Auditing Practices Board ethical standards

In the UK, the Auditing Practices Board (APB) was reorganised in
2012 as part of the restructuring of the Financial Reporting Council.
Nevertheless, the Ethical Standards (ESs) issued in December 2004 remain
as authoritative statements governing auditors in the UK. In substance
the ESs conform to the revised independence code of the International
Federation of Accountants and so will be similar in content to many
independence rules around the world. These standards seek to deal with
the various threats to auditors’ objectivity. These are:
• self-interest threat (e.g. investing in clients)
• self-review threat (e.g. producing a valuation for inclusion in the
client’s financial statements)
• management threat (e.g. taking a decision on behalf of management)
• advocacy threat (e.g. supporting management in litigation)
• familiarity threat (or trust) (e.g. close relationship with client
personnel)
• intimidation threat (e.g. by dominant senior executive).

ES1 Integrity, objectivity and independence

Firms should have policies and procedures in place to identify threats to
their actual and perceived objectivity and independence and to identify
and assess the effectiveness of any safeguards.
In the case of listed company audits, an independent partner should
review the firm’s compliance.

ES2 Financial, business, employment and personal relationships

Financial relationships

Financial interests: An audit firm, a partner, or a person in an
influential position in the firm (or an immediate family member)
should not have a direct financial interest in a client. Neither should an
auditor have a material indirect interest or an indirect interest through
an intermediary where the auditor has the ability to influence the
intermediary or knows of the underlying investment in the client.
If, for example, an auditor inherits under a will shares in an audit client,
the shares must be disposed of immediately.
Interests held as trustee: Trustee holdings in an audit client are
acceptable where the auditor is not a beneficiary of the trust, or the
interest is immaterial to the trust, or the trust is not able to exercise
significant influence over the client, or the auditor does not have
significant influence over the trust.
Loans and guarantees: No loans should be made to – or received from
– a client except in the ordinary course of business on normal business
terms and the loan is not material either to the firm or its client.

Business relationships

General: Auditors should avoid doing business with audit clients unless
the transaction involves the purchase of goods or services in the ordinary
course of business on arm’s-length terms and for values which are not
material to either party. Firms should not provide audit services to any
party able to influence the affairs of the audit firm or conduct of its audit.

Employment relationships

Management role: Auditors should avoid situations where they are
employed by both the audit firm and the audit client. Such situations
might arise when an audit client is faced with a sudden vacancy caused
by the unexpected departure, illness or death of a key member of its staff.
The client may turn to its audit firm for help in an emergency. Audit firms
should not provide staff on secondment unless it is to a non-managerial
post and the client accepts responsibility for directing the work of that staff
member. On return to the audit firm, that individual should not be given
responsibility for auditing the work that they did for the client (since this
would ignore the self-review threat).
Auditor joining client: If a member of the audit firm leaves the firm
to join an audit client, that individual must sever all links with the firm.
Auditors should notify the audit firm’s management as soon as a move to
an audit client looks likely. The individual concerned should stand down
from the audit and their work on the current and last audit should be
reviewed.
If the individual moving to the client is the audit partner and they are
moving to take up a senior management post, then the audit firm should
resign from the audit and should not allow itself to be considered for
re-appointment for two years. If a more junior member of the audit team
makes the move to a key management post with the audit client, then the
audit firm should reconsider the composition of the team. It may be that
those who remain on the audit team had developed such close ties with
their former colleague that their objectivity, now that the colleague holds a
senior post with the client, cannot be guaranteed.
The evidence on this aspect of independence is not compelling. Dart and
Chandler (2013) find that institutional investors hardly seem concerned
at all that ex-auditors often find work in a former audit client. And while
there is more concern among private individuals as shareholders there is
very little desire on the part of shareholders generally for the professional
rules to be further tightened to prevent movement of personnel between
audit firm and audit client. However, financial journalists are not slow
to pick up on apparently cosy relationships as witnessed recently in the
Independent newspaper in June 2013 when it reported warnings to the
board of the Royal Bank of Scotland not to appoint any more former
executives from its auditors, KPMG.
Governance role: Auditors should avoid being appointed to the board
or a subcommittee of the board of an entity that holds more than 20 per
cent of the voting rights in one of their audit clients.
Employment with auditor: It sometimes happens that audit firms wish
to appoint to a staff position a former employee of an audit client. Where
that individual had some influence over the accounting function in the
client or the production of its financial statements, the audit firm should
take care to ensure that the new employee is not allocated to the audit team
responsible for the audit of their former employer for two years.

