Fee dependence, a related-party loan and a threat to withdraw the audit

Several threats arise. There is a self-interest threat because the client provides 18% of firm revenue; losing it would be financially significant to the firm and to individual partners. There is an intimidation threat because the CEO threatens to tender the audit if the matter is raised. There is a familiarity threat from the tax partner's close relationship with the CFO, and a self-review threat because tax advisory services are provided to an audit client. There may also be an advocacy threat if the firm has been promoting the client's tax positions.

The most significant are the intimidation and self-interest threats because they directly pressure the engagement partner to suppress a material related-party matter. Fee dependence makes the threat harder to resist, and the tax partner's relationship weakens the firm's ability to challenge management. These threats cannot be eliminated by a vague disclosure note. Safeguards could include escalating to the firm's ethics partner, removing the tax partner from the engagement, appointing an independent engagement quality control reviewer and discussing the matter directly with the audit committee. If the threats cannot be reduced to an acceptable level, the firm should resign from the audit.

Confidentiality does not permit the auditor to withhold material related-party information from those charged with governance or to accept management's assertion without evidence. The auditor's duty of confidentiality applies to client information, but it is subject to legal or regulatory requirements and to the proper performance of the audit. The loan may be a related-party transaction under IAS 24 because the CEO is key management personnel and the supplier may be related to him. The auditor must obtain evidence about the terms, purpose and disclosure, and assess whether the financial statements give a true and fair view.

The auditor should not agree to a vague note to avoid conflict. If management refuses to provide evidence or to make adequate disclosure, the auditor should escalate to the audit committee, consider the effect on the opinion and document the dispute. The threat to withdraw the audit is not a valid reason to suppress the issue. Depending on the facts and local law, the auditor may also have a duty to report to a regulator; legal advice should be obtained before any external disclosure.

The engagement partner should immediately escalate the matter to the firm's ethics partner or managing board. The firm should appoint an independent engagement quality control reviewer, since the current reviewer is on leave. The tax partner should be removed from any role in the audit and the firm should assess whether the tax advisory services create a self-review threat that can be safeguarded or whether they must be discontinued. The audit committee should be informed directly, without the CEO controlling the communication, and should receive a clear description of the loan and the disclosure issue.

The firm should document the threat assessment, the safeguards considered, the discussions with management and the audit committee, and the reasons for the final conclusion. If the client refuses adequate disclosure or evidence, the auditor should modify the opinion and consider resignation. The firm should also consider whether the CEO's threat affects the firm's ability to act objectively and whether any legal or regulatory reporting obligation arises. Signing the report with a vague note would not be defensible.