Motivación

In the discussion of the joint provision of audit and NAS in the above section, Mautz and Sharaf (1961) acknowledged the lack of standards in regulating such provision. The lack of understanding of different types of NAS and their limits to which these might be

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considered as not harmful for auditor independence, exerted a challenge for development of such standards. However, as auditor independence is of utmost importance for the sake of credibility of financial statements, professional and regulatory bodies across the world have attempted to identify the threats to auditor independence (for example, the APB ES (APB 2004, 2010a), the IFAC Code of Ethics (2005), the ICAEW Code of Ethics (2011) and so on). The ICAEW, in its Section 200 - Professional Accountants in Public Practice - has identified five threats to auditor objectivity and auditor independence, namely, self-interest threat; self-review threat; advocacy threat; familiarity threat; and intimidation threat (ICAEW 2011). In 2004, the APB enacted five ES, one of which specifically addresses the provision of NAS supplied by incumbent auditors. The APB ES, aimed to provide effective ethical guidance to auditors in upholding their professional independence post-Enron, identified one more threat, namely, the management threat that involves incumbent auditor making judgement or decisions that are normally the responsibility of the management whilst providing NAS. APB (2010a) also attempts to identify other threats arising out of the provision of specific NAS.

„Self-interest‟ threat, as defined in APB (2010a), arises whenever auditors have financial or other interests that may restrict them from taking actions that would harm the interest of the client company. ICAEW (2011) defines „self-review threat‟ as threats that may occur when a previous judgment needs to be re-evaluated by the auditors responsible for that judgment12_{. The APB (2010a) explicitly mentions that the provision}

of NAS may give rise to a self-review threat when the results of such services may be included or disclosed in the financial statements (Paragraph 35, ES1 – Integrity, objectivity and independence). In such cases, the auditors may be unable to take an impartial view on evaluating the effects on financial statements stemming from a NAS engagement.

A „management threat‟, as defined earlier, arises when an audit firm undertakes a non- audit work that involves making judgments or decisions, which are normally the

12 _{Some of the circumstances that may give rise to self-review threats as mentioned in section 200.3 of}

the ICAEW Code include (a) an audit firm issuing an assurance report on the effectiveness of the operation of financial systems after designing or implementing the systems; (b) an audit firm having prepared the original data used to generate records that are the subject matter of the assurance engagement; (c) a member of the assurance team being, or having recently been, a director or officer of the client.

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responsibility of the management (Paragraph 35, ES1). In such cases, the auditors‟

views and interests may become closely aligned to that of the management that may lead to impair auditor independence and objectivity. „Advocacy threats‟, also defined in Paragraph 35 of ES1, may occur when an auditor advocates or supports a position taken by the client management to an extent that subsequent objectivity and independence may be threatened. APB (2010a) mentions that in order to act in an advocacy role, the audit firm has to adopt a position closely aligned to that of the management that gives rise to both real and perceived threats to auditor independence.

„Familiarity threats‟ may arise when an auditor is predisposed to agree with client management view or when an auditor does not question sufficiently the views taken by the client management (Paragraph 35, ES1). ICAEW observes that a familiarity threat may emerge when, because of a close relationship, a professional accountant becomes too sympathetic to the interests of others (Section 200.7, ICAEW 2011). When auditors develop a close association with a client through long association, they may be content

with asking fewer questions regarding the client‟s point of view. This may create threats

to auditor objectivity and independence. APB also defines „intimidation threat‟ that may occur when an auditor‟s conduct may be influenced by fear and threats that deters them from acting objectively (Paragraph 35, ES1).

Having identified the potential threats to auditor independence in ES1, the APB (2010a) then associates provision of specific NAS to different categories of auditor independence threat (Paragraphs 58 to 167, ES5). Table 2.1 presents the specific threats identified by the APB.

Table 2.1 Independence threats for specific NAS (ES5, APB 2010a)

NAS Specific independence threats

Internal audit services (Paragraphs 58-69) Self-review, management Information Technology (Paragraphs 70-75) Self-review, management Valuation services (Paragraphs 76-83) Self-review, management Actuarial valuation services (Paragraphs 84-88) Self-review

Tax services (Paragraphs 89-108) Self-interest, management, advocacy, self-review

Litigation support services (Paragraphs 109-112) Self-review, management, advocacy Legal services (Paragraphs 113-114) Self-review, management, advocacy

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Recruitment and remuneration services(Paragraphs 115-125)

Management

Corporate finance services (Paragraphs 126-136) Self-review, management, advocacy, self- interest

Transaction related services (Paragraphs 137- 142)

Management

Restructuring services (Paragraphs 143-155) Accounting services (Paragraphs 156-168)

Management, advocacy Self-review, management

ES4 – Fees, remuneration and evaluation policies, litigation, gifts and hospitality (APB

2010a) identifies presence of „self-interest threat‟ when an audit firm becomes

economically dependent on a particular client. As mentioned in Table 2.1 above, ES5identifies the presence of specific auditor independence threats against provision of different types of NAS (APB 2010a). It can be noted from the above Table that most categories of NAS give rise to the „self-review threat‟, as the auditors will be required to

review their own prior NAS engagement.

The presence of „self-interest threat‟ is attributed to the performance of tax services and

corporate finance services, when such services are performed on a contingent fee basis. Table 2.1 reveals that the „management threat‟ is also assigned to performance of most

of the twelve categories of NAS listed, when the scope of such services involve making decisions which are normally the responsibility of the client management. According to ES5, the „advocacy threat‟ emerges when auditors are engaged in litigation support services, legal services, and corporate finance services as the audit firm may need to advocate or support the position of management in a manner that could compromise their professional independence.

NAS may also create the potential threat of economic dependence in addition to the specific threats identified above. The problem of economic dependence occurs when the fees receivable from one client and its associates make up a significantly high

percentage of the audit firm‟s gross fees. Referring to this problem as „the self-interest

threat‟, the ICAEW defines this as “a threat to the auditor‟s objectivity stemming from a financial or other self-interest conflict” (Section 200.4, ICAEW 2011). The ICAEW Code of Ethics observes that if the recurring fees from a client company or group of companies constitute a substantial proportion of the fee income of an audit firm, a self-

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interest threat is likely to arise, that may lead to imperil auditor independence (ICAEW 2011).

An unduly large proportion is normally considered to be 15 per cent or more, or, in the case of listed or other public interest companies, 10 per cent13 _{or more. Therefore, it is}

apparent that the ICAEW considers over-dependence on a single client as a threat for auditor independence14_{. Paragraph 31 of ES4 state that if the total fees for both audit and}

NAS receivable from a listed audited entity and its subsidiaries regularly exceed 10 per cent of the annual fee income of the audit firm, then the firm shall not act as the auditor and shall either resign as auditor or not stand for reappointment (APB 2010a). The same rule applies where the total fees regularly exceed 15 per cent in case of a non-listed audited entity and its subsidiaries (Paragraph32, ES4). However, if it does not regularly exceed 15 per cent, the auditor should report it to its ethics partner and the audit committee of the client and the auditor shall arrange for external independent quality control review before the audit report is finalized (Paragraph 39, ES4). In case of a listed company, if the total fees remain between 5 per cent and 10 per cent on a regular basis the auditor shall report this fact to the ethics partner of the audit firm and the audit committee of the audited entity and will consider if any safeguards need to be applied (Paragraph 37, ES4).