Independence Threats at a Publicly Listed Audit Client

Threats: (1) Maria's brother as CFO creates a familiarity and self-interest threat; for a listed entity, a close family member in a key financial position is a significant threat and removing Maria from the engagement is the minimum safeguard. (2) Designing a tax shelter creates an advocacy threat; for a public interest entity, aggressive tax planning may be prohibited if material. (3) Implementing a new IT system creates a self-review threat if the system generates financial information; for a listed entity, designing and implementing financial reporting systems is generally prohibited. (4) The IT fees are 25% of total fees, creating a self-interest and intimidation threat; for a listed entity, fee dependency above 15% requires disclosure and safeguards, and 25% is high. (5) The junior auditor's shares create a direct financial interest threat. (6) Maria's six-year tenure may breach rotation requirements for public companies. Given the combination, the firm likely cannot continue as auditor unless it resigns from the tax and IT engagements, removes Maria, and addresses the shares. Even then, the fee dependency and the close family relationship make independence difficult to sustain.

Possible safeguards: remove Maria and ensure she has no influence; require the junior auditor to sell the shares; separate the tax and IT teams from the audit; have an independent quality control review; disclose the fee dependency to the audit committee; rotate the engagement partner. However, some threats cannot be mitigated: designing and implementing an IT system that is significant to the financial statements creates a self-review threat that no safeguard can reduce to an acceptable level for a public interest entity. Designing a tax shelter may create an advocacy threat that cannot be mitigated if the shelter is material or aggressive. The close family relationship of the engagement partner to the CFO is so significant that removal of the partner is the only effective safeguard. The 25% fee dependency is high and may require the firm to decline the audit if it cannot reduce the dependency. The firm should apply the conceptual framework and, if threats cannot be reduced, decline or withdraw.

A direct financial interest in an audit client is prohibited. The junior auditor must dispose of the shares immediately, before participating in the engagement. If the auditor does not, the auditor should be removed from the engagement. The quality control partner's unawareness indicates a deficiency in the firm's independence monitoring. The firm should have a system for annual independence declarations, training, and review. The matter should be reported to the ethics partner and the quality control partner. The firm should conduct an independence review of the engagement and document the resolution. If the firm cannot demonstrate that independence is maintained, the audit report may be compromised.