Assurance clients

/63  Rule 204.4(1) provides that a member or student who participates on an engagement team for an assurance client, including an audit or review client, and the member’s or student’s immediate family may not hold a direct financial interest or a material indirect financial interest in the assurance client.

/64  A reasonable observer will not view a member who holds a direct financial interest or material indirect financial interest as a trustee differently than someone who holds the interest beneficially. Accordingly Rule 204.4(1) applies to members, students and immediate family of members or students who hold a direct financial interest or material indirect financial interest in the capacity of a trustee.

/65  When a person on an engagement team, or any of the person’s immediate family, receives, for example, by way of gift or inheritance or as a result of a merger or reorganization, a direct financial interest or a material indirect financial interest in a particular assurance client, or a related entity of the client in the case of an assurance client that is an audit or review client, one of the following actions should be taken to comply with Rule 204.4(1):

• dispose of the financial interest at the earliest practical date but no later than 30 days after the person has knowledge of the financial interest and the right or ability to dispose of it; or
• remove the person from the engagement team.

During the period prior to disposal of the financial interest or the removal of the person from the engagement team, consideration should be given to whether additional safeguards are necessary to reduce the threat to independence to an acceptable level. Such safeguards might include:

• discussing the matter with the audit committee; or
• involving another member of the firm who is not, and has not been, on the engagement team to review the work done by the person, or advise as necessary.

Members are reminded that Rule 204.5 requires a member who has an interest that is precluded by this Rule to advise in writing a designated partner of the firm of the interest.

/66  When a person on an engagement team knows that a close family member has a direct financial interest or a material indirect financial interest in the particular assurance client, or a related entity of the client in the case of an assurance client that is an audit or review client, a self-interest threat may exist. In evaluating the significance of any such threat, consideration should be given to the nature of the relationship between the person on the engagement team and the close family member and the materiality of the financial interest. Once the significance of the threat has been evaluated, safeguards should be applied. Such safeguards might include:

• the close family member disposing of all or a sufficient portion of the financial interest at the earliest practical date;
• discussing the matter with the audit committee;
• involving another member of the firm who is not, and never was, on the engagement team to review the work done by the particular person on the engagement team or advise as necessary; or'
• removing the person from the engagement team.

/67  Consideration should be given to whether a self-interest threat may exist because of the financial interests of individuals other than those on the engagement team and their immediate and close family. Such individuals would include:

• a member of the firm who provides a non-assurance service to the assurance client;
• a member of the firm who has a close personal relationship with a person on the engagement team;
• a spouse or dependant of an immediate or close family member of a person on the engagement team; and
• an individual for whom a member of the engagement team holds power of attorney

Whether the interests held by such individuals may create a self-interest threat will depend upon factors such as:

• the firm’s organizational, operating and reporting structure;
• the nature of the relationship between the individual and the person on the engagement team; and
• in the case of a power of attorney, the degree of decision making power granted by the power of attorney

The significance of the threat should be evaluated and, if the threat is other than clearly insignificant, safeguards should be applied to reduce the threat to an acceptable level. Such safeguards might include:

• where appropriate, policies to prohibit such individuals from holding such interests;
• discussing the matter with the audit committee; or
• involving another member of the firm who is not, and never was, on the engagement team to review the work done by the particular individual or advise as necessary.

/68  Subject to Rule 204.4(7) relating to an audit or review engagement, the specific prohibitions of Rule 204.4 do not preclude a firm from accepting an assurance engagement with an entity if one or more partners of the firm who do not participate on the engagement team, and who do not practice in the same office as the lead engagement partner, have a financial interest in the entity. However, Rule 204.1 requires the firm to be independent in fact and appearance and requires the firm to identify threats to independence arising from such circumstances, evaluate the significance of the threats and, if they are other than clearly insignificant, apply safeguards to reduce the threats to an acceptable level. If adequate safeguards are not available the firm should not accept the engagement.

/69  An inadvertent breach of the principles in this Council Interpretation as they relate to a financial interest in an assurance client, or a related entity of the client in the case of an assurance client that is an audit or review client, would not impair the independence of the member of the firm or the firm when:

• the firm has established policies and procedures that require a network firm and all members of the firm to report promptly any breaches resulting from the purchase, inheritance or other acquisition of a financial interest in the assurance client;
• the firm promptly notifies the network firm or the member of the firm that the financial interest should be disposed of; and
• the disposal occurs at the earliest practical date after identification of the issue, but no later than 30 days after the person has both the knowledge of the financial interest and the right or ability to dispose of it, or the person is removed from the engagement team.

/70  When an inadvertent breach of the principles relating to a financial interest in an assurance client has occurred, the firm should consider whether, and if so which, safeguards should be applied. Such safeguards might include:

• involving another member of the firm who is not, and has not been, on the engagement team to review the work done by the particular member involved in the breach; or
• excluding the particular person from any substantive decision-making concerning the assurance engagement.

Members are reminded that Rule 204.5 requires a member who has an interest that is precluded by this Rule to advise in writing a designated partner of the firm of the interest. Inadvertent breaches are also discussed in paragraph 35 of this Council Interpretation.

 

Audit or review clients

/71  Rule 204.4(2) provides that a member or firm may not perform an audit or review engagement for an entity if the member, firm or a network firm has a direct financial interest or a material indirect financial interest in the entity or in a related entity of the entity.

/72  Rule 204.4(3) provides that a member or firm may not perform an audit or review engagement for an entity if a pension or other retirement plan of the firm or a network firm has a direct financial interest or a material indirect financial interest in the entity or in a related entity of the entity.

/73  Rule 204.4(4) provides that a partner of a firm who holds, or whose immediate family holds, a direct financial interest or a material indirect financial interest in an audit or review client of the firm, or a related entity of the client, may not practice in the same office as the lead engagement partner for the client.

/74  The office in which the lead engagement partner practices in connection with an audit or review engagement is not necessarily the office to which that partner is ordinarily assigned. Accordingly, for the purposes of Rule 204.4 (4) and this Council Interpretation, when the lead engagement partner is located in a different office from others on the engagement team, professional judgment should be exercised to determine in which office the partner practices in connection with the audit or review engagement.

/75  Rule 204.4(5) provides that a partner or managerial employee of a firm who holds, or whose immediate family holds, a direct financial interest or a material indirect financial interest in an audit or review client of the firm, or in a related entity of the client, may not provide a non-assurance service to the client, unless the non-assurance service is clearly insignificant.

/76  Subject to Rule 204.4(7), a financial interest in an audit or review client, or a related entity of the client, that is held by an immediate family member of:

• a partner located in the office in which the lead engagement partner practices in connection with the audit or review engagement; or
• a member of the firm who provides a non-assurance service to the client;

would not create an unacceptable threat to independence provided the financial interest is received as a result of the immediate family member’s employment rights (e.g., pension rights or share options) and, where appropriate, safeguards are applied to reduce any threat to independence to an acceptable level.

/77  A self-interest threat may exist if the firm, or the network firm, or a person on the engagement team has a financial interest in a particular entity, and an audit or review client or a director, officer or controlling owner thereof also has a financial interest in that entity. Independence is not impaired with respect to the audit or review client if the respective financial interests of the firm, the network firm, or person on the engagement team, and the client or director, officer or controlling owner thereof are immaterial and the client cannot exercise significant influence over the entity.

/78  Rule 204.4(6) provides that a member or firm may not perform an audit or review engagement for a client if the firm or a network firm has a financial interest in another entity, and the member or firm knows that the client or a director, officer or controlling owner of the client also has a financial interest in the other entity, unless the respective financial interests referred to are immaterial and the client cannot exercise significant influence over the other entity. In addition, a member or student may not participate on the engagement team for an audit or review client if that person has a financial interest in another entity and knows that the client or a director, officer or controlling owner of the client also has a financial interest in the entity, unless the respective financial interests referred to are immaterial and the client cannot exercise significant influence over the entity.

/79  Rule 204.4(7) provides that a member or a firm may not perform an audit or review engagement for an entity if a partner or a professional employee of the firm owns, or such person’s immediate family owns, more than 0.1% of the securities of the entity or controls the entity by means other than the ownership of the majority of the entity’s common shares. The rule further provides that such interest may not be held in a related entity of the entity.

