New auditor independence guidance – what does it mean for me?

6 Jul 2020

Lyn Formica

Head of SMSF Technical & Education Services

All approved SMSF auditors are required to comply with the independence requirements set out in the APES 110 Code of Ethics. Recent changes to the Code and the associated Independence Guide will have major repercussions for the SMSF industry in the months and years ahead.

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The Accounting Professional & Ethical Standards Board (APESB), in collaboration with the three professional accounting bodies (Chartered Accountants Australia and New Zealand (CAANZ), CPA Australia and the Institute of Public Accountants (IPA)), recently published a new and updated Independence Guide. The Guide incorporates the changes to the APES 110 Code of Ethics, which became effective on 1 January 2020, and is mandatory for SMSF auditors.

So, what do the changes mean for me? Let’s consider a few common scenarios.

I am an audit partner with my firm. Another partner of the firm is responsible for the preparation of the financial statements for the SMSFs I audit.

The updated Guide makes it clear that a “Chinese Walls” style arrangement such as yours will always now result in a breach of the independence requirements. In the words of the Guide, the self-review threat is so great that there is no safeguard which could reduce that threat to an acceptable level. As a result, auditors are expected to decline the audit engagement.

The only exception is where the accounting or bookkeeping services are of a “routine or mechanical nature”. For example, transactions are coded by the SMSF trustee (including tax entries) and the firm simply prepares the financial statements from a trial balance prepared by the trustee. In our view, it would be rare for an SMSF trustee to have the knowledge, skills and experience to undertake such duties.

What if my firm was to set up a separate entity through which to conduct the audit business in the future? Some or all of the existing partners would have a direct or indirect financial interest in the new audit business.

In our view, if the “owners” of the new entity are the same or similar to the “owners” of the entity providing the accounting or bookkeeping services, there is still a clear threat to independence and no safeguards capable of eliminating that threat.

Is the situation different if my firm (Auditor A) has a reciprocal arrangement with another auditor (Auditor B)? My firm audits Auditor B’s SMSF accounting clients and Auditor B audits my SMSF accounting clients.

Whilst this situation does present self-interest, familiarity and intimidation threats, it may be possible to adopt appropriate safeguards to mitigate those threats. These safeguards may include:

  • spreading your referral arrangement across a number of different auditors instead of just the one, and/or
  • engaging an external quality control reviewer to evaluate your audit work on a regular basis.

Of course, a reciprocal arrangement between yourself and Auditor B in respect of your personal SMSF would not be acceptable. Such arrangements have been on the ATO and ASIC’s radar for a few years now.

SMSF audit is the more profitable part of my business. Rather than declining the audit engagement, could I outsource the SMSF accounting work instead?

This will depend on what you mean by “outsource” and your intended relationship with the “outsourcer”.

If you intend merely contracting out the accounting work, and will remain the fund’s tax agent and the person responsible for the financial statements, then the threats to your audit independence remain the same with no safeguards capable of mitigating them.

If your arrangement results in an independent third party signing off on the financial statements and acting as the fund’s tax agent, whilst there may still be threats to your independence, those threats may be able to be eliminated by ensuring the independent third party has a varied client base.

My firm provides audit services exclusively. The majority of my audit work comes from a single referral source (eg an SMSF administration firm).

As with the reciprocal scenario above, your situation also presents self-interest, familiarity and intimidation threats. Appropriate safeguards to mitigate those threats may include:

  • increasing your client base to reduce your dependence on the single referral source, and/or
  • engaging an external quality control reviewer to evaluate your audit work on a regular basis.

I have been auditor of some of my SMSFs for many years. Does my long association with the funds present a problem?

Your situation potentially presents self-interest and familiarity threats. Appropriate safeguards to mitigate those threats may include:

  • auditor rotation with your firm (which may be difficult to implement depending on the size of your firm), and/or
  • engaging an external quality control reviewer to evaluate your audit work on a regular basis.

After auditing a fund for 10 years, at a minimum, it is considered best practice that an internal or external independent review of the audit is undertaken.

I can’t restructure my business overnight. Where do I go from here?

Whilst the writing has been on the wall for “Chinese Wall” style arrangements for quite some time, it is our understanding that the ATO are not expecting impacted auditors to immediately decline their existing audit arrangements. Complying with the revised Code and Independence Guide has the potential to cause capacity problems within many audit firms.

Rather, during the 2020/21 financial year, we understand the ATO:

  • intends to issue further communication to auditors detailing their expectations (we expect the professional accounting bodies will do the same),
  • will be writing to auditing firms where the ATO data indicates the auditor may be auditing the financial statements prepared by the same firm, and
  • will be expecting auditors to have in place by 1 July 2021 concrete plans to remove their threats to independence.

In the meantime, we would encourage auditors to review their professional indemnity insurance to ensure their coverage remains valid even if they were considered to be in breach of the independence standards.

We will be covering the new independence guidance as well as a range of other issues impacting the 2019/20 year end work in our upcoming webinar for accountants and auditors.