THREAT TO AUDITORS’ INDEPENDENCE AND THEIR RESOLUTIONS

The IFAC Code of Ethics for Professional Accountants gives a comprehensive
coverage of threats to auditors’ independence and their resolution. The Rules
of Professional Conduct for Members also cover the same topic. Excerpts of the
sections in the IFAC Code are adapted or reproduced in the following sections:

Threats to Independence

Independence is potentially affected by:
(a) self-interest,
(b) self-review,
(c) advocacy,
(d) familiarity and
(e) intimidation threats.
“Self-Interest Threat” refers to when a firm or a member of the assurance team
could benefit from a financial interest in, or other self-interest conflict with, an
assurance client.
Examples of circumstances that may create self-interest threat include:
(a) A direct financial interest or material indirect financial interest in an
assurance client;
(b) A loan or guarantee to or from an assurance client or any of its directors
or officers;
(c) Undue dependence on total fees from an assurance client;
(d) Concern about the possibility of losing the engagement
(e) Having a close business relationship with an assurance client;
(f) Potential employment with an assurance client; and
(g) Contingent fees relating to assurance engagements.
“Self-Review Threat” occurs when:
(a) any product or judgement of a previous assurance engagement or nonassurance
engagement needs to be re-evaluated in reaching conclusions
on the assurance engagement; or
(b) when a member of the assurance team was previously a director or
officer of the assurance client, or was an employee in a position to exert
direct and significant influence over the subject matter of the assurance
engagement.
Examples of circumstances that may create self-review threat include:
(a) A member of the assurance team being, or having recently been, a
director or officer of the assurance client;
(b) A member of the assurance team being, or having recently been, an
employee of the assurance client in a position to exert direct and
significant influence over the subject matter of the assurance
engagement;
(c) Performing services for an assurance client that directly affect the subject
matter of the assurance engagement; and
(d) Preparation of original data used to generate financial statements or
preparation of other records that are the subject matter of the assurance
engagement.
“Advocacy Threat” occurs when a firm, or a member of the assurance team,
promotes, or may be perceived to promote, an assurance client’s position or
opinion to the point that objectivity may, or may be perceived to be, compromised.
Such may be the case if a firm or a member of the assurance team were to
subordinate their judgement to that of the client.
Examples of circumstances that may create advocacy threat include:
(a) Dealing in, or being a promoter of, shares or other securities in an
assurance client; and
(b) Acting as an advocate on behalf of an assurance client in litigation or in
resolving disputes with third parties. “Familiarity Threat” occurs when,
by virtue of a close relationship with an assurance client, its directors,
officers or employees, a firm or a member of the assurance team becomes
too sympathetic to the client’s interests.
Examples of circumstances that may create familiarity threat include:
(a) A member of the assurance team having an immediate family member
or close family member who is a director or officer of the assurance
client;
(b) A member of the assurance team having an immediate family member
or close family member who, as an employee of the assurance client, is
in a position to exert direct and significant influence over the subject
matter of the assurance engagement;
(c) A former partner of the firm being a director, officer of the assurance
client or an employee in a position to exert direct and significant
influence over the subject matter of the assurance engagement;
(d) Long association of a senior member of the assurance team with the
assurance client; and
(e) Acceptance of gifts or hospitality, unless the value is clearly insignificant,
from the assurance client, its directors, officers or employees.
“Intimidation Threat” occurs when a member of the assurance team may be
deterred from acting objectively and exercising professional scepticism by
threats, actual or perceived, from the directors, officers or employees of an
assurance client.
Examples of circumstances that may create intimidation threat include:
(a) Threat of replacement over a disagreement on the application of an
accounting principle; and
(b) Pressure to reduce inappropriately the extent of work performed in order
to reduce fees.

