Developing the IFAC SMP Committee Response: Proposed Changes to the IESBA Code Regarding Long Association
The Code of Ethics for Professional Accountants (the Code) requires that members of both audit and assurance teams and firms be independent of audit and assurance clients. The Code states that familiarity and self-interest threats are created by using the same senior personnel on an audit engagement over a long period of time.
The issues involved in evaluating the threats created by long association are complex and interwoven. With respect to audit engagements, the concern is that over a period of time a member of the audit team may become too familiar with the audit client, its personnel, and their interests, including accounting and reporting issues. This can result in a loss of independence either of mind or in appearance. On the other hand, the cumulative knowledge and experience of an audit client’s business, management, and internal controls gained through familiarity with the audit client contribute positively to audit quality and evaluation as well as identification of audit risk areas.
The International Ethics Standards Board for Accountants (IESBA) recently released for public comment the Exposure Draft (ED), Proposed Changes to Certain Provisions of the Code Addressing the Long Association of Personnel with an Audit or Assurance Client. The proposed changes broadly cover:
- Strengthening the general provisions that apply to all audits and assurance engagements with respect to the threats created by long association;
- Increasing the mandatory “cooling-off” period, from two to five years, for the engagement partner on the audit of an entity that is a public interest entity (PIE);
- Strengthening the restrictions on the type of activities that can be undertaken with respect to the audit client and audit engagements by a former key audit partner during the cooling-off period; and
- Ensuring the concurrence of those charged with governance with respect to the application of certain exceptions to the rotation requirements.
The rationale supporting the proposed changes includes concerns raised by stakeholders about the appearance of independence, the public interest, and continued confidence and trust in the independence of the audit process.
The IFAC Small and Medium Practices (SMP) Committee will be responding to these proposals. Indeed, we have been closely monitoring the development of the ED from the outset, providing input and providing an SMP and small- and medium-sized entity (SME) perspective on IESBA agenda materials. The SMP Committee is developing our preliminary views in response to various questions posed in the ED. These comments may include:
- The proposed enhancements to the general provisions should provide more useful guidance for identifying and evaluating familiarity and self-interest threats created by long association. However, we disagree with the IEBSA that these should apply to all individuals on the audit team. In practice, junior team members will not be exposed to areas involving significant decisions or judgment without full review by more senior team members and, therefore, it seems excessive to have provisions beyond senior personnel.
- We agree with the “time-on” period remaining at seven years for key audit partners on the audit of PIEs.
- We disagree with the proposal to extend the cooling-off period to five years for the engagement partner on the audit of PIEs. We accept the rationale for the proposed differentiation between the key audit partner and lead audit engagement partner based on the fact that the more influential a partners is, the more critically his or her objectivity will be viewed. However, the five year period appears excessive and could pose considerable difficulties for many SMPs that audit PIEs as they have a smaller number of partners to rotate amongst.
- In our opinion, the revision of the cooling-off period should be based on robust evidence in support of change. The current partner rotation requirements in the Code were only effective for the audit of financial statements for years beginning on or after December 15, 2011. There is no evidence to suggest that the current provisions for audit partner tenure for a maximum of seven years on and a two year cooling off period have not been working effectively in practice. We therefore believe that it is too early to determine whether the two year cooling off period is inappropriate.
- The proposals could also have significant unintended consequences, which should be further considered by the IESBA. For example, it may further exacerbate market dominance of the largest accountancy firms and lead to a further erosion of choice in the PIE audit market.
- We believe that there are other equally effective, if not more appropriate, alternatives to the proposals that are in place as safeguards rather than having to sacrifice the knowledge and experience accumulated over time.
- The rationale behind the proposal of relaxing certain non-permissible activities that the lead audit engagement partner could undertake after two years of a five-year cooling off period is counterintuitive to the main proposal. We believe this could also make application of the Code overly complex and that the layering of two-tier requirements for different roles over local legislation and standards will make implementation difficult.
- We do not agree with the additional restrictions placed on activities that can be performed by a key audit partner during the cooling-off period. A complete ban on some activities seems inappropriate in certain areas, especially where it might be possible to introduce other safeguards. These additional restrictions could be particularly punitive for SMPs and would not necessarily enhance audit quality.
Join the Conversation
You can respond to the IESBA ED here. To help the SMP Committee develop its response, we would be keen to hear the views of professional accountants in SMPs and SMEs. In particular, on any operational or implementation costs you anticipate that the IESBA should consider. Please log in and comment below to share your thoughts on the proposed changes to the IESBA Code addressing Long Association.