top stories

Share

Exposure Draft ED 00-2 issued by the Independence Standards Board

Comments from the Association of Chartered Certified Accountants
February 2001

Executive Summary

The Association of Chartered Certified Accountants (ACCA) is pleased to have the opportunity to comment on Exposure Draft ED 00-2 Statement Of Independence Concepts A Conceptual Framework For Auditor Independence (the proposed Statement) issued by the Independence Standards Board (ISB).

ACCA welcomes the proposed Statement as it embodies a framework approach to independence. This consideration of threats and safeguards is inherently superior to a rules based approach and is supported by the International Federation of Accountants (IFAC), the European Union, ACCA and many other professional bodies.

In our view, the most important step which can be taken to serve the public interest and protect and promote investors' confidence in securities markets is the adoption of an appropriate approach to auditor independence which is consistent worldwide. In order to achieve this, we consider that it is imperative that ISB repositions the proposed Statement and its extant Standards to align with the relevant aspects of the IFAC Code of Ethics for Professional Accountants (the IFAC Code of Ethics).

1 General Comments

Status of the Independence Standards Board

1.1 With the exception of the proposed Statement, ISB has deferred development of its pronouncements. We understand that this action has been taken as a result of the separate decision of the Securities and Exchange Commission (SEC) to modernise its auditor independence requirements (Rule 2-01). We assume, therefore, that ISB and its stakeholders will reconsider its mission in the light of these circumstances. In this regard, we would like to highlight the following structural matters.

1.2 Historically, the American Institute of Certified Public Accountants (AICPA) has acted as both professional body and standard setter. To an extent, for public companies, the SEC has acted as both a regulator and a standard setter. We suggest that ISB has not been able fully to establish itself as an independent standard setter because:

• ISB is concerned with independence rather than the whole range of professional ethics
  
  
• ISB is concerned only with auditors of public companies
  
  and
  
  
• ISB is not independent of the profession (there is no majority of lay members on its Board).

Consistent worldwide approach to independence

1.3 The IFAC Ethics Committee is currently developing revised material for the independence aspects of the IFAC Code of Ethics. We strongly suggest that the proposed Statement should be aligned with that material since, when it is finalised, it will have worldwide authoritative status.

1.4 The principal advantages of aligning the proposed Statement to the finalised IFAC Code of Ethics are that:

• a consistent worldwide approach to auditor independence will best serve the public interest and protect and promote investors' confidence in securities markets
  
  
• benchmarking of US requirements to best international standards will protect and promote US investor confidence
  
  
• there is greater likelihood of auditor compliance with US independence requirements when these are familiar because they are equivalent to requirements in other jurisdictions (for example, where an overseas subsidiary of a US corporation has local auditors)
  
  and
  
  
• compliance with US independence requirements may be enforced through accountancy bodies which promulgate the IFAC Code of Ethics and which have the power to discipline members in all jurisdictions. Effect on the proposed Statement of the mission of the Independence Standards Board

1.5 The foreword to the proposed Statement notes that:

The mission of the Independence Standards Board (ISB or Board) is to establish independence standards applicable to the audits of public entities in order to serve the public interest and to protect and promote investors' confidence in the securities markets. One of the Board's most fundamental projects since its establishment has been the development of a conceptual framework for auditor independence to help the Board issue principles-based independence standards for auditors of public companies.

1.6 The mission and the proposed Statement may be contrasted with the pronouncements (and proposed pronouncements) of other bodies dealing with professional ethics. Because of its importance, we restrict our comparative analysis to differences between the proposed Statement and the IFAC Code of Ethics.

1.7 In two respects, the proposed Statement may be seen to have a narrower focus than the IFAC Exposure Draft 'Independence Proposed Changes to the Code of Ethics for Professional Accountants' (the proposed IFAC Ethics Code):

• the proposed Statement focuses on audits, whereas the proposed IFAC Ethics Code deals with assurance engagements which are wider in their application (as defined in International Standard on Auditing 100 'Assurance Engagements')
  
  and
  

•  the proposed Statement focuses on the audit of public entities, whereas the proposed IFAC Ethics Code is applicable to public and non-public entities alike.

