Independence Threat from a Long-standing Partner and a Contingent Fee
Orin & Vale LLP has audited Brightwater Logistics Ltd for nine years. The engagement partner, Sana Orin, has led the audit for seven consecutive years and her husband holds a 3% equity stake in Brightwater, purchased eighteen months ago and disclosed to the firm's ethics partner at the time. Brightwater has asked Orin & Vale to provide a tax structuring opinion on a proposed cross-border reorganisation, with the fee set at 12% of any tax saving achieved, estimated at £400,000, giving a potential fee of £48,000 against an audit fee of £95,000. Brightwater is a public interest entity. The firm also provides payroll processing for 340 employees. The ethics partner recorded the shareholding as 'immaterial' and took no further action. Brightwater's audit committee has asked the firm to confirm its independence in writing.
1. Evaluate the independence threats arising from the shareholding, the partner rotation position and the contingent fee, and state the safeguards or actions required.
Read the worked answer
Three threats must be assessed. First, the shareholding. A direct financial interest held by the engagement partner's immediate family in an audit client creates a self-interest threat that cannot be reduced to an acceptable level by safeguards - the IESBA Code requires the interest to be disposed of, or the individual removed from the engagement team. A 3% stake is not trivial in absolute terms and the 'immaterial' label applied by the ethics partner is not a valid basis for accepting it. Second, rotation. Brightwater is a public interest entity, so the engagement partner is subject to a seven-year time-on period followed by a five-year cooling-off period. Sana Orin has completed seven years and must rotate off now; the firm cannot extend the period without applying the relevant exemption and disclosing it, and no such exemption applies here. Third, the contingent fee. A fee contingent on the outcome of a tax structuring opinion creates a self-interest threat and, because the outcome depends on the firm's own advice, it is effectively a fee dependent on the results of the audit relationship. For a public interest entity the firm should not accept a contingent fee arrangement of this kind. If the tax service is to proceed, it should be on a fixed or time-based fee and the tax team should be separate from the audit team.
2. Draft the substance of the written independence confirmation the firm can properly give to the audit committee, and explain what must happen before it is issued.
Read the worked answer
Before any confirmation is issued, the firm must remedy the position: Sana Orin's husband must dispose of the shareholding (or she must be removed from the engagement entirely, which for a public interest entity also requires rotation), and a new engagement partner must be appointed with the appropriate transition. The contingent fee proposal must be declined or restructured on a non-contingent basis. Only then can the firm confirm independence. The confirmation should state that the firm and its partners and staff have no financial interests in Brightwater other than those permitted, that the engagement partner has rotated in accordance with the applicable rotation requirements, that no contingent fees are receivable in respect of the audit or related services, and that the payroll service is a permitted non-audit service that does not create a management or self-review threat because Brightwater retains responsibility for the data and decisions. The firm should disclose the historic breach - the shareholding held for eighteen months - to the audit committee, explain the remedial action and the date it took effect, and record the matter in the firm's own independence register. Issuing a clean confirmation without those steps would be misleading and could expose the firm to disciplinary action.