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Ethics In Focus - Insight Training

A Question of Ethics

It’s been a tough period for the audit profession, with a number of the bigger firms hitting the headlines for all the wrong reasons. A recurring theme in a number of the cases has been independence and objectivity, and compliance with the Financial Reporting Council’s (FRC) Ethical Standard (ES). Here are seven key themes, all of which are being covered on our current audit update courses:

  1. Be careful with the provision of non-audit services

For public interest entity audits, the rules on the provision of non-audit services are very tough, but even for SME audits care must be exercised. Where an audit firm provides complicated forensic or tax planning services, the auditor might end up having to treat another department in their own firm as a ‘client appointed expert’ and subject its work to audit scrutiny.

Even where the non-audit services are quite simple (such as the preparation of accounts) a self-review threat will still exist unless the audit firm can demonstrate that it is providing little more than a typing service. This threat will need to be carefully safeguarded, typically by independent review or a separate engagement team for the non-audit work.

  1. Keep an eye on non-audit / audit fee proportions

Again, this is a bigger issue for public interest entity audits, but even for SME audits, where non-audit fees dwarf the audit fee, regulators will challenge auditors on how they have mitigated the resulting self-interest threat.

This can be a particularly problematic issue where audit firms are providing corporate finance services to relatively small but ambitious companies. A firm will argue that ‘Chinese walls’ exist between its respective departments, but this sometimes simply doesn’t cut for smaller audit firms.

It is important that a firm’s ethics partner is consulted before any non-audit services are provided. This will allow them to consider whether the non-audit services create an insurmountable risk to auditor independence. This point demonstrates that an awareness of relevant ethical issues is very important for senior firm staff NOT involved in audit.

  1. Watch for rules where senior staff join clients

One case in the press over the summer resulted from a firm’s senior partner retiring and quickly joining a client’s board whilst still working for the firm in a consultancy capacity. Where the partner concerned is a ‘covered person’ on an audit, a two year ‘cooling off period’ would be required, effectively requiring the firm to resign.

New legislation introduced within the ES also now expressly prohibits an audit engagement partner from joining a client in a senior management capacity for a full year after stepping down from the audit role. In other words, the cooling off period rules now work two ways.

  1. Don’t ignore the threat of familiarity

A familiarity threat can exist where an engagement partner has been incumbent for 10 years or more, even on an SME audit, so careful consideration needs to be given to relevant and timely safeguards.

Such a threat can also materialise where excessive hospitality is provided by a client to an auditor. Don’t forget that, under the new ES, hospitality offered to any partner in the firm or by a covered person to an audit client is only acceptable if ‘trivial and inconsequential.’ This is still a VERY hot topic. In the light of recent press coverage, your regulatory body might well ask you to demonstrate the adequacy of your procedures in this area – and take a dim view if you can’t.

  1. There is some relief for smaller audits

The provisions available to the audit of small entities (PAASE) are copied across from the old ES-PASE to the new ES pretty much intact which is a blessed relief for many. PAASE allows a firm to do accounts preparation work followed by an audit without putting safeguards in place to mitigate the resulting self-review threat provided that (1) management is informed and (2) the firm’s programme of cold file reviews is extended. This should be relatively straightforward.

  1. Apply the spirit – as well as the letter – of the standard

The ES is split into two parts – part A deals with fundamental concepts and part B with specific issues. During a recent ICAEW Audit & Assurance Faculty webinar it was commented that there is often too much focus on the detail of section B and not enough focus on the spirit of section A. In the light of recent press coverage of the profession it’s crucial to be and be seen to be independent.

As a partner in a firm recently commented during an Insight Training workshop, if you’re hacking around in section B to find justification for what you’re doing, it’s probably not right for you to be doing it!

  1. Always document your thought process

Compliance with ethical standards has, for a long time, been a major focus for the audit profession’s regulatory bodies. And with the FRC meting out very stringent penalties for non-compliance (£10M for a firm and £0.5M for a partner in one recent well-documented instance) this will continue to be the case.

Our experience over many years working with firms is that they do generally strive to do the right thing – and that failings often lie with documentation. If firms do need to put their house is order in this area, it may be more about devising a robust set policies and procedures, getting senior management buy-in to these and establishing processes to ensure that they are adhered to and on a timely basis.

Peter Herbert

Insight Training

November 2018

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