Auditor Independence When a Client Offers a Consulting Engagement

Conclusion: Accepting the engagement as proposed would create an unacceptable self-review threat and is likely prohibited.

Threats identified:

1. Self-review threat – the firm would design and implement the very system it must audit; it would be reviewing its own work.
2. Self-interest threat – the fee (Rs 25m) is 3× the audit fee (Rs 8m); economic dependence on a single client is a recognised threat.
3. Management participation threat – 'design and implement' may involve making management decisions, which is prohibited for an audit client.

IESBA position: For a listed audit client, a firm shall not assume management responsibility, and shall not provide services that create a self-review threat where the results are material to the financial statements. Inventory at 30% of total assets is clearly material.

Safeguards that might permit a narrower scope:

• Limit the firm to advisory/design review only, with client management taking all decisions and implementing.
• Use a separate team with no audit involvement and no fee-sharing.
• Obtain audit committee pre-approval.
• Even then, the self-review threat on a material system is hard to eliminate - likely still prohibited for a listed entity.

Procedural steps:

1. Do not agree on the call. Tell the CFO the request must go through the firm's independence process.
2. Consult the firm's ethics/independence partner and document the assessment.
3. Refer to the audit committee - for listed entities, non-audit services require pre-approval; the committee must assess the threat and the fee ratio.
4. Check the listing rules - many regimes cap non-audit fees or require disclosure of the ratio; a 3:1 ratio triggers scrutiny.
5. Consider the audit's stage - 60% complete; switching providers mid-audit would itself impair the audit.
6. Document the decision and the safeguards considered.

Response to the CFO:

• Decline the design and implementation scope as proposed.
• Offer a permitted alternative: an independent review of the design produced by a third party, or a separate firm for implementation, with your firm providing only technical advice to management.
• If the client insists on the full scope, resign from the audit - and note that resigning mid-audit creates its own problems; better to complete this year's audit and decline the engagement.

Key principle: Independence is not negotiable on a fee argument; the audit committee, not the CFO, decides.

Safeguards:

1. Separate engagement team – no personnel overlap with the audit; separate reporting lines.
2. No fee-sharing between audit and advisory partners.
3. Management responsibility – client management must make all decisions, sign off the design, and own implementation.
4. Audit committee approval – documented pre-approval of the specific scope and fee.
5. Rotation/oversight – a second partner reviews the advisory output.
6. Ongoing monitoring – reassess the threat if the scope expands.

Disclosures:

• Financial statements – disclose non-audit fees paid to the auditor (often required by company law or listing rules).
• Audit report – consider a key audit matter on inventory if the system change affects valuation.
• Audit committee report – explain how independence was safeguarded and why the service was permitted.
• Regulator – some regimes require notification of non-audit services above a threshold.

Residual risk: Even with safeguards, the self-review threat on a material inventory system is difficult to reduce to an acceptable level. If the audit committee cannot be satisfied, the firm should decline.