/80  Rule 204.4(8) provides that a member or student may not participate on the engagement team of an audit or review client if such person knows that his or her close family owns more than 0.1% of the securities of the client, or a related entity of the client, or controls the client, or related entity of the client, by means other than the ownership of the majority of the entity’s common shares. Rule 204.4(8) only applies when the person has knowledge of the securities held by his or her close family member. The rule does not put an onus on the person to determine which, if any, securities his or her close family members hold.

 

Assurance clients that are not audit or review clients

/81  Rule 204.4(9) provides that a firm may not have a direct financial interest or a material indirect financial interest in an assurance client that is not an audit or review client. It also provides that a firm may not have a material financial interest in an entity that has a controlling interest in an assurance client that is not an audit or review client. The rule does not extend to related entities of the client.

/82  With respect to a restricted-use report for an assurance engagement that is not an audit or review engagement, members are referred to the provisions in paragraph 28 of this Council Interpretation.

 

B. Loans and Guarantees

/83  Rule 204.4(10) provides that a firm may not have a loan from or have a loan guaranteed by an assurance client except where the client is a bank or similar financial institution and the loan or guarantee is immaterial to the firm and the client and the loan or guarantee is made under normal commercial terms and conditions and is in good standing. The rule further provides that a firm may not make a loan to an assurance client that is not a bank or similar financial institution nor guarantee a loan of an assurance client.

/84  Rule 204.4(11) provides that a firm may not accept a loan from, or have a loan guaranteed by an officer or director of an assurance client, or a shareholder of the client who owns more than 10% its equity securities. In addition, a firm shall not make a loan to, or guarantee a loan of, such a person.

/85  Rule 204.4(12) provides that a member or student may not participate on the engagement team for an assurance client of the firm if:

(a) the member or student accepts a loan from, or has a loan guaranteed by, the client, unless the client is a bank or similar financial institution and the loan or guarantee is made under normal commercial terms and conditions and the loan is in good standing;

(b) the member or student accepts a loan from, or has a loan guaranteed by, an officer or director of the client, or a shareholder of the client who owns more than 10% of its equity securities; or

(c) the member or student has made a loan to, or guaranteed the borrowings of the client that is not a bank or similar financial institution, an officer or director of the client, or a shareholder of the client who owns more than 10% its equity securities.

/86  A loan from, or a loan guaranteed by, from an assurance client that is a bank or a similar financial institution to a person on the engagement team or his or her immediate family member would not create a threat to independence provided the loan or guarantee is made under normal commercial terms and conditions and is in good standing. Examples of such loans include home mortgages, bank overdrafts, car loans and credit card balances.

87  Similarly, deposits or brokerage accounts of a firm or a person on the engagement team with an assurance client that is a bank, broker or similar financial institution would not create a threat to independence provided the deposit or brokerage account was held under normal commercial terms and conditions.

/88  Rules 204.4 (10) and (11) relate to loans and guarantees between a firm and an assurance client. In the case of an assurance client that is an audit or review client, the provisions of Rules 204.4 (10) and (11) also apply network firms. In the case of an assurance client that is an audit or review client the provisions of Rule 204.4(10), (11) and (12) should be read as applying also to related entities of the client.

 

C. Close Business Relationships

/89  A close business relationship between a firm, a network firm or a person on the engagement team and the assurance client or its management, involving a common commercial or financial interest may create a self-interest or an intimidation threat. The following are examples of such relationships:

(a) having a material financial interest in a joint venture with the client or a controlling owner, director, officer or other individual who performs senior management functions for that client;

(b) arrangements to combine one or more services or products of the firm with one or more services or products of the client and to market the package with reference to both parties; and

(c) arrangements under which either the firm or the client acts as a distributor or marketer of the other’s products or services.

A close business relationship does not include the relationship created by the professional engagement between the client and the member, the firm, or the network firm as the case may be.

/90  Rule 204.4(13) provides that a firm or a network firm may not have a close business relationship with an audit or review client or its management unless that relationship is limited to a financial interest that is immaterial and the relationship is clearly insignificant to the firm or network firm and the client or its management. In the case of an assurance client that is not an audit or review client, a firm may not have a close business relationship with the client or its management unless that relationship is limited to a financial interest that is immaterial and the relationship is clearly insignificant to the firm and the client or its management, as the case may be.

/91  Rule 204.4(13) also provides that a member or student who has a close business relationship with an assurance client (whether audit, review or other) or its management may not be on the engagement team for the client unless that relationship is limited to a financial interest that is immaterial and the relationship is clearly insignificant to the member or student and the client or its management.

/92  In the case of an audit or review client, a business relationship involving an interest held by a firm, a network firm or a person on the engagement team or any of that person’s immediate family in a closely held entity in which the client or a director or officer of the client, or any group thereof, also has an interest, does not create threats to independence provided:

• the relationship is clearly insignificant to the firm, the network firm and the client;
• the interest held is immaterial to the investor, or group of investors; and
• the interest does not give the investor, or group of investors, the ability to control the closely held entity.

/93  The purchase of goods or services from an assurance client by a firm (and, in the case of an audit client, by a network firm) or a person on the engagement team will not generally create a threat to independence, provided the transaction is conducted in the normal course of the client’s business and on an arm’s length basis. However, such a transaction may be of a nature or magnitude such that it does create a self-interest threat. If the threat so created is other than clearly insignificant, safeguards should be applied to reduce it to an acceptable level. Such safeguards might include:

• reducing the magnitude of or eliminating the transaction;

• removing the individual involved from the engagement team; or
• discussing the issue with the audit committee.

 

D. Family and Personal Relationships

/94  Family and personal relationships between a person on an engagement team and a director, officer or certain employees, depending on their role, of the assurance client may create a self-interest, familiarity or intimidation threat. The significance of such a relationship will depend on a number of factors, including the person’s responsibilities on the assurance engagement, the closeness of the relationship and the role of the family member or other individual within the assurance client. Consequently, there are many circumstances that involve a threat to independence that will require evaluation.

/95  Rule 204.4(14) provides that a member or a student may not participate on the engagement team for an assurance client if such person’s immediate family is a director or officer of the client or an employee of the client in a position to exert direct and significant influence over the subject matter of the engagement, or was in such a position during any period covered by the engagement.

/96  When a close family member of a person on the engagement team is a director, an officer or an employee of the assurance client in a position to exert direct and significant influence over the subject matter of the assurance engagement, a threat to independence may be created. The significance of the threat will depend on factors such as:

• the position the close family member holds with the client; and
• the role of the particular person on the engagement team.

The significance of the threat should be evaluated and, if it is other than clearly insignificant, safeguards should be applied to reduce the threat to an acceptable level. Such safeguards might include:

• removing the particular person from the engagement team;
• where possible, restructuring the engagement team’s responsibilities so that the particular person does not deal with matters that are within the responsibility of the close family member; or
• policies and procedures to empower staff to communicate, without fear of retribution, to senior levels within the firm any issue of independence and objectivity that may concern them.

/97  A self-interest, familiarity or intimidation threat may exist when a director, officer or employee of an assurance client who is not an immediate or close family member of a person on the engagement team has a close relationship with a person on the engagement team, and is in a position to exert direct and significant influence over the subject matter of the assurance engagement. Those on the engagement team should identify such individuals, and evaluate the relationship and consult with others in the firm in accordance with its policies and procedures. The evaluation of the significance of any such threat and the availability of safeguards appropriate to eliminate it or reduce it to an acceptable level will include considering matters such as the closeness of the relationship and the role of the individual within the client.

/98  Consideration should be given to whether a self-interest, familiarity or intimidation threat exists because of a personal or family relationship between a member of the firm who is not part of the engagement team and a director, officer or employee of the assurance client who is in a position to exert direct and significant influence over the subject matter of the assurance engagement. Members of the firm should identify and evaluate the relationship and consult with others in the firm in accordance with its policies and procedures. The evaluation of the significance of any threat and the availability of safeguards appropriate to eliminate it or reduce it to an acceptable level will include considering matters such as the closeness of the relationship, the interaction of the member of the firm with the engagement team, the position held within the firm, and the role of the individual within the client.

/99  An inadvertent breach of the principles in this Council Interpretation as they relate to family and personal relationships would not impair the independence of a member of the firm, or a firm, when:

• the firm has established policies and procedures that require all members of the firm to report promptly to the firm any breaches resulting from changes in the employment status of their immediate or close family members or other personal relationships that create a threat to independence;
• either the responsibilities of the engagement team are restructured so that the person on the engagement team does not deal with matters that are within the responsibility of the person with whom he or she is related or has a personal relationship, or, if that is not possible, the firm promptly removes that person from the engagement team; and
• additional care is given to reviewing the work of the particular person on the engagement team.

