Revised draft ethical standards for auditors

Comments from ACCA to the Auditing Practices Board, June 2009.

Executive summary 

ACCA welcomes the opportunity to comment on the Consultation Paper Revised Draft Ethical Standards for Auditors issued for comment by the Auditing Practices Board (APB) in March 2009.

Alignment with the IFAC Code

ACCA is in favour of closer alignment with the IFAC Code. This provides greater clarity in the case of group audits where there are overseas companies and in other situations where an auditor audits entities both in the UK (or Ireland) and overseas.  We fully support the principled-based approach adopted by the IFAC Code, and therefore, closer alignment with (and reinforcement of) the IFAC Code will help to establish enhanced clarity and increased regard for compliance with rigorous fundamental principles by auditors.  This standpoint of ACCA is reiterated throughout this consultation response.

We would prefer not to be commenting on what are perceived as relatively minor changes to the APB Ethical Standards, when we should be discussing adoption of the IFAC Code.  The changes proposed by the APB overlook the need to take a broader view.  ACCA believes that the UK should accept the IFAC standard as the default.  The IFAC approach is also preferred in that the Code is not written with large audits in mind with exemptions for small audits, but is aimed at the majority of audits with additional provisions for larger ones (ie ‘think small first’).

Partner rotation periods

We strongly advocate increasing the rotation period for audit engagement partners and Engagement Quality Control Reviewers on listed company audits to seven years.  We are not aware of a widespread view that requiring rotation after five rather than seven years has enhanced auditor independence: indeed the increased loss of knowledge and the reduction in ability to always have the most appropriate partner for the job may have been counter-productive to audit quality.  A change to a seven year rotation period, as well as enhancing international harmonisation by moving in line with the IFAC (and indeed Statutory Audit Directive) provisions, would also enhance the ability of audit firms with fewer partners, to compete at appropriate levels of the listed company audit market.

In view of our firm belief that the rotation period should generally be seven years (subject to compliance with the fundamental principle of objectivity), we would only support the proposal to require the approval of an audit committee if there was significant opposition to ACCA’s established view that the usual rotation period should be seven years.  In any event, we believe that the proposals to require disclosure to the shareholders if the audit committee decides to extend the rotation period beyond five years are inappropriate, and the current requirements of the Combined Code on Corporate Governance are sufficient to safeguard objectivity in this respect.

Remuneration and evaluation polices

As with many of the proposed changes in the consultation paper, the extension of the requirements relating to remuneration and evaluation policies represents additional detail to the rules within the ESs, and a move further away from focusing on compliance with fundamental principles.  If we accept that ES 4 as it stands is unclear (because it currently only prescribes that the policies should relate to members of the audit team), then we would support the proposed change to the current wording to refer also to key partners involved in the audit.  However, we would not support further changes to ES 4 to extend the requirements to yet further categories of partners and staff.

Other proposed changes

Many of the other proposed changes in the consultation paper are considered to be minor changes, relating to specific situations.  Whilst we agree that they would strengthen the content of the ESs, we have doubts concerning the effects they would have on clarity.  In addition, additional rules (either in strengthening the requirements or relaxing them in specific situations) invariably result in the user of those rules losing sight of the fundamental principles.  Therefore, in the case of each of the proposed amendments, we would advocate greater reference to fundamental ethical principles.  We suggest that clarity would be enhanced by removing examples of breaches of fundamental principles (including certain prohibited activities) to a document apart from the ESs.

General comments

The review of the ESs in 2007 resulted in amendments for the purposes of:

  • implementing legislation arising from the EU Statutory Audit Directive,
  • allowing continued adherence to the principles of the IFAC Code, and
  • adding to the clarity of the ESs and assisting their implementation in practice.

ACCA supports these objectives, and they form the background to many of the comments in this consultation response.  Of these objectives, we believe the most important to be the continued adherence to the principles of the IFAC Code. The proposed implementation date of the updated ESs is broadly in line with that of the new Clarity ISAs, and so we suggest that broad adoption of the IFAC Code at this time would be a preferable approach to the updating of ethical standards in the UK and Ireland.