Personal relationships

Firms should institute policies and procedures to alert them to family and
other relationships between audit team members and clients. For example,
audit firms should inform their employees on a regular basis of their client
portfolio and employees should be asked to make a declaration of their
relationships and financial interests in clients of the firm.

ES3 Long association with the audit engagement

To ensure that the relationship between listed companies and their
auditors does not become too familiar, the audit engagement partner
should be replaced after five years (other partners who have a role in the
audit should not serve the same listed client for more than seven years).
For non-listed companies, audit firms need to consider whether the partner
is or may be seen to be independent after 10 continuous years. If an audit
client becomes listed then the five-year rule still applies, although a special
arrangement allows an audit partner who has served the client for four
years prior to listing to continue to serve for two years after listing.

ES4 Fees, remuneration, evaluation policies, litigation, gifts and hospitality

Fees

Fees should not be charged on a contingent basis, for example as a
commission or as a percentage of some unknown amount, such as some
future financial saving made by the client.
Firms should be aware that unpaid audit fees may threaten their
independence (unless they are for trivial amounts). In effect, outstanding
fees owed by the client to the firm are a form of loan by the auditors
and may be used by the client as a lever to get the auditors to accept
treatments they would not otherwise accept. The client may threaten not
to pay these overdue amounts unless the auditors agree with the client.
A firm should not act where fees (audit and non-audit) from the client
exceed 10 per cent of the firm’s total income.

Remuneration and evaluation policies

Firms should ensure that the objectives of the audit team do not include
selling non-audit services, nor are their appraisals or pay dependent on
persuading clients to engage the firm to perform such other services.

Litigation

When litigation in relation to an audit firm’s services, which is not
insignificant, has been or is about to be started, the audit firm should not
continue with or accept the engagement.

Gifts and hospitality

Auditors should not accept gifts from clients unless they are clearly of
insignificant value, nor should they accept hospitality unless it is reasonable
in terms of frequency, nature and cost. Audit firms should have policies to
ensure that staff understand these principles and comply with them.

ES5 Non-audit services provided to audit clients

The audit partner must be informed of all non-audit services that the firm
renders to the audit client. Before accepting a non-audit engagement,
the audit engagement partner must consider the appearance of the
firm’s independence (or lack of it), identify possible threats and assess
effectiveness of the firm’s safeguards. Where there appears to be a conflict,
a firm should either not accept the non-audit engagement or decline/
withdraw from the audit.
The firm should inform those charged with governance (i.e. the audit
committee or its equivalent).
There are restrictions on the kind of other services that the firm must also
bear in mind:
• Internal audit services are generally thought not to be compatible with
the external audit.
• Information technology services, again, are not thought to be
compatible with the independent audit function.
• Valuation services should not be provided where the matter is highly
subjective and material to the financial statements.
• Actuarial services should not be provided unless all significant
judgements are taken by management or are immaterial.
• Tax services should not be provided where the audit partner has
doubts about the appropriateness of any accounting treatments or the
tax services are to be remunerated on a contingent fee basis which is
material or is dependent on uncertain tax law.
• Litigation support services should not be provided where they involve
giving an estimation of the likely outcome of a case, which is material
and very subjective.
• Legal services should not be provided if the matter is material.
• Recruitment services should not be provided if they involve making
a decision to appoint personnel to the client’s staff. For listed clients,
no recruitment services should be provided in relation to key
management positions. Auditors should not undertake to advise on
remuneration packages of key management posts.
• Corporate finance should not be offered if it amounts to dealing or
promoting shares, or if the firm has doubts as to the appropriateness of
any accounting treatment, or if the service is to be remunerated on a
contingent fee basis.
• Accounting services should not be offered for listed companies (except
to cover emergency situations). Auditors may assist audit clients who
are not publicly listed, provided transactions are not initiated by the
audit firm employees, no decisions are taken by them and the firm
implements safeguards to maintain their independence.
Holland and Lane (2012) report evidence that only when the level of
non-audit fees becomes extremely high do shareholders get sufficiently
concerned about the threat which non-audit services pose to auditors’
independence that they sell their shares,. They suggest that this behaviour
indicates that investors are relatively comfortable with moderate levels
of non-audit services even though in theory these might still compromise
auditor independence.
A study by Barkess and Simnett (1994) of Australian companies’ use of
their auditors for non-audit services produced no evidence that there was
a link between non-audit services and either type of audit report or length
of tenure – which suggests that in Australia non-audit services pose no real
threat to auditor independence.

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