/100  When an inadvertent breach of the principles in this Council Interpretation relating to family and personal relationships has occurred, the firm should consider whether, and if so which, safeguards should be applied. Such safeguards might include:

• involving another member of the firm who is not, and never was, on the engagement team to review the work done by the person on the engagement team; or
• excluding that person from any substantive decision-making concerning the assurance engagement.

Members are reminded that Rule 204.5 requires a member who has a relationship that is precluded by this Rule to advise in writing a designated partner of the firm of the interest. Inadvertent breaches are also discussed in paragraph 100 of this Council Interpretation.

 

Audit clients that are reporting issuers

/101  Rule 204.4(15) provides that a member or a student may not participate on the engagement team for an audit client that is a reporting issuer if such person’s close family is in an accounting role or a financial reporting oversight role at the client, or was in such a position during any period covered by the engagement.

E. Employment With an Assurance Client

General provisions

/102  The independence of a firm or a person on the engagement team may be threatened if a director, officer or employee of the assurance client in a position to exert influence over the subject matter of the assurance engagement has been on the engagement team or a partner of the firm. Such circumstances may create a self-interest, familiarity or intimidation threat, particularly when a significant connection remains between the individual and his or her former firm.

/103  The significance of a threat so created will depend upon the following factors:

• the position the individual has taken at the client and whether the position involves direct or significant influence over the subject matter;
• the amount of any involvement the individual will have with the engagement team;
• the length of time since the individual was on the engagement team or with the firm; and
• the former position of the individual within the engagement team or firm.

 

The significance of such a threat should be evaluated and, if it is other than clearly insignificant, available safeguards should be applied to reduce it to an acceptable level. Such safeguards might include:

• considering the appropriateness or necessity of modifying the plan for the assurance engagement;
• assigning an engagement team to the subsequent assurance engagement that is of sufficient seniority and experience in relation to the individual who has joined the assurance client;
• involving another member of the firm who is not, and never was, on the engagement team to review the work done or advise as necessary; or
• performing an additional quality control review of the assurance engagement by the firm.

In such cases, all of the following safeguards will be necessary to reduce the threat to an acceptable level:

• the particular individual is not entitled to any benefits or payments from the firm unless these are made in accordance with fixed predetermined arrangements. In addition, any amount owed to the individual should not be of such significance to threaten the firm’s independence; and
• the particular individual does not continue to participate or appear to participate in the firm’s business or professional activities.

 

/104  A self-interest threat exists when a person on the engagement team participates in the assurance engagement while knowing, or having reason to believe, that he or she will or may join the client. In all such cases the following safeguards should be applied:

• having firm policies and procedures that require those on the engagement team to notify the firm when entering employment negotiations with the assurance client; and
• removing the person from the engagement team.

In addition, consideration should be given to performing an independent review of any significant judgments made by that person while performing the engagement.

 

Audit clients that are reporting issuers

/105  Notwithstanding the general guidance in paragraphs 102 to 104 of this Council Interpretation, Rule 204.4(16) provides that a firm may not perform an audit engagement for a client that is a reporting issuer if a person who participated in an audit capacity in an audit of the financial statements of the client is employed in a financial reporting oversight role for the client within a period of one year after the date when the financial statements of the client were filed with the relevant securities regulator or stock exchange. An individual holding one of the following titles will generally be considered to be in a financial reporting oversight role: a member of the board of directors or similar management or governing body, president, chief executive officer, chief operating officer, chief accounting officer, controller, director of internal audit, director of financial reporting, treasurer, and, depending upon the particular facts and circumstances, the general counsel.

/106  The term “financial reporting oversight role” means a position in which a person may or does exercise influence over either the contents of the financial statements or anyone who prepares them. When the financial statements of the reporting issuer are consolidated, a financial reporting oversight role can extend to the reporting issuer and its subsidiaries. In determining whether an individual is in a financial reporting oversight role for the reporting issuer, consideration should be given to the position of the individual, the extent of the individual’s involvement in the financial reporting process of the reporting issuer and the impact of the individual’s role of the consolidated financial statements of the reporting issuer.

/107  For the purposes of Rule 204.4(16), other than the lead engagement partner and the engagement quality control reviewer, the following persons are not considered to have participated in an audit capacity in an earlier audit:

(a) a person who is employed by the reporting issuer due to an emergency or other unusual situation provided that the entity’s audit committee has determined that the employment of such person is in the interest of the shareholders;

(b) a person who has provided ten or fewer hours of assurance services in the earlier audit;

(c) a person who recommended the compensation of, or who provided direct supervisory, management or oversight of, the lead engagement partner in connection with the performance of the earlier audit, including those at all successively senior levels above the lead engagement partner through to the firm’s chief executive; and

(d) a person who provided quality control for the audit engagement.

/108  An individual may have fully complied with Rule 204.4(16) in accepting employment with an entity, and subsequently thereto, the entity merged with or was acquired by another entity resulting in that individual having a financial reporting oversight role of a combined entity which is audited by the firm in which the individual was previously an employee or a partner. In such a circumstance, unless the employment offer was accepted in contemplation of the merger or acquisition, the individual or the entity could not be expected to know that the employment decision could result in a threat to independence. In all such cases the safeguard of informing the audit committee should be applied.

/109  For the purposes of Rule 204.4(16) audit procedures are deemed to have commenced for the current audit engagement period on the day after the financial statements for the previous period are filed with the relevant securities regulator or stock exchange.

 

F. Recent Service With an Assurance Client

/110  A self-interest, self-review or familiarity threat may exist when a former officer, director or employee of an assurance client becomes a part of the engagement team for that client.

/111  Rule 204.4(17) provides that a member or a student may not participate on the engagement team for an assurance client if such person served as an officer or director of the client or had been an employee thereof in a position to exert direct and significant influence over the subject matter of the engagement during the period covered by the assurance report.

/112  If, prior to the period covered by an assurance report, a person on the engagement team served as an officer or on the board of directors of the assurance client, or had been an employee in a position to exert direct and significant influence over the subject matter of the assurance engagement, a self-interest, self-review or familiarity threat may exist. For example, such a threat will exist if a decision made or work performed by that individual in the prior period, while employed by the client, is to be evaluated in the current period as part of the assurance engagement. The significance of the threat will depend upon factors such as:

• the position the individual held with the client;
• the length of time since the individual left the client; and
• the role of the individual on the engagement team.

The significance of the threat should be evaluated and, if it is other than clearly insignificant, safeguards should be applied to reduce it to an acceptable level. Such safeguards might include:

• involving another member of the firm who is not, and never was, on the engagement team to review the work of the particular person or advise as necessary; or
• discussing the issue with the audit committee.

 

G. Serving as an Officer or a Member of the Board of Directors of an Assurance Client

/113  Rule 204.4(18) provides that a member of a firm may not serve as an officer or director for an assurance client. In the case of an audit or review client, this prohibition is extended to related entities of the client and members of network firms by Rule 204.4 (19). However, a partner or employee of a network firm may serve as company secretary for an audit or review client that is not a reporting issuer where permitted by local law, professional rules or practice, and the duties and functions undertaken are limited to those of a routine and formal administrative nature.

 

Company secretary

/114  The position of company secretary has different implications in different jurisdictions. The duties of company secretary may range from administrative duties such as personnel management and the maintenance of company records and registers, to duties as diverse as ensuring that the company complies with regulations or providing advice on corporate governance matters. Generally this position is seen to imply a close degree of association with the entity and may create self-review and advocacy threats.

/115  If a partner or employee of a network firm serves as company secretary for an audit or review client, the self-review and advocacy threats created would generally be so significant that safeguards are unlikely to be available to reduce the threats to an acceptable level. However, when the practice of acting as company secretary is specifically permitted under local law, professional rules or practice, the duties and functions undertaken should be limited to those of a routine and formal administrative nature such as the preparation of minutes and maintenance of statutory returns.

/116  Routine administrative services to support a company secretarial function or advisory work in relation to company secretarial administration matters is generally not perceived to impair independence, provided client management makes all relevant decisions.

