Auditor independence and Joint Ventures 2322

  • I saw discussions on whether JVs would fall under Section 404. And that is often also dependent on materiality. What about other sections of SOX? I came across an issue on auditor independence in one of our JVs. Do JVs need to comply with the rule regarding auditor’s prohibited services?

  • JVs are generally not public companies and therefore are not required to comply with SOX.
    Public companies do enter into JVs and will need to have controls around how they account for their interests in the JV where material.

  • Thanks, Denis.
    Would that mean a JV of a public company that is material to the F/S of the company needs to comply with the independence rule (e.g. cannot hire the company’s auditor to compile their books), while an immaterial JV will not be bound by those rules?
    While the scope of 404 is subject to materiality, I am not sure how the independence rules apply.

  • Here are the SEC rules - %0AAudit Partner%0AThe rules will define a new term-audit partner-for purposes of the requirements for partner rotation and partner compensation. An audit partner will be defined as a partner who is a member of the audit engagement team who has responsibility for decision-making on significant auditing, accounting and reporting matters that affect the financial statements or who maintains regular contact with management and the audit committee. The term audit partner will include the lead and concurring partners as well as partners who serve the client at the issuer level, other than a partner who consults with others on the audit engagement team regarding technical or industry-specific issues, and the lead partner on subsidiaries of the issuer whose assets or revenues constitute 20% or more of the consolidated assets or revenues of the issuer.%0ACooling Off Period%0ASection 206 of the Sarbanes-Oxley Act establishes a one-year cooling off period before a member of the audit engagement team may accept employment in certain, designated positions with an issuer. The rules, therefore, will provide that an accounting firm is not independent if a member of management involved in overseeing financial reporting matters was the lead partner, the concurring partner, or any other member of the audit engagement team who provided more than ten hours of audit, review or attest services for the issuer within the one year period preceding the commencement of the audit of the current year’s financial statements.%0AThe term audit partner does not extend to all partners on the audit engagement team. For example, partners serving on subsidiaries which constitute less than 20% of the assets and revenues of the issuer would not be audit partners as we have defined that term and, thus, would not be subject to rotation. Likewise, partners on subsidiaries above the 20% threshold, other than the lead partner on those subsidiaries, are not subject to rotation.139

  • Based on my review of the accounting criteria for the general partner of limited partnerships under the consolidation or equity method, please consider the following:

    1. Based on EITF 96-16 it appears the general partner may not have a controlling interest based on the following examples where both partners must approve:
      ’ Approval of any new business plan or material modification to the business plan.
      ’ Any capital or the expenditures in excess of USD50,000
      ’ Any acquisition or lease of real property in excess of USD50,000, including the exercise of extension options under the leases
      ’ Any material change in product designs, programs or offerings
      ’ Appointment and removal of key officers, other than the manufacturing manager.
      ’ Operating and managing the day-to-day business and affairs in a manner consistent with the business plan and then-current budgets
      ’ Hiring and removal of employees
      ’ Proposing revisions to the Business Plan or budget for submission to the Board of Directors for consideration
      ’ Implementing the business plan and budget as approved by the Board of Directors
      ’ Executing contracts or other instruments on behalf of the Company
    2. Because the limited partner has the ability to participate in significant decisions that would be made in the ordinary course of business it appears the general partner does not control the partnership, therefore the general partner should account for its investment in the limited partnership using the equity method of accounting.
    3. In addition, based on the white paper by Deloitte, the partnership agreement should have been reviewed for other criteria that may need to be considered to determine who has controlling interest, for example:
      ’ Ability to block acquisition or dispositions of assets
      ’ Ability to select, terminate, and set the compensation of management responsible for
      implementing the limited partnership’s policies and procedures
      ’ Ability to approve the limited partnership incurring additional indebtedness
      ’ Right to block dividends
      ’ Right to initiate or resolve a lawsuit
      ’ Relationships between the general partners and the limited partners (e.g., whether the limited partners are parties related to the general partner);
      ’ Whether the limited partners’ rights relate to operating or capital decisions that are not significant to the ordinary course of business of the limited partnership;
      ’ Whether it is remote that the event or transaction that requires the limited partner approval will occur; and
      ’ Whether the general partners have a contractual right to buy out the interest of the limited partners for fair value or less,
      ’ thereby giving the general partners the ability to prevent the limited partners from exercising their participating rights.
    4. It may also be worth looking at reporting relationships, this could be a key factor of control.
    5. The non-controlling status of the general partner should be assessed each reporting period that financial statements are prepared.
    6. Equity method investments should be classified as a non-current asset. [IAS 28.38]
    7. If the joint venture is classified as a non-current asset under the equity method, it may be subject to SOX auditing as part of the general partner’s audit based on the risk matrix (considering the known risks, possible materiality of the investment), sampling of account reconciliations or review of investments under the treasury matrix.

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