Background
The revised 12th edition of the Code of Ethics i.e. Code of Ethics 2019 came into effect from July 1, 2020 consisting of Volume I, Volume II and Volume III. However, 3 provisions of Volume I were deferred and subsequently were announced to come into force from April 1, 2022. The Council of the Institute of Chartered Accountants of India (‘ICAI’) has deferred it further for a period of six months (i.e. till 30th September, 2022).
These 3 provisions are as under:
Responding to Non-Compliance with Laws and Regulations (NOCLAR) – [Sections 260 and 360]
Fees – Relative Size [Paragraphs 410.3 to R410.6]
Tax Services to Audit Clients [Subsection 604]
The circumstances in which professional accountants operate might create threats to compliance with the fundamental principles. Section 120 of Volume I,sets out requirements and application material, including a conceptual framework. This will assist accountants in complying with the fundamental principles and meeting their responsibility to act in the public interest. It includes range of facts and circumstances, including the various professional activities, interests and relationships that create threats to compliance with the fundamental principles. In addition, they deter accountants from concluding that a situation is permitted solely because that situation is not specifically prohibited by the Code.
The conceptual framework specifies an approach for a professional accountant to (a) Identify threats to compliance with the fundamental principles; (b) Evaluate the threats identified, and (c) Address the threats by eliminating or reducing them to an acceptable level.
In this article, we have summarised the provisions of Fees – Relative Size and Tax Services to Audit clients.
Fees – Relative Size [Paragraphs 410.3 to R410.6]
As specified in Section 410 on Fees, the nature and level of fees or other types of remuneration might create self-interest or intimidation threat. Section 410.3 to R410.6 consists of provisions as regards how the threat is created, factors that should be considered while evaluating the level of threats and action that might be taken to safeguard to address such threat. The summary of these provisions is given in the table below:
|
Applicable to |
Circumstances that create a threat |
Actions to be taken to address such threat |
|
All audit clients |
– Total fees from audit clients of the firm expressing audit opinion represent a large proportion of the total fees of the firm.
– Dependence on that client and concern about losing the client. |
– Increase the client base to reduce the dependency. |
|
All audit clients |
– Fees from audit client of the firm represent a large proportion of the revenue of one partner or one office of the firm |
– Increase the client base of the partner or the office to reduce the dependency. – Have an appropriate reviewer, who did not take part in an audit engagement, review the work. |
|
All audit clients |
For 2 consecutive years, Gross annual professional fees (total fees) from the audit client and its related entities is >15% of the total fees received by the firm expressing the opinion on the financial statements of the client.
– Ceiling of 15% is not applicable in case;
– Where such fees doesn’t exceed Rs. 5 lakhs including fees received for other services rendered through the medium of a different firm or firms where such member or firm may be partner or proprietor.
– Audit of government companies, public undertakings, nationalised banks, public financial institutions or where appointments are made by the Government. |
– Disclose this to those charged with governance of the audit client.
– Take either of the following actions
o Pre-issuance review:
Prior to the audit opinion being issued on 3rd year’s financial statements, a professional accountant (not a member of the firm), performs an engagement quality control review or a professional body performs a review equivalent to an engagement quality control review.
o Post issuance review:
After the audit opinion on 3rd year’s financial statements has been issued and before 4th year’s audit opinion is issued, professional accountant (not a member of the firm) or a professional body performs a review of 2nd year’s audit that is equivalent to engagement quality control review.
– The firm should have a pre-issuance review performed where it is determined that level of threat is such that post-issuance review would not reduce the threat to an acceptable level.
– If fees for 2 consecutive years continue to exceed 15%, the above actions are required to be taken every year thereafter. |
Tax Services to Audit Clients [Subsection 604]
As specified in sub-section 604 of Tax services, providing tax services to an audit client might create a self-interest or advocacy threat. This subsection consists of provisions as regards how the threat is created, factors that should be considered while evaluating the level of threats and action that might be taken to safeguard to address such threat. It also prohibits firms and network firms from providing tax services to audit clients in some circumstances where threats cannot be addressed.
The summary of these provisions given in the table below:
|
Applicable to |
Nature of tax services |
Circumstances that create threat/nature of threat |
Actions to be taken to address such threat |
|
All audit clients |
Tax return preparation
– Assisting clients with tax reporting by drafting & compiling information required to be submitted to the applicable tax authorities
– Advising on tax return treatment of past transactions and responding on behalf of the audit clients. |
It does not usually create a threat. |
– |
|
All audit clients |
Tax calculations for the purpose of preparing accounting entries |
Preparing current and deferred tax calculations for audit clients creates a self-review threat. |
Action depends on whether audit clients are public interest entities or not. |
|
Audit clients that are not public interest entities |
—-‘’—– |
—-‘’—– |
– Use professionals who are not part of the audit team
– Appropriate reviewer who was not involved in the providing services, should review the audit work or service performed. |
|
Audit clients that are not public interest entities |
—-‘’—– |
—-‘’—– |
– Firm/network firm shall not prepare tax calculations that are material to the financial statements.
– However, professional accountant may review tax calculations prepared by the client and provide recommendations.
– Where tax calculations are immaterial, a firm can consider the option of (a) use of professionals who are not part of the audit team or (b) reviewer who was not involved in the providing services, should review of audit work or service performed. |
|
All audit clients |
Tax planning and other tax advisory services |
Self-review or advocacy threat |
– Use professionals who are not part of audit team.
– Have an appropriate reviewer who was not involved in the providing services, review the audit work or service performed.
– Obtain pre-clearance from the tax authorities.
– Firm or network firm shall not provide these services to audit client when the effectiveness of the tax service depends upon a particular accounting treatment or presentation in the financial statements and (a) audit team has reasonable doubt as to appropriate accounting or presentation and (b) outcome or consequences of tax advice will have a material effect on the financial statements. |
|
All audit clients |
Tax services involving valuations
– Firm/network firm might perform the valuation for tax purposes only; where the result of the valuation will not have a direct effect on the financial statements. |
This would not usually create threats if the effect on financial statements is immaterial, or the valuation is subject to external review by tax authorities or any regulatory authority. |
– |
|
All audit clients |
——“——- |
Self-review or advocacy threat, if the valuation is not subject to external review and the effect is material. |
– Use professionals who are not audit team members.
– Have an appropriate reviewer not involved in providing the service, should review the audit work.
– Obtain pre-clearance from tax authorities |
|
All audit clients |
Assistance in the resolution of tax disputes. |
Self-review or advocacy threat. |
– Use professionals who are not audit team members
– Have an appropriate reviewer not involved in providing the service, should review the audit work.
– Firm/network firm shall not provide tax services of assisting in the resolution of tax disputes to an audit client if
o It includes acting as an advocate for the audit client before the court
o Amounts involved are material
– However, firm/network firm is not precluded from having continued advisory role in relation to matter that is being heard before court. |
Conclusion:
With increasing focus for ensuring independence of auditors, above mentioned provisions are of key importance. Auditors must provide a professional and an unbiased opinion always. There is no exception. Ruling out the threats to independence being that of self-interest, self-review, advocacy, familiarity, and intimidation will avoid conflict of interest and assist in risk management for the audit firm. To achieve this, audit firms will have to implement the necessary checks and balances. The guidance provided in the revised edition of the Code of Ethics sets a good benchmark for accounting firms whenever they are faced with a potential conflict of interest for the provision of services to an audit client.
