independence threats & safeguards
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INDEPENDENCE THREATS & SAFEGUARDS
ICAI CODE OF ETHICS
Sairam Natarajan, CFE, IRMCert | June 2020
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Agenda
■ Fundamental Principles
■ What is Independence?
■ Managing Perceptions
■ Exercise of Professional Judgement
■ Reasonable and Informed Third
Party Test
■ Questions
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■ Threats to
Independence
■ Addressing Threats
■ Case study
■ Things to think about
■ Questions
■ Additional resources
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Fundamental Principles
■ Integrity: being straight-forward & honest
■ Objectivity: Free from bias, conflict of interest or undue influence
■ Professional Competence and due care: maintains professional
knowledge and skill at the level required
■ Confidentiality: Non-disclosure of client information and/or personally
identifiable information
■ Professional Behaviour: compliance with relevant laws and regulations
and avoiding actions which discredit the profession.
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What is Independence?
■ Independence of mind
The state of mind that permits the expression of a conclusion without
being affected by influences that compromise professional judgment,
thereby allowing an individual to act with integrity, and exercise
objectivity and professional skepticism.
■ Independence in appearance
The avoidance of facts and circumstances that are so significant that a
reasonable and informed third party would be likely to conclude that a
firm’s or an audit or assurance team member’s integrity, objectivity or
professional skepticism has been compromised.
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Managing Perceptions
Independence in appearance is difficult to manage but you can do this by:
■ Exercising professional judgment (or skepticism)
■ Remaining alert to changes in facts and circumstances
■ Using reasonable and informed third party test
NOT DOCUMENTED IS NOT DONE
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Exercise of Professional Judgment
Matters to consider Examples
There is reason to be concerned that potentially
relevant information might be missing from the facts
and circumstances known to the accountant
Do you know whether you/your firm provides any
non-assurance services to your assurance
clients?
There is an inconsistency between the known facts
and circumstances and the accountant’s
expectations
Does the client expect you to represent them at
the tax tribunal when you are aware of the
potential advocacy issues?
There is a need to consult with others with relevant
expertise or experience
Given your relationships with your assurance
client, do you need to consult someone else in
your firm/the regulator/an ethics professional?
The accountant’s own preconception or bias might
be affecting the accountant’s exercise of
professional judgment
In the above example, could your relationships
affect or be perceived as having affected your
professional judgement?
There might be other reasonable conclusions that
could be reached from the available information
Is it possible that a regulator or an informed
investor might reach a different conclusion?
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Reasonable and Informed Third Party
The reasonable and informed third party test is a consideration by the
professional accountant about whether the same conclusions would
likely be reached by another party. Such consideration is made from the
perspective of a reasonable and informed third party, who weighs all the
relevant facts and circumstances that the accountant knows, or could
reasonably be expected to know, at the time the conclusions are made.
The reasonable and informed third party does not need to be an
accountant, but would possess the relevant knowledge and experience to
understand and evaluate the appropriateness of the accountant’s
conclusions in an impartial manner.
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Threats to Independence
■ Self-interest threat
■ Self-review threat
■ Advocacy threat
■ Familiarity threat
■ Intimidation threat
A particular scenario might create more than one threat
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Threats to Independence
Self-interest threat
The threat that a financial or other interest will inappropriately influence
a professional accountant’s judgment or behaviour
e.g. income from other services provided by the auditor (other than ones
disallowed by the Act) affects how far the auditor may be influenced (or
perceived as such) by the management.
