Appendix 5 - Specific threatsto objectivitywithrelevantsafeguards Self-interest —a result of financial or otherinterestsof auditors, or theirclose family, in clients. Firms should publish "prohibitedshareholding list". Threat Dependence on client Why Safeguard The auditorwill have a fear of o reduce fee dependency, auditors should losing a lotof incomethereforewill notaccept appointmentof clients if their Lowballing appease the client The auditorwill keep the client happy to ensure furtherwork. Therefore will not disagree with client totalgross recurringfees exceed certain limits. Total gross recurringfees should be no more than: Listed Co's —10% of the Firms totalfees Other Co's —15% of the Firms totalfees Setting an audit fee low to try and get more lucrativework is frowneduponthefee must be based on pre-determinedlevel of work required Loans, guarantees The auditorwill havefear of not and overdue fees gettingpaid so will keep the client happy to ensure payment Hospitality, gifts or This could be deemed a bribeand other benefits Contingentfees potentiallythe auditor may lose professional scepticism e auditorhas an incentive, hereforemay notbe independent • No loans or guarantees allowed to or fromclient. unless in normalcourse of business Significant overduefees are deemed a loan, hence notallowed Benefits should notbe accepted unless modest Modest —means available to all the company's staff at same terms The assurance firmshould establish policies on gifts and hospitalityand should be communicated(e.g. decision must be made by partners and documented in the audit file) Assurance work should notbe conductedon a contingentbasis (i.e. where you receive a commission, or a % offees is payableupona specific event occurring) No safeguard —fee must be based on pre-determinedamount Financial/business The auditorwillwant the greatest Close business, family or personal interest returnfrom investment, therefore relationship should be avoided between the may cover anythingthatcould clientand the assurance firm can also lead to devalue theinterest intimidation threat i.e. seeking togain employment with an assurance client i.e. enteringa jointventure/ arrangement withclient Financial interest in shares etc nyone involvedwithassurance must NOT have direct or indirectinterestin a client i.e. holdingshares Rules apply to Assurance firm Any partner in the firm Person in a positionto influence engagement Immediatefamily member of above Safeguards: Dispose of interest Remove individualfrom the team Independentpartner review InternalQC procedures in place (i.e. prohibited shareholding list) 0 Self-review threats - it mightoccurs when and auditorhas to re-evaluate work they have already completed (e.g. the external auditors prepare the financial statements and then they will audit them). Threat ccounting services InternalAudit Services Former employee of client joining assurance firm Wh If the auditor reviews their own ork they may miss errors, or be more relaxed about doing the work. Also if they do find any errors it's easier tocover them up and not disclose in the fear of looking incompetent Safeguard Should notdo for LISTED companies, unless it is an emergency • For non-listedclients —permittedas long as safeguards in place (applicable toall self-review threats) No management decisions are made; clientto prepare judgemental area Separate engagement letter/personnel/ terms / partners Independentpartnerreview Should notbe provided to listed external audit clients, or where significant reliance ill be placed upon thework of internal auditors he employee cannot be involvedwiththe audituntil2 years have elapsed ("coolingff' period). Familiarity —when the auditoris too sympathetic or trusting of the client because of a close relationshipwiththem (because a close friend or relative of the auditorworks in a key role for the client). The auditormay trust theirfriend/relativeto not make mistakes and thereforenot review their work as itshould be (a consequence mightbe undetectedmaterialerrors in thefinancialstatements). It might also arise after a long association withthe client. Threat Wh Participation in he auditormay client affairs/family loseprofessional and personal scepticism,or have relationships thefear of upsetting the client Audit partners leaving tojoin the client cting for prolonged period o Safeguard Cannot be director,employeeor a business partnerif you are going to audit a client Must not take part in audit if have been officer / employee in that period, or in the last 2 yrs If the director/ employee or business partneris an immediatefamily member of someone on the audit team, thatauditteammembermustbe removed May be extended to otherclose relationships within thefirm not ustthoseon theteam Can join the client, but must sever all links withthe assurance firm(e.g. pension) Audit partnerhas to informthe audit firm immediately and is thenremovedfromauditteamas soon as decision tojoinclientis made If partnerbecomes directoror key managementand has workedas partneron theauditin prior2 years the auditfirmmustresign as auditors 2 year periodmustthenelapse beforethefirmcan be re-appointedas auditors Listed clients—Engagement partnerscan act fora maximumof 5 years, shouldthenhave a break of a minimumof 5 years beforeresumingrole Anyone who has acted as a key auditpartnerfora periodof 7 years should have a breakof 2 years Senior staff on listed clients should also not act for longerthan7 years Non-listed clients —no compulsory rotation,butfirm carry out annual reviews to ensure objectivitynot threatened, but is advised thatpartners act for no Ion er than 10 ears Advocacy- when theauditorpromotesor representstheclientin some way (e.g. theclientis asked to promoteclient's shares for a stock exchange listing or to represent the client in the court). In this situationthe auditorwould have to biased in favour of the client and thereforecannot be objective. Threat Wh Legal services Whenrepresenting the client you automaticallyview he same views as he client therefore may lose independence Safe uard Should notofferlegal services toa clientand defend them in dispute or litigationwhich is material to the FS Corporatefinance services Should notadvise on debt restructuringas part of Corporate finance —don'tenter negotiationswith bank or other lenders on clients' behalf Should notadvise clients on debt restructuringas part of a corporate finance engagement Intimidation —clients may try to harass or bully auditors intogiving an preferentialaudit reports. They may use the fee as leverage. The auditorshould notgive in to such pressure and, in the circumstances, may choose to resign fromsuch client. Auditors should maintainthe fee thresholds notedas a safeguard to self-interestthreat Auditors should always maintain an up-to-dateengagement letteragreeing the basis of the fee, which has been signed by the client If therelationshipwiththe client breaks down irrevocably,the auditorshould resign Management - takingon a managementrole. Threat Why Safeguard Undertakingany work which involves making udgements and taking decisions that are responsibilityof management An engagement partneror employee ofthe assurance firm should notserve on the board of directors as they would be involved withdecision making Engagement lettersshould always specify thatclients are responsible for theirown decision making Auditorsshould never make decision fortheirclients O