Constant amendment of the detail within the ESs reduces clarity – particularly for audit firms that audit overseas companies – and dilutes the principles-based approach.  ACCA would like to emphasise the importance of safeguarding an approach founded on compliance with fundamental principles, rather than relying of detailed rules which often give rise to a lack of understanding of the ethical issues involved.

Specific Questions

QUESTION 1: Do you believe that any of the proposed changes will add to audit costs?  

If so, which changes and why?

APB does not believe that compliance with the proposals will have a significant impact on audit costs.  However, any changes in the ESs will result in costs to firms of changing their systems, regardless of whether or not the changes are simplifications.  ACCA believes that we are heading towards alignment with international ethical standards.  Therefore, to expend time and resources making detailed changes to the current ESs which will need to be changed again in due course to bring about alignment with the IFAC Code must result in unnecessary costs, as well as a reduction in clarity.

QUESTION 2: Are there any changes to the ESs proposed by the APB which will be difficult to implement for audits of financial statements for periods commencing on or after 15 December 2009?

As many of the changes are relaxations of the current position, we see no significant difficulty in early implementation of the changes.  In most cases (but with the exception of audits with short accounting periods), the changes are aligned with the effective dates for the new Clarity ISAs.  However, it might be more sensible to align implementation precisely by defining the effective date of the ESs with reference to periods ending on or after 15 December 2010.

QUESTION 3: The APB would appreciate commentators’ views on whether it would be appropriate to provide greater flexibility to ES 3 (Revised) to permit in certain circumstances, and with the prior approval of the audit committee, the rotation period to be extended from five to seven years?

The APB’s consultation paper identifies the issue of striking the right balance between auditor objectivity and audit quality derived from the relevant knowledge and experience of the audit engagement partner.  However, the paper does not cite evidence that a five-year rotation period provides greater protection of auditor objectivity than a seven-year rotation period – particularly when objectivity is assessed on the basis of fundamental ethical principles.  Since the five year rotation period was introduced (being an immediate reaction to the Enron scandal), other regulatory measures have been introduced that undermine the support for continuing the requirement for five-yearly rotation.

Extending the period of rotation to seven years would have a positive impact on audit quality, particularly in the case of complex entities such as banks.  ACCA believes that this benefit exceeds any benefit arising from a fresh view of the audit being taken more frequently due to a five-year rotation period.  (In any event, a fresh view is achieved by changing other members of the audit team.)

We note that the APB recognises that ‘there are a number of disadvantages’ to providing flexibility whereby the audit engagement partner’s involvement with the audit may be extended under certain prescribed circumstances and with the approval of the audit committee – most notably, the lack of clarity it creates.  Clarity and audit quality are enhanced by establishing a seven-year rotation period as the norm (subject of course to compliance with fundamental ethical principles) in alignment with the requirements of the IFAC Code and the Statutory Audit Directive.

It is argued that audit committees considering the matter of audit engagement partner rotation would closely link in with their review of audit effectiveness under the Combined Code on Corporate Governance.  However, such review is intended to monitor the external auditor’s independence and objectivity as a firm.  To allow an audit committee to determine that an audit engagement partner (or any member of the audit team) should be removed would, in our opinion, be inappropriate.

Nevertheless, should the APB decide that it cannot fully support a seven year rotation period for engagement partners on listed entities as the norm, we would, reluctantly, advocate considering allowing a seven year rotation period on the condition that the matter be discussed with the audit committee. 

A complication with the proposed amendment is that some listed entities do not have audit committees or equivalents (for example some AIM listed companies, for which an audit committee is not a requirement).  In addition, if the entity does have an audit committee, the proposed amendment assumes that the audit committee will provide its agreement (or otherwise) based on the perceived independence of the audit engagement partner.  However, in practice, the audit committee might base its decision on a range of other factors not envisaged by the consultation paper.

Movement to a seven-year default period for rotation of the audit engagement partner is more compatible with a principles-based approach whereby, if a threat to objectivity is perceived in the intervening period (at any time), the engagement partner may be required to rotate before the end of the seven-year period.

QUESTION 4: In addition to large listed companies which are also complex or diverse, are there any other circumstances where some flexibility as regard the rotation period for audit engagement partners on listed companies would be appropriate?  

If so, please explain the rationale for your views.