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Threats to Independence
Self-review threat
The threat that a professional accountant will not appropriately evaluate
the results of a previous judgment made; or an activity performed by the
accountant, or by another individual within the accountant’s firm or
employing organization, on which the accountant will rely when forming
a judgment as part of performing a current activity
e.g. auditor assists with preparation of the financial statements for ABC
Company while also serving as the auditor for ABC Company
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Threats to Independence
Advocacy threat
The threat that a professional accountant will promote a client’s or
employing organization’s position to the point that the accountant’s
objectivity is compromised
e.g. advocating or negotiating on behalf of client in resolving disputes
with third parties
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Threats to Independence
Familiarity threat
The threat that due to a long or close relationship with a client, or
employing organization, a professional accountant will be too
sympathetic to their interests or too accepting of their work
e.g. auditing same client for numerous years or having a close
relationship with director or officer
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Threats to Independence
Intimidation threat
The threat that a professional accountant will be deterred from acting objectively because of actual or perceived pressures, including attempts to exercise undue influence over the accountant
e.g. being threatened with dismissal as auditor of client or being pressured to reduce extent of work below what is required in an attempt to reduce fees
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Threats to Independence
Factors Relevant in Evaluating the Level of Threats
■ Specific factors
– whether client is a public interest entity (PIE)
– qualitative as well as quantitative factors relevant to the facts and
circumstances
– the combined effect of multiple threats
In your firms, have you agreed to treat certain clients or categories of
entities as PIEs? 16
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Threats to Independence
Factors Relevant in Evaluating the Level of Threats
■ General factors
– Corporate governance procedures including role of Those
Charged With Governance
– Educational, training and experience of professionals
– Effective complaint systems which enable the professional
accountant and the general public to draw attention to unethical
behaviour
– Monitoring and disciplinary procedures
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Threats to Independence
Consideration of New Information or
Changes in Facts and Circumstances
Do these:
■ Impact the level of a threat
■ Affect the accountant’s conclusions
about whether safeguards applied
continue to be appropriate to
address identified threats
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Addressing Threats
Independence Financial
relationships
Business relationships
Non-audit services
Gifts, entertainment and hospitality
Auditor/partner rotation
Employment relationships
Actual or threatened
litigation
Fee matters
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Eliminating the
circumstance
Applying safeguards
Declining or ending
professional activity
Addressing Threats • Disposing off a financial
interest
• Changing the
partner/employee
working on an
engagement
• Partner rotation
• Using professionals who are not audit
team members to perform the
service
• Additional review of audit and/or non-
audit work by an internal or external
professional
• Regular independent internal or
external quality reviews
• Ensuring that client management
makes all judgments and decisions
• Declining or ending
business relationship
• Declining or ending
non-audit engagement
• Declining or ending
audit engagement
Examples only. Not an exhaustive list. 20
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Case study Facts and circumstances Independence issues Threats to consider Potential safeguards to
consider
• PIE audit client, in scope for NFRA
• Advisory Services for the conversion
of the financial statements of the
company to converge to IndAS
• Provide advice, recommendation,
and observation on the impact
analysis report, accounting policies,
the draft opening Balance Sheet,
specific advances classification and
measurement, review of valuations
for specific securities
• Expected credit loss (maximum two
types of model) for retail and
corporate
• Advice in preparation of financial
statements
Engagement Partner: Ms. ABC (Ms. ABC
is also involved in audit engagement)
• Does the engagement involve
design and implementation of
financial information system?
• To what extent will the results of
the work be subject to review as
part of audit procedures?
• Do the services fall in the
purview of accounting and book-
keeping services?
• Does Ms. ABC’s involvement in
audit engagement create
familiarity threat?
• Has the service been approved
by the audit committee?
• Self-review
• Familiarity
Self-review
• For PIE audits, any services
in the nature of design and
implementation of a
financial system is
PROHIBITED.
• No safeguards can be put
in place.
Familiarity
• Using different partners
with separate reporting
lines for the provision of
non-assurance services
• Approval by audit
committee before
accepting the engagement
AQR report by NFRA 21
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Case study Facts and circumstances Independence issues Threats to
consider
Potential safeguards to consider
• Private audit client
• ERP implementation assistance
for indirect tax laws
• International tax services in
relation to EPC, Royalty, FTS,
analysis of constitution of PE etc.
• TP Planning, Study &
Compliances
• Representation before
adjudication/appellate
authorities
In addition,
• Audit partner’s brother-in-law is
the finance director at the client
• Each year, the finance director
takes the audit partner and his
wife (BIL and sister) to the IPL
final in the hospitality box on
company cost
• Will the ERP implementation
services including designing or
implementation of the ERP or is it
limited to assistance and support?
• Are the amounts in dispute with
tax authorities material to the
client?
• As part of the international tax
services involve calculation of tax
values that may have a direct
effect on the financial
statements?
• Does Mr. XYZ’s long association
with the client create familiarity
threats?
• Does the audit partner’s
relationship create familiarity
threats?
• Does the hospitality offered by the
finance director cause a
perception of undue influence?
• Self-review
• Advocacy
• Self-interest
• Familiarity
Self-review
• Using different partners with
separate reporting lines for the
provision of non-assurance
services
• Ensuring that management
assigns the responsibility to an
informed and competence
employee (preferably senior
management) to make all
management decisions
Advocacy
• Any services where the
amounts are material is
PROHIBITED.
Self-interest and familiarity:
• Audit partner rotation
• Declining further gifts and
hospitality
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Things to think about
■ What is your independence policy? Does your firm audit any PIEs? If yes,
does your policy sufficiently address independence risks with regard to PIE
audits?
■ What is your firm’s approach to managing independence risk? Who do you
consult for complex/technical independence risk matters?
■ How often do your firm’s partners and employees undergo independence
and ethics training? When was the last time?
■ To what extent have you invested in people, systems and tools to enable
your firm identify, assess, manage, document and report independence
risk matters? Is this consistent with the size and scale of your firm’s and
your clients’ operations?
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Additional Resources
■ ICAI Code of Ethics, 2019
■ Section 144, Companies Act 2013
■ AQR Report, NFRA
■ Business of Ethics
If you have any questions on topics discusses, please write to me at
[email protected] or WhatsApp me on +44 7788 383686
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