Safeguards

The firm and members of the assurance team have a responsibility to remain
independent by taking into account the context in which they practice the threats
to independence and the safeguards available to eliminate the threats or reduce
them to an acceptable level.
When threats are identified:
(a) Appropriate safeguards should be identified and applied to eliminate
the threats or reduce them to an acceptable level;
(b) This decision should be documented;
(c) The nature of the safeguards to be applied will vary depending upon
the circumstances;
(d) Consideration should always be given to what a reasonable and informed
third party having knowledge of all relevant information; including
safeguards applied, and would reasonably conclude to be unacceptable;
and
(e) The consideration will be affected by matters such as the significance of
the threat, the nature of the assurance engagement, the intended users
of the assurance report and the structure of the firm.
Safeguards fall into three broad categories:
(a) Safeguards created by the profession, legislation or regulation;
(b) Safeguards within the assurance client; and
(c) Safeguards within the firm’s own systems and procedures.
The firm and the members of the assurance team should select appropriate
safeguards to eliminate or reduce threats to independence, other than those
that are clearly insignificant, to an acceptable level.
Safeguards created by the profession, legislation or regulation, include the
following:
(a) Educational, training and experience requirements for entry into the
profession;
(b) Continuing education requirements;
(c) Professional standards and monitoring and disciplinary processes;
(d) External review of a firm’s quality control system; and
(e) Legislation governing the independence requirements of the firm.
Safeguards within the assurance client include the following:
(a) When the assurance client’s management appoints the firm, persons
other than management ratify or approve the appointment;
(b) The assurance client has competent employees to make managerial
decisions;
(c) Policies and procedures that emphasise the assurance client’s
commitment to fair financial reporting;
(d) Internal procedures that ensure objective choices in commissioning nonassurance
engagements; and
(e) A corporate governance structure, such as an audit committee, that
provides appropriate oversight and communications regarding a firm’s
services.
Audit committees have an important corporate governance role when they are
independent of client management and, in performing their statutory role,
assist the board of directors in satisfying themselves that a firm of auditors is
independent in carrying out its audit role.
There should be regular communication between the firm and the audit
committee (or other governance body if there is no audit committee) of listed
entities, in the course of the audit, regarding relationships and other matters
that might, in the firm’s opinion, reasonably be thought to bear on independence.
The Companies and Allied Matters Act makes provision for the establishment
of audit committees and stipulates their functions. The audit committee shall
consist of an equal number of directors and representatives of the shareholders
of the company (subject to a maximum number of six members) and shall
examine the auditors’ report and make recommendations thereon to the annual
general meeting as it may think fit.
Firms should establish policies and procedures relating to independence,
communications with audit committees, or others charged with governance.
Safeguards within the firm’s own systems and procedures may include firmwide
safeguards such as the following:
(a) Firm leadership that stresses the importance of independence and the
expectation that members of assurance teams will act in the public
interest;
(b) Policies and procedures to implement and monitor quality control of
assurance engagements;
(c) Documented independence policies regarding the identification of
threats to independence, the evaluation of the significance of these
threats and the identification and application of safeguards to eliminate
or reduce the threats, other than those that are clearly insignificant to
an acceptable level;
(d) Internal policies and procedures to monitor compliance with firm policies
and procedures as they relate to independence;
(e) Policies and procedures that will enable the identification of interests
or relationships between the firm or members of the assurance team
and assurance clients;
(f) Policies and procedures to monitor and, if necessary, manage the reliance
on revenue received from a single assurance client;
(g) using different partners and teams with separate reporting lines for the
provision of non-assurance services to an assurance client;
(h) Policies and procedures to prohibit individuals who are not members of
the assurance team from influencing the outcome of the assurance
engagement;
(i) Timely communication of a firm’s policies and procedures, and any
changes thereto, to all partners and professional staff, including
appropriate training and education thereon;
(j) Designating a member of senior management as responsible for
overseeing the adequate functioning of the safeguarding system;
(k) Means of advising partners and professional staff of those assurance
clients and related entities from which they must be independent;
(l) A disciplinary mechanism to promote compliance with policies and
procedures; and
(m) Policies and procedures to empower staff to communicate to senior levels
within the firm any issue of independence and objectivity that concerns
them;this includes informing staff of the procedures open to them.
(n) Safeguards within the firm’s own systems and procedures may include
engagement specific safeguards such as the following:
(o) Involving an additional professional accountant to review the work done
or otherwise advise as necessary. This individual could be someone from
outside the firm, or someone within the firm or network firm who was
not otherwise associated with the assurance team;
(p) Consulting a third party, such as a committee of independent directors,
a professional regulatory body or another professional accountant;
(q) Rotation of senior personnel;
(r) Discussing independence issues with the audit committee or others
charged with governance;
(s) Disclosing to the audit committee, or others charged with governance,
the nature of services provided and extent of fees charged;
(t) Policies and procedures to ensure members of the assurance team do
not make, or assume responsibility for, management decisions for the
assurance client;
(u) Involving another firm to perform or re-perform part of the assurance
engagement;
(v) Involving another firm to re-perform the non-assurance service to the
extent necessary to enable it to take responsibility for that service; and
(w) Removing an individual from the assurance team, when that
individual’s financial interests or relationships create a threat to
independence.
When the safeguards available, such as those described above, are insufficient
to eliminate the threats to independence or to reduce them to an acceptable
level, or when a firm chooses not to eliminate the activities or interests creating
the threat, the only course of action available will be the refusal to perform, or
withdrawal from, the assurance engagement.

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