 

H. Religious Organizations

/117  A threat to independence is ordinarily not created when a person on the engagement team, or any of the person’s immediate or close family, belongs to a religious organization that is an assurance client provided the person on the engagement team, or the immediate or close family member:

(a) does not serve on the religious organization’s governing body; and

(b) does not have the right or responsibility to exercise significant influence over the financial or accounting policies of the religious organization or any of its associates.

 

I. Social Clubs

/118  Notwithstanding Rules 204.1 to 204.4, a threat to independence is ordinarily not created when a person on the engagement team, or an immediate or close family member of the engagement team, holds qualifying shares in a social club, such as a golf club, curling club, co-operative or similar organization, where the shareholding is a prerequisite of club membership, provided:

(a) the assets of the organization cannot by virtue of the organization’s by-laws be distributed to the individual club members other than in circumstances of forced liquidation or expropriation, unless there is a written undertaking with the organization to forfeit entitlement to such distributed assets;

(b) neither the person on the engagement team nor the immediate or close family member:

(i) serves on the governing body or as an officer of the organization;

(ii) has the right or responsibility to exercise significant influence over the financial or accounting policies of the organization or any of its associates; or

(iii) exercises any right derived from membership to vote at meetings of the organization; and

(c) the club member cannot dispose of the membership for gain.

 

J. Long Association of Senior Personnel With an Assurance Client

/119  The use of the same senior personnel on the engagement team on an assurance engagement over a long period of time may create a familiarity threat. The significance of such a threat will depend upon factors such as:

• the length of time that the particular individual has been on the engagement team;
• the role of that individual on the engagement team;
• the structure of the firm; and
• the nature of the assurance engagement including the complexity of the subject matter and degree of professional judgment needed.

The significance of the threat should be evaluated and, if it is other than clearly insignificant, safeguards should be applied to reduce it to an acceptable level. Such safeguards might include:

• discussing the matter with the audit committee;
• replacing the senior personnel on the engagement team;
• involving an additional member of the firm who is not, and never was, on the engagement team to review the work done by the particular individual, or advise as necessary;
• the member or firm is subject to external practice inspection; or
• an independent internal quality review of the assurance work performed by a member of the firm who was not part of the engagement team.

Audit clients that are reporting issuers (December 2010)

/120  Rule 204.4(20)(a)(i) provides that a member may not continue as the lead engagement partner, or the engagement quality control reviewer, for an audit client that is a reporting issuer for more than seven years in total and shall not resume or assume either such role until five years have elapsed since the member ceased to be the lead engagement partner or the engagement quality control reviewer.

/120A  Rule 204.4(20)(b)(ii) provides that a member, who is a partner other than the lead engagement partner or the engagement quality control reviewer on the engagement team, providing, during the engagement period, more than ten hours of assurance services in connection with the annual financial statements or interim financial information of the reporting issuer or is a subsidiary engagement partner may not provide such services for a period of more than seven years in total and shall not resume providing such services until two years have elapsed since the member ceased to provide such services.

/120B  In the case of a reporting issuer that is a mutual fund Rules 204.4(20(a)(ii) and (b)(ii) extend the partner rotation requirements and restrictions described above to mutual funds within the same mutual fund complex, as defined.

/120C  The provisions in Rule 204.4(20)(b) do not apply to those “specialty” and “technical” partners who consult with others on the engagement team regarding technical or industry-specific issues, transactions or events, including taxation matters. In addition, the provisions do not apply to those partners who, subsequent to the issuance of the audit report, provide quality control for the engagement. Such partners typically have a low level of involvement with senior management as well as a relatively low level responsibility for overall presentation in the financial statements.

/121  Intentionally left blank.

/122  When an audit client becomes a reporting issuer, the length of time the lead engagement partner has served in that capacity should be considered in determining when the partner must be replaced on the engagement team. However, if the lead engagement partner has served in that capacity for five or more fiscal years at the time the client becomes a reporting issuer, such person may continue in that capacity for two more fiscal years before being replaced as lead engagement partner.

 

K. Audit Committee Prior Approval of Services to a Reporting Issuer Audit Client

/123  Rule 204.4(21) provides that a member or firm may not provide a service to a reporting issuer, that is an audit client, or to a subsidiary thereof, unless the audit committee of the client pre-approves such service. The requirement applies to all audit and non-audit services. For the purpose of Rule 204.4(21) the audit committee recommendation to the entity’s board of directors that the particular audit firm be the entity’s auditor will be considered to be the approval of the audit service. Subject to paragraph 125, all non-audit services for the reporting issuer and its subsidiaries must be specifically pre-approved by the audit committee.

/124  The audit committee may establish policies and procedures for pre-approval provided that they are detailed as to the particular services and designed to safeguard the independence of the member and the firm. For example, one or more audit committee members who are independent board directors may pre-approve the service provided decisions made by the designated audit committee members are reported to the full audit committee.

/125  Notwithstanding Rule 204.4(21), audit committee pre-approval of services other than assurance services provided to an audit client that is a reporting issuer, or to a subsidiary of the client, is not required where all such services that have not been pre-approved:

(a) do not represent more than five per cent of total revenues paid by the audit client to the member, the firm and network firms in the fiscal year in which the services are provided;

(b) were not recognized as non-audit services at the time of the engagement; and

(c) are promptly brought to the attention of the audit committee and the audit committee or one or more designated representatives approves the services prior to the completion of the audit.

/126  For the purposes of Rule 204.4(21) audit services include all those services performed to discharge responsibilities to provide an opinion on the financial statements of the reporting issuer. For example, in connection with some audit engagements, a tax partner may be involved in reviewing the tax accrual of the client. Since it is a necessary part of the audit process, the activity constitutes an audit service. Similarly, complex accounting issues may require consultation with a national office technical partner to reach an audit judgment. That consultation, being a necessary part of the audit process, also constitutes an audit service, and as such will be considered to have been pre-approved by the audit committee whether or not the firm charges separately for it. These examples contrast with a situation where a client is evaluating a proposed transaction and requests the member, the firm or a network firm to evaluate it and, after research and consultation, the member, firm or network firm provides an answer to the client and bills for those services. Such services would not be considered to be audit services and, therefore, will not be considered to have been pre-approved with the audit service.

 

L. Provision of Non-Assurance Services to an Assurance Client

General provisions

/127  Firms have traditionally provided to their assurance clients a range of other services that are consistent with their skills and expertise. The provision of a service not referred to in Rule 204.1 may, however, create a self-interest, self-review or advocacy threat to the independence of the member or firm. Consequently, before a firm accepts an engagement to provide a non-assurance service to an assurance client, it should evaluate the significance of any threat created by providing the service. When such a threat is other than clearly insignificant, the non-assurance engagement should be declined unless appropriate safeguards can be applied to eliminate the threat or threats or reduce them to an acceptable level.

/128  Subject to any specific prohibition in these rules to the contrary, a firm or a member of a firm may provide a non-assurance service to an assurance client provided that any threats to independence have been reduced to an acceptable level by safeguards, such as:

• policies and procedures to prohibit members of the firm from making management decisions for the client, or assuming responsibility for such decisions;
• discussing independence issues related to the provision of non-assurance services with the audit committee;
• policies within the assurance client regarding the oversight responsibility for provision of non-assurance services by the firm;
• involving another member of the firm who is not on the engagement team to advise on any impact of the non-assurance engagement on the independence of the persons on the engagement team and the firm;
• involving a professional colleague from outside of the firm to provide assurance on a discrete aspect of the assurance engagement;
• obtaining the client’s acknowledgement of responsibility for the results of the work performed by the firm;
• disclosing to the audit committee the nature of the engagement and extent of fees charged; or
• arranging that the members of the firm providing the non-assurance service do not participate on the engagement team.

/129  Notwithstanding the foregoing, the provision of certain non-assurance services to an audit or review client may create a threat to independence so significant that no safeguard will eliminate the threat or reduce it to an acceptable level. However, the provision of such a service to a related entity or division or the provision of a service that relates to a discrete financial statement item of the audit client may be permissible if all threats to the firm’s independence have been reduced to an acceptable level by:

• arranging for that related entity, division or discrete financial statement item to be audited by another firm that is not a network firm; or
• arranging for another firm that is not a network firm to re-perform the non-assurance service.

