Auditor Independence and a Contingent Fee
A licensed Saudi audit firm has audited Dammam Logistics for four years; the engagement partner, Fahad, has led the audit throughout. Dammam Logistics has now asked the firm to (a) continue as auditor for the coming year, (b) prepare its statutory financial statements from the trial balance, and (c) accept a fee arrangement under which 30% of the audit fee is contingent on the company obtaining a bank loan, which the bank has indicated will depend on the audited statements. The total audit fee is SAR 350,000; last year's fee of SAR 300,000 remains unpaid. Fahad's brother-in-law is the company's financial controller. The company is listed on Nomu.
1. Identify the threats to independence and the safeguards, addressing each of the three requests.
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Threats and analysis (IESBA Code / SOCPA Code of Professional Conduct):
| Issue | Threat | Assessment |
|---|---|---|
| Contingent fee (30% on loan success) | Self-interest; and a prohibited arrangement | A fee contingent on the outcome of an audit-related engagement is not permitted for assurance work. It creates a direct self-interest threat and compromises objectivity, since the auditor would be incentivised to reach a conclusion that secures the loan. Must be declined. |
| Preparing the financial statements | Self-review | For a listed entity (Nomu), the firm cannot assume management responsibility for preparing the FS. Preparing the FS from the trial balance and then auditing them creates a self-review threat that cannot be reduced to an acceptable level for a public-interest entity. Decline; the client's own staff must prepare the FS, with the firm limited to advice. |
| Unpaid prior-year fee (SAR 300,000) | Self-interest | A significant overdue fee before the current report is issued is generally treated as a loan to the client and impairs independence. Settle before accepting reappointment, or decline. |
| Four-year tenure + partner tenure | Familiarity; self-interest (fee dependence) | Rotation of the engagement partner is required for listed entities (typically after 5 years, with a cooling-off period). Fahad is approaching the limit and should plan rotation. |
| Brother-in-law as financial controller | Familiarity / intimidation | A close family member in a key financial position is a prohibited relationship for a member of the engagement team. Fahad must be removed from the engagement, or the firm must resign. |
Overall conclusion: the firm cannot continue as auditor on the current terms. It could continue only if it (i) refuses the contingent fee, (ii) refuses to prepare the FS, (iii) collects the overdue fee, (iv) removes Fahad from the engagement and rotates the partner, and (v) applies appropriate safeguards.
2. Explain the ethical reasoning framework you would apply, and the consequences of non-compliance.
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Conceptual framework (threats → evaluate → safeguard → document):
- Identify threats: self-interest (contingent fee, overdue fees, fee dependence), self-review (preparing FS), familiarity (family relationship, long tenure), intimidation (client pressure to secure the loan).
- Evaluate the level: is the threat at an acceptable level? For a listed entity, a contingent fee and preparing the FS are prohibited regardless of safeguards - no safeguard can reduce them to an acceptable level.
- Address: eliminate the activity (refuse the contingent fee; refuse FS preparation), apply safeguards (rotate the partner, remove Fahad, collect fees, independent quality review / engagement quality control review), or decline/resign if no safeguard is available.
- Consult internally (ethics partner) and, where significant, with the SOCPA professional conduct committee.
- Document the issue, the analysis, the conclusion and the safeguards applied.
Consequences of non-compliance:
- Professional: disciplinary action by SOCPA (the Saudi Organization for Chartered and Professional Accountants), including censure, suspension or withdrawal of the licence.
- Regulatory: referral to the Capital Market Authority for a listed (Nomu) entity; possible sanctions and a requirement to re-tender the audit.
- Legal: potential liability to third parties (the bank) who relied on the audited statements; the contingent fee could also be characterised as improper inducement.
- Reputational: loss of the firm's registration and client base.
Practical recommendation: issue a formal engagement letter for the coming year that explicitly excludes FS preparation and any contingent arrangement, confirm in writing the fee settlement date, and notify those charged with governance of the partner rotation and the removal of Fahad from the team.