007.

The Yellow Book independence standards have historically garnered a great deal of attention because of restrictions and safeguards imposed with regard to non-audit services, and because of the difficulty involved in navigating the guidance. The general objectives of the standards include preventing auditors from making decisions that are the responsibility of management, and preventing auditors from auditing their own work, since both of these situations would result in bias on the part of the auditor. Beginning in January of 2002 with the introduction of Amendment No. 3, the standards were laden with broad, subjective language that appeared to restrict auditors from providing a wide range of formerly routinely-provided services. To deal with the controversy, the GAO issued Answers to Independence Standard Questions in July of 2002. This 73-page document addressed many questions from the profession and specifically identified how auditor independence may be maintained in connection with certain nonaudit services (by implementing prescribed supplemental safeguards).  The document was a welcomed addition at the time; however, it still forced auditors to make subjective decisions about many nonaudit services. The 2007 revisions included substantially more guidance in evaluating nonaudit services and specifically addressed and allowed many of the traditional services that nonprofit organizations have historically relied on their auditors to provide; however, Answers to Independence Standard Questions was retained to augment the guidance in the 2007 Yellow Book. With the implementation of the 2011 Yellow Book, Answers to Independence Standard Questions is being retired and relevant content from it, along with further clarification of specific nonaudit services, has been added to the Yellow Book.

The 2011 revisions are a step in the right direction and provide a degree of much-needed clarity to what was poorly-worded and poorly-organized guidance. While most of the changes relate to structure and clarity, there are also certain changes that represent an apparent easing of OMB’s perspectives on independence. A new conceptual framework has been established for purposes of evaluating potential impairment to independence. The framework is designed to consider the facts of each situation and evaluate them in the context of their own unique circumstances. It’s anticipated that this approach will enable auditors to provide services that may previously have been interpreted as off limits under the former guidance.

The 2011 Yellow Book is effective for financial audits and attestation engagements of periods ending on or after December 15, 2012. Early adoption is not permitted.

The electronic version of the 2011 Yellow Book is available on the GAO website.

For more information on this topic, contact cjohnson@pmn.com

Note: This article represents a general overview of Federal and/or Massachusetts general topic issues or developments and should not be relied upon without an independent, professional analysis of how any legal provisions alluded to may apply in a specific situation.

IRS CIRCULAR 230 NOTICE: In compliance with U.S. Treasury Circular 230 Regulations and any applicable state laws, we hereby notify you that any tax advice contained in the body of this document, or attachments thereto, was not intended or written to be used, and cannot be used, by the recipient or any other party for the purpose of (1) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or (2) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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