/130  Rule 204.4(22) provides that, during the engagement period, a member of a firm may not make management decisions or perform management functions for an assurance client. The Rule further provides that in the case of an audit or review client a member of the firm or a network firm shall not make management decisions or perform management functions for the client during either the engagement period or the period covered by the financial statements subject to audit or review. Rule 204.4(22) also provides that in the case of an audit client that is a reporting issuer, a member of the firm or a network firm shall not make management decisions or perform management functions for a related entity of the client. Activities that would constitute a management decision or function include

(a) authorizing, approving, executing or consummating a transaction;

(b) having or exercising authority on behalf of the client;

(c) determining which recommendation of the member or the firm should be implemented; or

(d) reporting in a management role to those charged with governance of the client.

/131  Notwithstanding Rule 204.4(22) the independence of a member or a firm would not be impaired by the provision of services to assess the effectiveness of the internal control of an assurance client and to recommend improvements in the design and implementation of internal control and risk management control. Obtaining an understanding of the client’s internal control is required by generally accepted auditing standards. Members often become involved in diagnosing, assessing and recommending to management ways in which internal control can be improved or strengthened.

/132  The lending of staff by a firm or network firm to an audit or review client may create a self-review threat when a person so loaned is in a position to influence the preparation of the client’s financial statements. In practice, such assistance may be given but only on the understanding that client approval is obtained for the results of the service and that the person on loan will not be involved in:

• making management decisions for the client;
• approving or signing agreements or other similar client documents; or
• exercising discretionary authority to commit the client.

In such situations the circumstances should be carefully analyzed to identify any threat to independence created and to determine whether additional safeguards should be applied to reduce the threat to an acceptable level.

 

Audit clients that are reporting issuers

/133  Rules 204.4(24) to (28) set out non-audit services that may not be provided during either the period covered by the financial statements subject to audit or during the engagement period to an audit client that is a reporting issuer unless it is reasonable to conclude that the results of any such service will not be subject to audit procedures during the audit of the client’s financial statements. In determining whether such a conclusion is reasonable, there is a rebuttable presumption that the results of such services will be subject to audit procedures. Materiality is not an appropriate basis upon which to overcome this presumption. For example, determining whether a subsidiary, division or other unit of the consolidated entity is material is a matter of audit judgment. Therefore, the determination of whether to apply detailed audit procedures to a unit of a consolidated entity is, in itself, an audit procedure.

 

Preparation of accounting records and financial statements

General provisions

/134  It is the responsibility of management to ensure that accounting records are kept and financial statements are prepared, although in discharging its responsibility management may request a member or firm to provide assistance.

/135  Assisting an audit or review client in matters such as preparing accounting records or financial statements will create a self-review threat when the financial statements are subsequently audited or reviewed by the member or firm. The significance of any such threat should be evaluated and, if it is other than clearly insignificant, safeguards should be applied to reduce it to an acceptable level.

/136  Rule 204.4(23) provides that a member, or a member of a firm or network firm, may not perform any of the following activities for an entity, including a reporting issuer, that is an audit or review client:

(a) preparing, or changing a journal entry, determining or changing an account code, or a classification for a transaction or preparing or changing another accounting record without obtaining the approval of management of the entity;

(b) preparing or changing a source document or originating data in respect of any transaction undertaken or entered into by the entity.

/137  A source document is an initial recording or original evidence of a transaction. Examples of source documents are purchase orders, payroll time cards, customer orders, invoices, disbursement approvals, signed cheques and written contracts. Source documents are often followed by the creation of additional records and reports, such as trial balances, account reconciliations and aged account receivable listings, which do not constitute source documents or initial recordings. Source documents may also be preceded by documents containing calculations and advice, such as bonus calculations for tax purposes, ceiling test calculations in the oil and gas industry and sample wording for clauses in a contract that will be prepared by the client’s lawyers. The creation of such additional records, reports and documents would not constitute the creation of source documents.

/138  Notwithstanding Rules 204.4(23) and (24), the financial statement audit and review process involves extensive dialogue between persons on the engagement team and management of the audit or review client. During this process, management will often request and receive input regarding such matters as accounting principles and financial statement disclosure, the appropriateness of controls and the methods used in determining the stated amounts of assets and liabilities. The provision of technical assistance of this nature for an audit or review client is an appropriate method of promoting the fair presentation of the financial statements. The provision of such advice, per se, does not generally threaten the member’s or the firm’s independence. Other services that are usually a part of the audit or review process and that do not, under normal circumstances, threaten independence include:

• assisting a client in resolving account reconciliation problems;
• analyzing and accumulating information for regulatory reporting;
• assisting in the preparation of consolidated financial statements (including assisting in the translation of local statutory accounts to comply with group accounting policies and transition to a different reporting framework such as International Accounting Standards);
• assisting the drafting of disclosure items;
• proposing adjusting journal entries; and
• providing assistance and advice in the preparation of local statutory accounts of subsidiary entities.

 

/139  A self-review threat may exist when a member, firm or network firm assists in the preparation of subject matter other than financial statements and subsequently provides assurance thereon. For example, a self-review threat will exist if a member or firm develops and prepares prospective financial information and subsequently provides assurance on it. Consequently, a member or firm should evaluate the significance of any self-review threat created by the provision of such a service. If the threat is other than clearly insignificant, safeguards should be applied to reduce the threat to an acceptable level.

 

Audit or review clients that are not reporting issuers

/140  Subject to Rule 204.4(23) a member, firm or network firm may provide an audit or review client that is not a reporting issuer with accounting and bookkeeping services provided that any resulting self-review threat so created is reduced to an acceptable level. Examples of such services include:

• recording transactions for which the client has determined or approved the appropriate account classification;
• posting transactions to the client’s general ledger;
• preparing financial statements;
• drafting notes to the financial statements;
• posting journal entries to the trial balance;
• performing payroll services which do not involve having custody of client assets; and
• preparing tax receipts for charitable donations or tax information returns, such as T4 slips.

 

Client approval of journal entries

/141  A member, firm or network firm may prepare journal entries for an audit or review client that is not a reporting issuer provided management approves and takes responsibility for such journal entries. In obtaining this approval, the member, firm or network firm may choose to obtain approval for each journal entry or, alternatively, to obtain approval following a thorough review of the completed financial statements with management. This approval may also be obtained through the management representation letter.

Evaluation of significance of threats

/142  The significance of a threat created by providing accounting and bookkeeping services to an audit or review client that is not a reporting issuer should be evaluated. The significance of such a threat will depend upon factors such as:

• the degree of involvement of the member or firm;
• the complexity of the transactions to be accounted for; and
• the extent of professional judgment required in selecting the appropriate accounting treatment.

If the threat is other than clearly insignificant, safeguards should be applied to reduce the threat to an acceptable level. Such safeguards might include:

• making arrangements so that such services are not performed by a person on the engagement team;
• requiring the client to create the source data for the accounting entries;
• requiring the client to develop the underlying assumptions;
• obtaining the views of another professional accountant;
• arranging for another firm to review a significant accounting treatment; or
• discussing a significant accounting treatment with the practice advisory services department of the member’s provincial institute.

 

Complex transactions

/143  Preparing the journal entries for a complex transaction would likely create a self-review threat the significance of which could only be reduced to an acceptable level by applying safeguards that involve consultation with others, for example by:

• obtaining the views of another professional accountant;
• arranging for another firm to review a significant accounting treatment; or
• discussing the proposed accounting treatment with the practice advisory services department of the member’s provincial institute.

Audit clients that are reporting issuers

/144  Rule 204.4(24) provides that, during either the period covered by the financial statements subject to audit or the engagement period, a member, a firm or a network firm, or a member of the firm or a network firm, may not provide bookkeeping or other services related to the accounting records or financial statements of an audit client that is a reporting issuer, or of a related entity, unless it is reasonable to conclude that the results of these services will not be subject to audit procedures during an audit of the financial statements. Bookkeeping and other such services include:

(a) maintaining or preparing the entity’s, or a related entity’s, accounting records;

(b) preparing the financial statements on which the audit report is provided or that form the basis of the financial statements on which the audit report is provided; and

(c) preparing or originating source data underlying the such financial statements.

In determining whether such a conclusion is reasonable, there is a rebuttable presumption that the results of the bookkeeping or other services will be subject to audit procedures.

Valuation services

General provisions

/145  A valuation service involves the making of assumptions with respect to future events and the application of certain methodologies and techniques, in order to compute or provide an opinion with respect to a specific value or range of values, for a business as a whole, an intangible or tangible asset or a liability.

