FEE publishes paper on auditor independence provisions

31 January 2013

In the Paper, FEE provides a summary of key differences between the EU frameworks of Auditor Independence provisions (in the 2006 Statutory Audit Directive and the 2002 EC Recommendation on Statutory Auditor's Independence in the EU) and global independence standards of the Code of the IESBA.

In assessing the independence of a statutory auditor, an audit firm or both, the EC Recommendation on statutory auditor’s independence (ECR) and the IESBA Code use essentially the same conceptual approach. This approach requires the identification of threats to auditor independence and the application of safeguards to mitigate those threats. Thereby the ECR and the IESBA Code both apply the test of whether a reasonable and informed third party would conclude that the statutory auditor is exercising objective and impartial judgement. This approach is also endorsed by the Statutory Audit Directive (SAD) in its Article 22 (2) where also the importance of self-interest and self-review threats are highlighted with regard to statutory audits of Public Interest Entities (PIEs).

The analysis of the key differences between the frameworks provided by the EU provisions and the IESBA Code shows that in substance the outcomes of their respective application by statutory auditors within the European Union are not significantly different. Nevertheless, there are various differences that exist with respect to the definitions and terms used within the different sets of requirements. Although they are designed to achieve the same objective, there are some differences that significantly impact the scope of those covered by the specific requirements. For example:

• Key audit partner: According to the IESBA Code the term “key audit partner”, besides the partner being primarily responsible for the audit engagement, also includes the partner providing quality control for that audit engagement. Compared to the respective SAD definition this, in effect, results in broadening the range of individuals to whom the cooling-off and rotation requirements apply;
• Listed entity: This term is solely defined in the IESBA Code, and comprises a broad range of quoted and listed entities, including those entities listed on local stock exchanges that do not meet the criteria of an EU regulated market. As a consequence the scope of entities covered by the definition of a PIE also differs between the SAD and the IESBA Code, so that under the IESBA Code the range of entities to which the restrictive provisions on PIEs are to be applied is much broader than under the provisions of the SAD.

When comparing the requirements that apply in specific situations, it is to be noted that the SAD is regulating only two particular situations with respect to the statutory audits of PIEs, namely where a key audit partner is to join an audit client in a key management position (cooling-off), and the instance where a key audit partner has to rotate off the statutory audit engagement (partner rotation). Therefore, the following summary of key differences focuses primarily on the differences between the ECR and the IESBA Code.

• Financial Interests: The IESBA Code is more restrictive than the ECR; e.g. it does not allow the holding of immaterial direct financial interests, and extends the prohibition on holding financial interests to partners and managers who provide (permissible) non-audit services to an audit client.
• Business Relationships: The ECR is far more restrictive than the IESBA Code; e.g. unlike the Code, it does not permit the statutory auditor to obtain a material loan or guarantee from a bank that is an audit client.
• Cooling-off: The SAD requires a two-year cooling-off period for key audit partners joining the client in a key management position, whereas the IESBA Code requires a period of at least 12 months after the PIE has issued its audited financial statements.
• Managerial or supervisory role in audit clients: The IESBA Code prohibits all partners and employees from taking on such a role at any audit client of the audit firm, and is therefore more restrictive than the ECR, which applies this prohibition solely to those in a position to influence the outcome of the audit.
• Non-audit services:
  • Design and implementation of financial information technology systems: With respect to audits of PIEs, the IESBA Code is more restrictive than the ECR by providing a clear prohibition on certain defined IT services.
  • Valuation Services: With respect to audits of PIEs, the IESBA Code is more restrictive than the ECR as it prohibits valuation services that have a material effect on the financial statements.
  • Participation in the audit client’s internal audit: Concerning audits of PIEs, the IESBA Code is more restrictive than the ECR as it provides a catalogue of prohibited internal audit services.
  • Acting for the audit client in the resolution of litigation: The IESBA Code is more restrictive than the ECR as it prohibits the auditor from acting in an advocacy role for all audit clients where the amounts involved are material to the financial statements of such clients.
  • Recruiting senior management: With respect to audits of PIEs, the IESBA Code provides for a broader range of prohibited activities than does the ECR.
  • Taxation services: Unlike the ECR, the IESBA Code provides extensive and detailed guidance on how to deal with taxation services and prohibitions on certain tax services that would also meet the criteria for other prohibited services (e.g. tax calculations for preparing accounting entries).
  • Legal services: Legal services are not covered by the ECR whereas the IESBA Code refers to these types of services.
  • Corporate finance services: Similarly as for taxation and for legal services, the IESBA Code provides guidance and the prohibition of services that would also meet the criteria of other prohibited services, whereas the ECR does not provide any guidance in this respect.
• Compensation and evaluation policies: The IESBA Code includes a prohibition on evaluating or compensating a key audit partner based on his success for selling non-assurance services to his audit client; this matter is not addressed by the EU provisions.
• Partner rotation: The SAD is more restrictive with regard to key audit partners in group audit situations, but, unlike the IESBA Code, neither the SAD nor the ECR requires the partner responsible for the engagement quality control to rotate.
• Relative Size of Fees: With respect to statutory audits of PIEs, the IESBA Code requires restrictive safeguards where the total of audit and non-audit fees that an audit firm receives from its audit client exceeds the threshold of 15 per cent of the firm’s total revenues. Neither the SAD nor the ECR provides for such a threshold, although the ECR requires the auditor to consider unduly high percentages for any statutory audit.

In summary, it can be concluded that the overall approaches to statutory auditor independence, as applied by the EU provisions and the IESBA Code, are equivalent. The differences in scope are mainly the results of different concepts with regard to definitions and descriptions. However, the most significant differences relate to the fact that the IESBA Code provides more detailed guidance with regard to specific situations, for example, in respect of mergers of audit and non-audit clients, and on the application of the overall framework in connection with certain non-audit services. Finally, being more robust with respect to audits of PIEs than the ECR, the IESBA Code makes strict provisions for those non-audit services that are incompatible with the audit as well as for other matters that may be considered for inclusion in future EU audit legislation.

Press release

FEE's paper on auditor independence provisions

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