Independence, non-assurance services and fee dependency
Your firm has audited Falcon Energy Ltd, a listed oil and gas producer, since 20X1. Engagement partner Priya has held the role for seven years; firm policy requires rotation after seven years for listed clients. Falcon's 20X6 audit fee is $1.9 million against total firm revenue of $10.2 million, so Falcon represents 18.6%. Falcon asks the firm to (i) prepare its income tax returns and deferred tax calculations for 20X6, (ii) provide a technical hotline to the CFO on accounting matters, and (iii) second a junior accountant for three months to clear a backlog in the accounts payable ledger. The CFO was the audit manager on the Falcon engagement until 20X4. The audit committee has approved all three engagements. The firm's listed-client register shows no other fee dependency above 10%.
1. Assess the independence threats arising from each proposed service and whether safeguards can reduce them to an acceptable level.
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Assess each engagement against APES 110 threats and the Corporations Act. (i) Tax return and deferred tax calculations. Preparing the return is generally a compliance service and may be permissible with safeguards, but computing deferred tax balances and tax expense creates a self-review threat because the numbers go into the financial statements. For a listed audit client, the firm should not prepare the deferred tax calculations; it can review management's calculations. Safeguards such as a separate team and independent review reduce but do not eliminate the threat. (ii) Technical hotline. Advice on accounting matters can create a self-review threat if the firm later audits the treatment. Generic guidance that leaves decisions with management is acceptable with safeguards; advice that effectively designs the accounting policy is not. (iii) Secondment to accounts payable. A junior working on the payables ledger performs an accounting function in an area that feeds the financial statements. This creates self-review and familiarity threats. Because the secondee would be supervised by client staff and not be on the audit team, it may be acceptable only with strict safeguards; for a listed client, I would decline it. CFO conflict. The CFO was audit manager until 20X4; familiarity and self-interest threats arise. Apply the cooling-off and independence rules, and ensure the CFO does not influence the audit.
2. Evaluate the fee dependency and partner rotation issues.
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Fee dependency. Falcon is 18.6% of total firm revenue, above the 15% threshold in APES 110. The firm must disclose the dependency to those charged with governance, consider whether safeguards (independent quality review, external inspection) reduce the threat, and monitor it. It is not automatically a breach, but it is a significant self-interest threat, particularly combined with the other threats.
Partner rotation. Priya has been engagement partner for seven years. Under the Corporations Act (s 324DA) and APES 110 long-association rules, the lead auditor of a listed entity must rotate after five years, with a possible extension to seven years only if the audit is subject to review by another registered company auditor. At seven years, Priya cannot continue; she must rotate off now. The firm must plan the transition and consider whether other senior team members also need rotation.
Conclusion. Accepting all three services at once, with an 18.6% fee dependency and a former audit manager as CFO, would accumulate threats beyond an acceptable level.
3. What if the firm accepts all three services and the CFO then restricts audit access to the deferred tax workings?
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Independence. The firm prepared the deferred tax calculations, so auditing them is self-review. If the CFO then blocks access to the workings, the firm cannot obtain sufficient appropriate evidence over a material balance (deferred tax affects tax expense and the statement of financial position).
Audit response. First escalate to the audit committee and request access. If access is still refused, treat it as a scope limitation under ISA 705. If deferred tax is material, qualify the opinion; if pervasive, disclaim.
Independence breach. The combination of preparing the numbers and being unable to audit them means the firm is not independent in substance. The firm should withdraw from the non-assurance service; if the audit cannot be completed independently, resign and notify ASIC as required.
Document the threats, the safeguards considered and the conclusion, including why accepting all three services was judged to be in the public interest.