Audit or review clients that are not reporting issuers

/146  Performing a valuation service for an audit or review client that is not a reporting issuer will create a self-review threat when the valuation resulting from the service is incorporated into the client’s financial statements. The significance of such a threat should be evaluated. The significance will depend on factors such as:

• the materiality of the results of the valuation service;
• the extent of the client’s knowledge, experience and ability to evaluate the issues concerned, and the extent of the client’s involvement in determining and approving significant matters of judgment;
• the degree to which established methodologies and professional guidelines are applied when performing the particular valuation service;
• the degree of subjectivity inherent in the item concerned where the valuation involves standard or established methodologies;
• the reliability and extent of the underlying data;
• the degree of dependence on future events of a nature which could create significant volatility in the amounts involved; and
• the extent and clarity of the financial statement disclosures.

If the threat is other than clearly insignificant, safeguards should be applied to reduce it to an acceptable level. Such safeguards might include:

• involving an additional professional accountant who was not a member of the engagement team to review the valuation work or otherwise advise as necessary;
• confirming with the client its understanding of the underlying assumptions of the valuation and the methodology to be used and obtaining approval for their use;
• obtaining the client’s acknowledgement of responsibility for the results of the valuation work performed by the firm or network firm; or
• arranging that members of the firm or network firm providing such services do not participate on the engagement team.

/147  Performing a valuation service for an audit or review client that is not a reporting issuer involving matters that are material to the entity’s financial statements and involving a significant degree of subjectivity would likely create a self-review threat. The significance of such a threat could only be reduced to an acceptable level by applying safeguards that involve consultation with others, such as another professional accountant or valuation specialist.

/148  When a member, firm or network firm performs a valuation service for an audit or review client for the purposes of making a filing with a taxation authority, computing an amount of tax due by the client, or tax planning, no significant threat to independence ordinarily exists because such valuations are generally subject to the safeguard of external review by the taxation authority.

/149  Notwithstanding Rule 204.4(25), the independence of a member or a firm will not be impaired when:

• the firm’s valuation specialist reviews the work of an audit or review client or a specialist employed by the client, provided the client or the client’s specialist supplies the technical expertise that the client uses in determining the required amounts recorded in the financial statements. In such circumstances there will be no self-review threat because a client’s management or a third-party is the source of the financial information subject to audit; or
• the valuation service is provided for non-financial reporting purposes, for example, transfer pricing studies or other tax-only purposes.

/150  When a member or firm performs a valuation that forms part of the subject matter of an assurance engagement that is not an audit or review engagement, the firm should consider whether there is a self-review threat. If such a threat exists, and it is other than clearly insignificant, safeguards should be applied to eliminate it or reduce it to an acceptable level.

 

Audit clients that are reporting issuers

/151  Rule 204.4(25) provides that, during either the period covered by the financial statements subject to audit or the engagement period, a member, a firm or a network firm, or a member of the firm or a network firm, may not provide a valuation service to an audit client that is a reporting issuer, or to a related entity, unless it is reasonable to conclude that the results of the service will not be subject to audit procedures during an audit of the financial statements. In determining whether such a conclusion is reasonable, there is a rebuttable presumption that the results of the valuation service will be subject to audit procedures.

 

Provision of actuarial services to a reporting issuer audit client

/152  Rule 204.4(26) provides that, during either the period covered by the financial statements subject to audit or the engagement period, a member, firm or network firm, or a member of the firm or a network firm, may not perform an actuarial service for an audit client that is a reporting issuer, or to a related entity, unless it is reasonable to conclude that the results of the service will not be subject to audit procedures during an audit of the financial statements. In determining whether such a conclusion is reasonable, there is a rebuttable presumption that the results of the actuarial service will be subject to audit procedures.

/153  For the purposes of Rule 204.4(26), actuarial services include the determination of an amount to be recorded in the client’s financial statements and related accounts, except for: services that involve assisting the client in understanding the methods, models, assumptions and inputs used in determining such amounts; and advising management on the appropriate actuarial methods and assumptions that will be used in the actuarial valuations. In addition, the firm may use its own actuary to assist in conducting the audit if the client’s actuary or a third-party actuary provides management with its actuarial capabilities.

 

Provision of internal audit services to an audit or review client

General provisions

/154  A self-review threat may exist when a member, firm or network firm provides internal audit services to an audit or review client. Such services may comprise an extension of the firm’s audit service beyond the requirements of generally accepted auditing standards, assistance in the performance of the client’s internal audit activities, or outsourcing of the activities. In evaluating any threat to independence, the nature of the service should be considered.

/155  Services involving an extension of the procedures required to conduct an audit or review in accordance with the CICA Handbook – Assurance will not be considered to impair independence with respect to an audit or review client provided that a member of the firm or network firm does not act or appear to act in the capacity of the client’s management.

/156  During the course of an audit or review engagement the engagement team considers the client’s internal control and, as a result, may make recommendations for its improvement. This is part of an audit or review engagement and is not considered to be an internal audit service.

/157  For the purposes of Rule 204.4 and this Council Interpretation, internal audit services do not include operational internal audit services unrelated to the internal accounting controls, financial systems or financial statements.

/158  Safeguards that should be applied in all circumstances to reduce any threats created by performing internal audit services for an audit or review client to an acceptable level include ensuring that:

• the client is responsible for internal audit activities and acknowledges in writing, to the firm and the audit committee, its responsibility for establishing, maintaining and monitoring the system of internal controls;
• the client designates a competent employee, preferably within senior management, to be responsible for internal audit activities;
• the client or the audit committee approves the scope, risk and frequency of internal audit work;
• the client is responsible for evaluating and determining which recommendations of the firm should be implemented;
• the client evaluates the adequacy of the internal audit procedures performed and the findings resulting from the performance of those procedures by, for example, obtaining and acting on reports from the member, firm or network firm; and
• the findings and recommendations resulting from the internal audit services performed by the member, firm or network firm are reported appropriately to the audit committee.

/159  Consideration should also be given to whether the provision of internal audit services to an audit or review client should be provided only by a member or members of the firm not involved in the audit or review engagement and with different reporting lines within the firm.

/160  Performing a significant portion of the audit or review client’s internal audit activities may create a self-review threat and a member, firm or network firm should consider that possibility and proceed with caution before taking on such an activity.

 

Audit clients that are reporting issuers

/161  Rule 204.4(27) provides that, during either the period covered by the financial statements subject to audit or the engagement period, a member, firm or network firm, or a member of the firm or a network firm, may not provide an internal audit service to an audit client that is a reporting issuer, or to a related entity, that relates to the client’s, or the related entity’s, internal accounting controls, financial systems or financial statements, unless it is reasonable to conclude that the results of the service will not be subject to audit procedures during an audit of the financial statements. In determining whether such a conclusion is reasonable, there is a rebuttable presumption that the results of the internal audit service will be subject to audit procedures.

/162  Rule 204.4(27) does not prohibit the member, firm or network firm from providing a nonrecurring service to evaluate a discrete item or program, if the service is not in substance the outsourcing of an internal audit function. For example, the member, firm or network firm, or a member of the firm of a network firm, may conduct a nonrecurring specified auditing procedures engagement related to the internal control of an audit client that is a reporting issuer.

 

Provision of IT system services to an audit or review client

General provisions

/163  The provision of services by a member, firm or network firm to an audit or review client that involve the design or implementation of financial information technology systems that are, or will be, used to generate information forming part of the client’s financial statements may create a self-review threat.

 

Audit or review clients that are not reporting issuers

/164  The provision of services by a member, firm or network firm to an audit or review client that involve both the design and the implementation of such financial information technology systems would create a self-review threat that is likely to be too significant to allow the provision of such services to an audit or review client that is not a reporting issuer, unless appropriate safeguards are put in place ensuring that:

• the client acknowledges in writing to the firm and the audit committee its responsibility for establishing and monitoring a system of internal controls;
• the client designates a competent employee, preferably within senior management, with the responsibility to make all management decisions with respect to the design and implementation of the hardware or software system;
• the client makes all management decisions with respect to the design and implementation process;
• the client evaluates the adequacy and results of the design and implementation of the system; and
• the client is responsible for the operation of the system (hardware or software) and the data used or generated by the system.

/165  Consideration should also be given to whether such services should be provided only by members of the firm who are not part of the engagement team with different reporting lines within the firm.

/166  The provision of services by a member, firm or network firm to an audit or review client that involve either the design or the implementation of financial information technology systems that are used to generate information forming part of the client’s financial statements may also create a self-review threat. The significance of any threat should be evaluated and, if it is other than clearly insignificant, safeguards should be applied to eliminate it or reduce it to an acceptable level.