ACCA would not wish to consider a comprehensive list of situations in which the rotation period for the audit engagement partner may be extended to seven years.  Rather, if the general requirement was for a seven-year rotation period, regard to fundamental ethical principles would ensure that earlier rotation took place when a risk to objectivity was perceived (probably even within a five year period).

QUESTION 5: Do you agree that if an audit committee is able to decide to extend the period of rotation, this fact and the reasons for it should be disclosed to shareholders?

This proposed amendment would require not only the approval of the audit committee, but also the agreement of the company to make appropriate disclosure if the audit engagement partner were to continue in that role beyond five years.  In our opinion, the proposed amendment to ES 3 is inappropriate, as the actions of the company could, in effect, prevent the audit engagement partner from continuing in the role.

In some circumstances, the reasons for the audit committee authorising an extension of the rotation period to seven years may be commercially sensitive.  Therefore, full disclosure to the shareholders could not be made, and the audit engagement partner would nevertheless have to be removed from the role.

Currently, the Combined Code on Corporate Governance requires an audit committee to review and monitor the external auditor’s independence and objectivity, and to make recommendations to the board, for it to put to the shareholders for their approval in general meeting, in relation to the appointment, re-appointment and removal of the external auditor.  Whilst these requirements relate to the audit firm, rather than the audit engagement partner, any perceived threat to the objectivity of the audit engagement partner may effect the audit committee’s recommendations regarding reappointment.  Therefore, we do not perceive the need to amend either ES 3 or the Combined Code in this respect.

We believe that the proposed amendments regarding seeking the approval of the audit committee and requiring disclosure to the shareholders if the audit engagement partner is to remain in the role for more than five years are unnecessarily complicated.  ACCA strongly advocates a seven year rotation period as the norm, thereby providing clarity and (just as importantly) focus on the underlying fundamental principle of objectivity.

QUESTION 6: Do you agree that the APB should retain the existing requirement and provide additional guidance in respect of partners and staff in senior positions for a continuous period longer than seven years?

ACCA is in favour of a principles-based approach aligned to international standards.  We support the existing requirements in respect of managers with a long association with an audited entity becoming key partners involved in the audit.  With regard to partners and staff members in senior positions who have been involved in a listed company audit for more than seven years, ACCA believes that the additional guidance proposed would be useful.

We note that there is no suggestion in the consultation paper that the approval of an audit committee should be sought if a senior member of the audit team is to remain involved in the audit for more than seven years.  As stated under 22 above, the audit committee is required to make recommendations to the board regarding the auditor’s independence.  Discussion with the audit committee (where possible) might be one of the safeguards included in the guidance. This would enable the audit committee to make appropriate recommendations to the board regarding the independence of the auditor, based on information about the audit team, but would not enable the audit committee to dictate the audit team’s composition.

QUESTION 7: Do you support the proposed extension of the rotation period for the EQCR on listed company audits to seven years?

The EQCR is selected because he or she is seen to be independent and therefore, independence is assessed on a regular basis, regardless of the period for which he or she has been in the role of EQCR.  The EQCR does not make decisions regarding the audit opinion and therefore, the familiarity threat associated with their period of involvement in the audit is not as significant as that in respect of the audit engagement partner.

Therefore, ACCA supports the proposed extension of the rotation period for EQCRs on listed company audits to seven years.  It would be a form of simplification and enhanced clarity, whilst encouraging auditors to focus on a principles-based assessment of independence within any seven year rotation period.

QUESTION 8: Do you support the proposed approach of the APB towards internal audit staff working directly for the audit team?

ACCA agrees that the correct approach is to deal with this matter by way of guidance in auditing standards to which ES 2 could refer.  However, there is a trend towards increased reliance on internal audit staff, and care should be taken not to stifle this.  The APB should wait until ISA 610 has been revised by the IAASB, instead of developing a position that relates solely to the UK and Ireland.  Although it may be felt that including such guidance in ISA (UK and Ireland) 610 could enhance the strength of arguments for its adoption by the IAASB, guidance could be more extensive in an APB Bulletin, which would also assist in influencing the international position more widely.

QUESTION 9: Do you support the proposed approach of the APB towards the provision of restructuring services by the external auditor?

