Independence on a Long-Standing Audit Client
Harwell Logistics Ltd has been audited by your firm for nine years. The engagement partner, Priya, has been on the engagement for seven of those years. Last month the firm's tax department won a £120,000 engagement to design and implement Harwell's new transfer pricing policy, which will be reviewed by HMRC. Priya's spouse has just been appointed as Harwell's part-time financial controller on a two-day-a-week contract. Harwell is a private company with £80m turnover; it is not listed, but it has bank covenants that make the audit report important to two lenders. The firm is a mid-tier practice where Harwell is the largest audit client by fee. The managing partner has asked Priya to 'make it work' because losing Harwell would hit the firm's numbers.
1. Assess the ethical threats arising from each fact pattern and state whether safeguards can reduce them to an acceptable level.
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Take each fact separately, then consider the cumulative effect.
1. Partner tenure (seven years)
- For a non-listed entity there is no mandatory rotation, but long association creates a familiarity threat and, over time, a self-interest threat.
- Safeguards: independent quality control review, rotation of the engagement partner, or a fresh set of eyes on key judgements. These are usually sufficient for a private company, but seven years on a £80m client with covenant pressure is at the upper end.
2. Tax advisory engagement (£120,000)
- Designing a transfer pricing policy that HMRC will review creates a self-review threat if the audit team later relies on the policy or the numbers it produces.
- The tax work is significant relative to the audit fee. Safeguards: separate teams, no audit partner involvement in the tax design, and a review of whether the tax outputs are material to the financial statements. If the policy drives material tax balances, the self-review threat may not be reducible.
3. Spouse as financial controller
- A close family member in a key financial reporting role is a serious familiarity and intimidation threat. The financial controller prepares figures the auditor tests.
- Safeguards are limited. Removing Priya from the engagement is the obvious step; if the spouse remains in the role, Priya cannot be the engagement partner.
4. Managing partner pressure
- This is an intimidation threat at firm level. 'Make it work' is not an acceptable basis for an independence conclusion.
Conclusion: The spouse appointment alone likely requires Priya's removal. Combined with the tax engagement, the firm should consider whether it can continue as auditor at all. Safeguards cannot cure a close family member in a key role while the same partner signs the report.
2. Draft the points you would put to the managing partner, including the professional and regulatory considerations.
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Frame it around the Code and the firm's own quality management obligations, not personal discomfort.
Points to make
- Independence is a conclusion, not a negotiation. The spouse as financial controller is a close family member in a key position. The Code requires the threat to be eliminated or reduced to an acceptable level; here the practical answer is that Priya steps off the engagement.
- The tax engagement needs a self-review assessment. If the transfer pricing policy affects material balances, the firm may be providing a service that the audit then has to opine on. That is exactly the situation the Code warns about.
- Tenure: recommend rotation of the engagement partner and an EQCR for the current year regardless of the other issues.
- Commercial pressure is not a factor in the conclusion. The managing partner's concern about fees is a self-interest threat at firm level. Document that the decision was made on ethical grounds.
- Regulatory: the firm's quality management system must address independence monitoring. If the firm concludes it can continue, the file should record the safeguards and the reasoning. If not, it should resign and notify as required.
- Practical options: (a) Priya removed, new partner, EQCR, tax work ring-fenced - possibly acceptable; (b) firm resigns from the audit and keeps the tax work; (c) firm resigns from both. Weigh each against the Code and the lenders' reliance on the report.