/167  The provision of services to an audit or review client by a member, firm or network firm in connection with the assessment, design and implementation of internal accounting controls and risk management controls is not considered to create a threat to independence provided that members of the firm or network firm do not perform management functions for the client.

/168  Recommending or installing pre-packaged financial information technology software for an audit or review client that is not a reporting issuer generally will not create a threat to independence.

 

Audit clients that are reporting issuers

/169  Rule 204.4(28) provides that, during either the period covered by the financial statements subject to audit or the engagement period, a member, a firm or network firm, or a member of the firm or a network firm, may not design or implement a financial information system for an audit client that is a reporting issuer, or for a related entity, unless it is reasonable to conclude that the results of such service will not be subject to audit procedures during an audit of the client’s financial statements. Such services involve:

(a) directly or indirectly operating, or supervising the operation of, the entity’s, or a related entity’s, information system;

(b) designing or implementing a hardware or software system that aggregates source data underlying the financial statements or generates information that is significant to the entity’s, or a related entity’s, financial statements or other financial information systems taken as a whole; or

(c) directly or indirectly managing the entity’s, or a related entity’s, local area network.

In determining whether it is reasonable to conclude that the results of such service will not be subject to audit procedures, there is a rebuttable presumption that the results of the financial information systems design and implementation service will be subject to audit procedures.

/170  Information will be considered to be significant if it is reasonably likely to be material to the financial statements. Since materiality determinations may not be complete before the financial statements are prepared, the audit client and the member or firm should evaluate the general nature of the information as well as system output during the period of the audit engagement.

/171  Notwithstanding Rule 204.4(28), a member, a firm or a network firm may:

• design or implement a hardware or software system that is unrelated to the financial statements or accounting records of the reporting issuer, or a related entity;
• as part of the audit, or another assurance engagement, evaluate and make recommendations to management on the internal control of a system as it is being designed, implemented or operated; or
• make recommendations on internal control matters to management or other service provider in conjunction with the design and installation of a system by another service provider.

 

Provision of litigation support or expert services to an audit or review client

General provisions

/172  Litigation support services include such activities as acting as an expert witness, calculating estimated damages or other amounts that might become receivable or payable as the result of litigation or other legal dispute, and assistance with document management and retrieval in relation to a legal dispute or litigation.

/173  A self-review threat may exist when a member, firm or network firm provides to an audit or review client litigation support services that include the estimation of the possible outcome of a dispute or litigation and thereby affects the amounts or disclosures to be reflected in the client’s financial statements. The significance of any such threat will depend upon factors such as:

• the nature of the engagement;
• the materiality of the amounts involved; and
• the degree of subjectivity inherent in the matter concerned.

The member or firm should evaluate the significance of any threat so created and, if it is other than clearly insignificant, safeguards should be applied to eliminate it or reduce it to an acceptable level. Such safeguards might include:

• policies and procedures to prohibit individuals who assist the client from making management decisions on the client’s behalf;
• using a member of the firm who is not part of the engagement team to perform the litigation support service; or
• the involvement of others, such as independent specialists.

If adequate safeguards are not available to reduce a threat to an acceptable level the member, firm or network firm should decline the engagement.

 

Provision of expert services to a reporting issuer audit client

/174  Rule 204.4(29) provides that, during either the period covered by the financial statements subject to audit or the engagement period, a member, a firm or a network firm, or a member of the firm or a network firm, may not provide an expert opinion or other expert service for an audit client that is a reporting issuer, or for a related entity, or for a legal representative thereof. This rule prohibits a member, firm or network firm, or a member of the firm or a network firm, from performing an engagement to provide specialized knowledge, experience or expertise to advocate or support the audit client’s positions, or the positions of a related entity, in an adversarial or similar proceeding such as an investigation, a litigation matter, or a legislative or administrative tribunal.

/175  Notwithstanding Rule 204.4(29), a member, a firm or a network firm, or a member of the firm or a network firm, may be engaged by an audit committee of an audit client that is a reporting issuer to assist it in fulfilling its responsibilities to conduct its own investigation of a potential accounting impropriety. For example, if the audit committee is concerned about the accuracy of the inventory records at a subsidiary, it may engage the member, the firm or the network firm, or a member of the firm or a network firm, to conduct a thorough inspection and analysis of these records, the physical inventory at the subsidiary and related matters without impairing independence. This type of engagement may include forensic or other fact-finding work that results in the issuance of a report to the audit client. It will generally require performing procedures that are consistent with, but more detailed or more comprehensive than, those required by generally accepted auditing standards.

/176  In an investigation or proceeding for an audit client that is a reporting issuer, or for a related entity, the member, firm or network firm, or a member of the firm or a network firm, may provide an account or testimony with respect to a matter of fact, such as describing the work performed by the member’s firm or the predecessor auditor. The member, firm or network firm, or a member of the firm or network firm, may explain the positions taken or the conclusions reached during the performance of any service provided for the reporting issuer audit client.

 

Legal services to an audit or review client

General provisions

/177  A legal service refers to any service that may only be provided by a person licensed, admitted, or otherwise qualified to practice law in the jurisdiction in which the service is provided. Legal services encompass a wide and varied range of corporate and commercial services, including contract support, conduct of litigation, mergers and acquisition advice and support and the provision of assistance to client’s internal legal departments. For the purposes of Rule 204.4 legal services do not include those taxation services that may be provided by a person who is not admitted to the practice of law in the jurisdiction.

/178  Threats to independence created by the provision of legal services to an audit or review client should be considered based on:

• the nature of the service to be provided (for example, advocacy as opposed to other legal services);
• whether the service provider is separate from the engagement team; and
• the materiality of any pertinent matter in relation to the client’s financial statements.

/179  The provision of a legal service which involves matters that would not be expected to have a material effect on the client’s financial statements is not considered to create an unacceptable threat to independence with respect to that client.

/180  The provision of legal services to support an audit or review client in the execution of a transaction (e.g., contract support, legal advice, legal due diligence and restructuring) may create a self-review threat. The significance of any such threat should be evaluated and, if it is other than clearly insignificant, safeguards should be applied to reduce it to an acceptable level. Such safeguards might include:

• using a member of the firm who is not on the engagement team to provide the service;
• ensuring the member of the firm does not make a management decision for the client;
• ensuring the client makes the ultimate decision in relation to the advice provided; and
• ensuring the service involves the execution of what has been decided by the client in relation to the transaction.

/181  Notwithstanding the foregoing, Rule 204.4(30) provides that a member, firm or network firm may not, during either the period covered by the financial statements subject to audit or review or the engagement period, provide a legal service to an audit or review client in the resolution of a dispute or litigation in circumstances where the matters in dispute or subject to litigation are material in relation to the client’s financial statements.

/182  The provision of a legal service to assist an audit or review client in the resolution of a dispute or litigation may create an advocacy or self-review threat. When a member, firm or network firm is asked to act in an advocacy role for the client in the resolution of a dispute or litigation in circumstances where the amounts involved are not material to the client’s financial statements, the significance of any resulting threat should be evaluated and, if it is other than clearly insignificant, safeguards should be applied to eliminate it or reduce it to an acceptable level. Such safeguards might include:

• policies and procedures to prohibit members of the firm or network firm from assisting the client in making management decisions on behalf of the client; or
• using members of the firm who are not on the engagement team to perform the particular legal service.

 

Audit clients that are reporting issuers

/183  Rule 204.4(31) provides that, during either the period covered by the financial statements subject to audit or the engagement period, a member, firm or network firm, or a member of the firm or a network firm, may not provide a legal service to an audit client that is a reporting issuer, or to a related entity.

 

Human resource services for an assurance client

General provisions

/184  The recruitment of managers, executives or directors for an assurance client, where the person recruited will be in a position to affect the subject matter of the assurance engagement, may create a current or future self-interest, familiarity or intimidation threat. The significance of such a threat will depend upon factors such as:

• the role of the person to be recruited; and
• the nature of the assistance sought.

The significance of any such threat should be evaluated and, if it is other than clearly insignificant, safeguards should be applied to reduce it to an acceptable level. In all cases, the firm should not make management decisions and the client should make the hiring decision.