This is a very specific proposed amendment in reaction to current economic conditions.  Whilst ACCA prefers to focus on a principles-based approach to assessing the threats to objectivity brought about by the provision of non-audit services to an audit client, we are content that specific non-audit services may be noted as examples where the threats to the fundamental principles cannot be adequately reduced by appropriate safeguards.  Given the proposed prohibition to be added to ES 5, we are supportive of the proposed relief to be provided in paragraph 15 of the ES – PASE.  However, we would strongly support a move to include such examples of prohibited activities in a document apart from the ESs.

QUESTION 10: Do respondents support the APB’s analysis and conclusion in relation to securitisation services?

ACCA supports the APB’s analysis and conclusions, and agrees that there is no need to strengthen the current requirements of ES 5 in respect of securitisation services.

QUESTION 11: ES 5 (Revised) paragraph 119 sets out the circumstances in which securitisation services would be prohibited.  Are there other circumstances that should result in a prohibition?

In our opinion, there are no further circumstances that should result in a prohibition of the provision of securitisation services.  ACCA believes that the most significant threat to objectivity arises where the auditor takes a management role.

QUESTION 12: Do you support the proposed relaxation of the ESs with respect to financial interests of new partners joining the firm?

This is a very specific situation, and ACCA would not like to consider a full list of similar situations that should result in the relaxation of the current rules.  We prefer a principles-based approach, and the relaxation of a current rule in specific circumstances is, in essence, simply a further rule.  Other examples that might need to be addressed are where a partner inherits a financial interest or where the spouse of a partner acquires an interest.  ACCA is not in favour of such detailed amendments which give the appearance of the ESs being too prescriptive.

QUESTION 13: Do you support the proposed strengthening of the ESs with respect to governance roles with an audited entity?

This proposed strengthening is based on the IFAC Code, and ACCA is in favour of this further alignment with the Code.

QUESTION 14: Do you support the APB’s proposed definition of an affiliate?

ACCA is in favour of the proposal to bring the ESs more in line with IFAC’s definition of a related entity.  However, we can see no compelling reason not to align the definitions completely.  We note the comment in the consultation paper that the proposed wording ‘minimises the scope for subjectivity, since the burden of proof is reversed so as to guide the audit firms towards a more cautious approach’.  This is a good example of focusing on the fundamental ethical principles, and provides scope for the APB to continue to influence IFAC in the development of the IFAC Code.  Nevertheless, the term ‘materiality’ is not defined by IFAC to relate only to the size of the entity, and so the benefit of the proposed deviation from the IFAC wording is outweighed by the lack of clarity through consistency.

We propose that the IFAC wording be adopted in its entirety, and that further clarity be sought through the APB’s efforts to influence development of the IFAC Code.

QUESTION 15: Do you support the proposed change to the ESs with respect to extending the requirements relating to remuneration and evaluation policies to key partners involved in the audit?

If it is accepted that specific rules are required, ACCA supports the strengthening of those rules.  However, using a principles-based approach, the requirements relating to remuneration and evaluation policies would automatically extend to key partners involved in the audit.

QUESTION 16: Do you believe that the requirement for remuneration and evaluation policies should be applied to other partners and staff from non-audit disciplines?

In some circumstances, this would be appropriate.  However, it would be a complicated process to decide to which partners and staff such an extension should be applied.  This issue demonstrates the need to adhere to fundamental ethical principles, and therefore, ACCA is not in favour of ES 4 prescribing to which staff the remuneration and evaluation policies should relate.

QUESTION 17: Do you support the proposed strengthening of the ESs with respect to valuations and other non-audit services where legislation provides that the auditor is eligible to carry out non-audit service, but does not require the auditor to undertake such work?

Whether a non-audit service from the auditor is required or permitted by legislation, the subsequent threats to auditor objectivity are the same.  ACCA considers this proposed strengthening of ES 5 as dealing primarily with an issue of perception.  However, the ESs must focus on the safeguards that must be implemented when threats to objectivity arise in respect of the audit assignment.  Whilst we consider this proposed amendment to be an enhancement of ES 5, it highlights the need for the ESs to emphasise the requirement to focus on fundamental principles, and so any deviations from principles-based standards must be kept to a minimum.

Last updated: 12 Apr 2012