The International Ethics Standards Board for Accountants® (IESBA®) is in the midst of a second consultation in its efforts to reinforce global independence standards to address public concerns about the threats to auditors’ independence created by their long association with audit clients. While a number of jurisdictions such as the EU, Brazil, and India have chosen to mandate audit firm rotation (MFR) to address these concerns, the IESBA determined that the evidence concerning the effectiveness of MFR was inconclusive. Instead, the IESBA has chosen to pursue further strengthening of the partner rotation requirements in its Code of Ethics for Professional Accountants (the Code).
Long association is an area of great importance because of the adverse impact it can have on public perceptions of auditor independence. It is also an area of great complexity. At what point does association with an audit client become so long that it threatens independence? And which audit personnel should be rotated and in relation to which types of entity? These are no easy questions to answer, and that is why the IESBA has finalized its deliberations on some of the issues while sending others back out for further public consultation.
“Auditor independence, both in mind and in appearance, is the bedrock of public trust in the audit profession. Public expectations around the issue of long association have shifted in terms of what are considered acceptable safeguards that effectively mitigate long association risks. The board is responding to this shift in as thoughtful and measured a way as possible. It seeks to strengthen independence recognizing at the same time that changes in requirements in this area may be subject to practical constraints faced by firms,” said IESBA Chairman Stavros Thomadakis.
Key Changes
Long association is a tricky balancing act. On one hand, a certain amount of familiarity with an audit client is beneficial, even necessary, for audit quality. Longer association can lead to a deeper knowledge and understanding of the entity’s business and its operations. On the flip side, objectivity and professional skepticism are also important contributors to audit quality. Unconscious biases may develop and over-familiarity may blunt the auditor’s willingness to ask difficult questions.
Let’s take a closer look at what the IESBA has settled so far and what auditors internationally can expect to see. The maximum number of years that key audit partners (KAPs) may stay on a public interest entity (PIE) audit engagement—seven years—will not change. Among the key changes will be:
- An increase in the cooling-off period for engagement partners (EPs) on audits of PIEs from two to five consecutive years;
- A requirement for firms to evaluate the potential threats created by long association with respect to any individual on the audit team, not just senior personnel, and to determine the appropriate cooling-off period for that individual if rotation is determined to be a necessary safeguard;
- A prohibition on the rotated partner from acting as the “relationship partner” for the client; and
- A prohibition on activities, including the provision of non-assurance services, that would result in the rotated partner having significant ongoing interactions with the client or exerting direct influence on the outcome of the audit engagement during the cooling-off period.
Whether or not the EP cooling-off period should be extended, and by how long, proved to be extremely polarizing as responses to the first public consultation on this issue varied significantly. However, responses were more closely aligned in relation to applying the extension only to PIE audits. Ultimately, after lengthy deliberation, the IESBA decided that an increase to five years for audits of such entities was necessary to ensure a “fresh look” by the EP, given that the EP plays the most significant role on the audit. For more information on the board’s decisions regarding these and other changes, see the IESBA staff-prepared Basis for Conclusions, included in the February 2016 Exposure Draft (ED).
There are now only three issues that remain on the table:
Cooling-Off Period for the Engagement Quality Control Reviewer (EQCR) on the Audit of a PIE. This issue has been equally polarizing, with some views arguing for no change given that the EP and EQCR roles are different, and other views arguing for an extension of the EQCR cooling-off period to match that of the EP, given the EQCR’s significant role on the audit and familiarity with the audit issues. After much debate, the IESBA has settled for a “middle ground” by proposing that the cooling-off period for the EQCR be increased from two to five years with respect to a listed entity, and to three years with respect to a non-listed PIE. This position strikes a balance between the principle of a “fresh look” and the practical implementation consequences given the more limited availability of individuals able to serve as EQCR.
Jurisdictional Safeguards. The IESBA debate on this issue was framed in the context of developments relating to MFR, etc. in the EU and other jurisdictions. There were concerns in particular that overlaying the new partner rotation provisions over pre-existing jurisdictional requirements might have the unintended consequence of making the requirements applicable in the particular jurisdiction stricter than those proposed by the Code, or making the overlay of requirements too complicated to interpret and apply. The IESBA concluded that both these outcomes could undermine its goal of promoting widespread adoption and implementation of the Code. Accordingly, the ED proposes that the cooling-off period of five years for both the EP on PIE audits and the EQCR on listed audits may be reduced to three years where jurisdictions have established certain specified robust legislative or regulatory safeguards regarding long association.
Service in a Combination of Roles during the 7-Year Time-On Period. The ED offers a revised approach to determining how long an individual should cool off after having served as an EP or EQCR, or in a combination of roles, for only part of the seven-year period they have served as a KAP.
The comment period for the current consultation is open until May 9, 2016. The IESBA encourages all stakeholders, in particular investors, preparers, audit committee members and members of the regulatory community, with an interest in auditor independence and audit quality to submit their feedback.
Recognizing that its finalized and proposed changes will result in some added complexity in an already complex area, the IESBA has commissioned its staff to develop a set of Questions and Answers (Q&As) to facilitate understanding and implementation of the new provisions. The proposed Q&As have been included in the ED.
As part of a larger discussion regarding how to further enhance the application of professional skepticism, the IESBA is actively contributing to the work of a Joint Professional Skepticism Working Group (PSWG) in coordination with the International Auditing and Assurance Standards Board (IAASB) and the International Accounting Education Standards Board (IAESB). Feedback on the direction of the PSWG’s further work in this area has been requested by May 15, 2016 as part of the IAASB’s Invitation to Comment, Enhancing Audit Quality in the Public Interest: A Focus on Professional Skepticism, Quality Control, and Group Audits (ITC). Such feedback will help the IESBA determine whether there are areas within the Code that would benefit from further elaboration, emphasis, or clarification to better support auditors in demonstrating professional skepticism.
Audit quality continues to be a topic of significant debate among investors, regulators, audit committees, and others with a role in the financial reporting supply chain. The IESBA is actively participating in this debate through seeking ways to further enhance the robustness of the Code. The IESBA’s new and revised pronouncements will likely come into effect sometime in 2018. Watch the IESBA’s website and sign up for news alerts to stay informed of developments.
In addition to submitting a formal comment on the Long Association Exposure Draft (ED), you are encouraged to log in to Join the Conversation below to let us know what you think about the ED and related issues.
This article was authored exclusively for Accountancy Ireland. It is reprinted here with the permission of Accountancy Ireland.