 

Audit clients that are reporting issuers

/185  Rule 204.4(32) provides that, during either the period covered by the financial statements subject to audit or the engagement period, a member, firm or network firm, or a member of the firm or a network firm, may not provide any of the following services to an audit client that is a reporting issuer, or to a related entity:

(a) searching for or seeking out prospective candidates for management, executive, or director positions;

(b) engaging in psychological testing, or other formal testing or evaluation programs;

(c) undertaking reference checks of prospective candidates for an executive or director position;

(d) acting as a negotiator or mediator on the entity’s behalf with respect to employees or future employees with respect to any condition of employment, including position, status or title, compensation, or fringe benefits; or

(e) recommending or advising the entity to hire a specific candidate for a specific job.

Notwithstanding Rule 204.4(32) a member, firm or network firm, or a member of the firm or a network firm may, upon request of the audit client, interview candidates and advise the client on the candidate’s competence for financial accounting, administrative or control positions.

 

Corporate finance and similar activities

/186  Rule 204.4(33) provides that, during the engagement period, a member or firm, or a member of the firm, may not provide any of the following services to an assurance client:

(a) promoting, dealing in or underwriting the client’s securities;

(b) making investment decisions on behalf of the client or otherwise having discretionary authority over the client’s investments;

(c) executing a transaction to buy or sell the client’s investments; or

(d) having custody of assets of the client, including taking temporary possession of securities purchased by the client.

The Rule further provides that in the case of an assurance client that is an audit or review client, during either the period covered by the financial statements subject to audit or the engagement period, a network firm or a member of a network firm shall not provide such services to the client. It also provides that in the case of an audit client that is a reporting issuer, the firm, a network firm, or a member of the firm or network firm shall not provide such services to a related entity.

/187  Other corporate finance services may create an advocacy or self-review threat that may be reduced to an acceptable level by the application of safeguards. Examples of such services include: assisting a client in developing corporate strategies; assisting a client in obtaining bank financing by explaining the financial statements to the bank; assisting in identifying or introducing a client to possible sources of capital that meet the client specifications or criteria; and providing structuring advice and assisting a client in analyzing the accounting effects of proposed transactions. The significance of the threat should be evaluated and, if it is other than clearly insignificant, safeguards should be applied to reduce the threat to an acceptable level. Such safeguards might include:

• policies and procedures to prohibit members of the firm from making management decisions on behalf of the client; and
• using members of the firm not part of the engagement team to provide the services.

 

Provision of taxation services to an audit or review client

/188  Members and firms have historically provided a broad range of tax services to their audit and review clients, including compliance, planning, provision of formal taxation opinions and assistance in the resolution of tax disputes. Taxation services are seen to be unique among non-assurance services for several reasons. Detailed tax laws must be consistently applied, and taxation authorities have discretion to audit any tax filing. Accordingly such engagements are generally not seen to create threats to independence that are not adequately offset by available safeguards.

 

/189  There are, however, some taxation services which, when provided to an audit or review client, may impair the independence of the member or firm. An example is when a member, a firm or a network firm represents an audit or review client before a court having jurisdiction to deal with tax matters.

M. Fees and Pricing

Fees - Relative size

/190  When the total fees generated from an assurance client represent a significant proportion a member’s or firm’s total fees, the financial dependence on that client, or group of clients of which it is a part, including the possible concern about losing the client, may create a self-interest threat. The significance of the threat will depend upon factors such as:

• the structure of the firm; and
• whether the member or firm is well established in practice.

The significance of the threat should be evaluated and, if it is other than clearly insignificant, safeguards should be applied to reduce it to an acceptable level. Such safeguards might include:

• taking steps to reduce the dependency on the client;
• discussing the extent and nature of fees with the audit committee;
• having firm policies and procedures to monitor and implement quality control of assurance engagements;
• involving another member of the firm who is not on the engagement team to review the work done or advise as necessary;
• arranging for external quality control reviews; and
• consulting a third party, such as a professional regulatory body or a professional colleague who is not a member of the firm.

 

Fees - Overdue

/191  A self-interest threat may exist if fees due from an assurance client for professional services remain unpaid for a long time, especially if a significant portion is not paid before the issue of the assurance report for the following year. Generally the payment of such fees should be required before that report is issued. The following safeguards may be applicable:

• discussing the level of outstanding fees with the audit committee; and
• involving another member of the firm who is not part of the engagement team, or a professional colleague who is not a member of the firm, to provide advice or review the work performed.

Members are cautioned that the overdue fees might create the same threats to independence as a loan to the client. Therefore, members should consider whether, because of the significance of such threats, it is appropriate for the firm to retain the client.

 

Pricing

/192  Rule 204.4(34) provides that a member or firm may not provide an assurance service at a fee level that the member or firm knows is significantly lower than that charged by the predecessor member or firm, or contained in other proposals for the engagement, unless the member or firm can demonstrate that the engagement will be performed properly by qualified staff and in accordance with all applicable professional standards.

N. Compensation of Audit Partners

/193  Compensating an audit partner for selling non-assurance services to an audit or review client of that partner may create a self-interest threat. The significance of the threat will depend on such factors as:

• the structure of the firm;
• the size of the fee for the assurance service; and
• the size of the fee for the non-assurance service.

The significance of the threat should be evaluated and, if it is other than clearly insignificant, safeguards should be applied to reduce it to an acceptable level. Such safeguards might include:

• discussing the nature and extent of the fees with the audit committee;
• having firm policies and procedures to monitor and implement quality control of assurance engagements;
• involving another member of the firm who is not a member of the engagement team to review the work done or advise as necessary; and
• being subject to external practice inspection.

 

Audit clients that are reporting issuers

/194  Rule 204.4(35) provides that a member who is an audit partner of a firm with five or more audit clients that are reporting issuers or ten or more partners, may not earn or receive compensation based on the partner procuring engagements from a reporting issuer audit client of the partner to provide any product or service other than an assurance service. Rule 204.4(35) does not apply to partners who are not “audit partners” as defined.

/195  The prohibition from compensating an audit partner for procuring or selling non-assurance services is not extended to compensation for performing such services and does not preclude an audit partner from sharing in the profits of the audit practice and the profits of the firm. An audit partner’s evaluation may take into account a number of factors directly or indirectly related to selling services to an audit client that is a reporting issuer. For example, an audit partner may be evaluated on the complexity of his or her engagements, the overall management of the relationship with the client including the provision of non-audit services, and the attainment of specific sales goals.

 

O. Contingent Fees

/196  Members and firms are referred to Rule 215 and the related Council Interpretation.

 

P. Gifts and Hospitality

/197  Rule 204.4(36) provides that a firm, or a member or a student who is part of an engagement team for an assurance client, may not accept a gift or hospitality, including a product or service discount, from the client unless the gift or hospitality is clearly insignificant to the firm or person as the case may be.

 

Q. Actual or Threatened Litigation

/198  Actual, threatened or prospective litigation between a firm or a member of an engagement team and the assurance client or a shareholder or creditor of the client may create a self-interest or intimidation threat. The relationship between client management and persons on the engagement team should be characterized by complete candour and full disclosure regarding all aspects of the client’s business operations and all matters relevant to the client’s financial statements. The firm and the client’s management may be placed in adversarial positions by actual, threatened or prospective litigation, which could impair complete candour and full disclosure, and in this, or other ways, the firm may face a self-interest or intimidation threat. The significance of the threat will depend upon such factors as:

• the materiality of the litigation;
• the nature of the assurance engagement;
• the stage of the litigation; and
• whether the litigation relates to a prior assurance engagement.

The significance of the threat should be evaluated and, if it is other than clearly insignificant, safeguards should be applied to reduce it to an acceptable level. Such safeguards might include:

• disclosing to the audit committee the extent and nature of the litigation;
• removing from the engagement team any person involved in the litigation; and
• involving an additional member of the firm who is not part of the engagement team to review the work done or advise as necessary.

If such safeguards do not reduce the threat to an acceptable level, the only appropriate action is for the member or firm to withdraw from, or refuse to accept, the assurance engagement.

/199  Members are cautioned that actual litigation often results in a conflict of interest between the client and the member or firm which will preclude the member or firm from continuing to provide professional services to the client. Threatened or prospective litigation can have the same result. When faced with threatened, prospective or actual litigation, members and firms should refer to Rule 210 and the related Council Interpretation, and consult with their legal counsel, to determine whether they can continue to provide professional services to the client and, if so, whether there are particular arrangements which should be made with the client.