1.8 In our comments at paragraph 1.2 above, we drew attention to the effect that this narrow focus could have on the ability of ISB fully to establish itself as an independent standard setter.

1.9 In one significant regard, however, the proposed Statement is much less clearly focused than the proposed IFAC Ethics Code. The objective of the proposed IFAC Ethics Code is to assist reporting accountants in decision making with regard to independence. The proposed Statement explains, however, that its principal purposes are:

a. to help the Independence Standards Board (ISB or Board) meet its responsibilities to set sound and consistent standards by providing direction and structure for resolving independence issues

b. to assist other independence decision makers in resolving questions about independence in the absence of ISB standards and other independence rules

c. to help investors, other users of financial information, and other interested parties understand the nature, significance, and limitations of auditor independence

and

d. to focus debate and serve as a boundary for discussions about auditor independence issues, thereby helping interested parties contribute to the development and application of, and better understand the rationale and process underlying, ISB standards.

1.10 The term 'independence decision makers' is defined in the Glossary as follows:

'Individuals, groups, and entities that make judgments about auditor independence issues. Independence decision makers include:
- the ISB and other independence standard setters
- auditing firms in adopting independence policies and procedures in the absence of existing rules or standards
- individual auditors in assessing their own independence and in making decisions when faced with situations for which there is neither authoritative guidance nor firm policy
- the management, audit committees, and boards of directors of auditees in meeting their responsibilities to retain auditors who are independent
- regulators in meeting their responsibilities to ensure the independence of auditors.'

1.11 This wide focus has devalued the document by making it less directly relevant to auditors. For example, the discussion of assessing the level of independence risk and determining its acceptability (paragraphs 22 to 26) should be of the utmost practical importance to auditors. However, the discussion is highly theoretical and hedged with modifying words. The table at paragraph 23, which is not used in the succeeding argument, describes a level of independence risk as 'no independence risk' and then suggests only that 'compromised objectivity is virtually impossible' (emphasis added).

1.12 By contrast, the IFAC Code of Ethics deals with practical decision points in an assessment: threats are either 'clearly insignificant' or safeguards must be considered, safeguards must be put in place to reduce significant threats to an 'acceptable level', but some threats are so significant that no safeguard is appropriate except refusal of the engagement.

1.13 We see no easy solution to the conflict between the desire of ISB to produce a conceptual framework for auditor independence to inform a wide spectrum of independence decision makers and the needs of firms and auditors when faced with situations for which there are no existing rules, standards or guidance. We believe that it places too great a demand on the proposed Statement fully to fulfil these principal purposes. We recommend, therefore, that the proposed Statement is addressed only to independence decision makers other than auditors. The practical needs of firms and auditors would be best met by ISB adopting and promulgating the IFAC Code of Ethics. To do this, it is necessary to align the terminology and concepts in the proposed Statement with those in the IFAC Code of Ethics.

Independence standards

1.14 In our comments above, we have argued that the proposed Statement should be aligned with the IFAC Code of Ethics first, to promote global consistency and, secondly, as a necessary consequence of its use to meet the practical needs of auditors. The IFAC Code of Ethics is intended to serve as the only mandatory pronouncement for independence: there are no separate 'standards'. This is in contrast to the ISB regime, where the Conceptual Framework does not itself establish rules.

1.15 We recognise that in the US environment greater emphasis is placed on rules and standards than is now the case in many other developed economies. Accordingly, we hesitate to suggest that ISB withdraws its extant Standards. It may be possible to continue to issue pronouncements as Standards which are, to all intents and purposes, the same as the analysis of specific situations in the IFAC Code of Ethics.

2 Comments on Specific Questions

Our comments on the specific questions set out in the preface to the proposed Statement are given below:

Definition of auditor independence

The proposed conceptual framework defines auditor independence as 'freedom from those pressures and other factors that compromise, or can reasonably be expected to compromise, an auditor's ability to make unbiased audit decisions.' The definition and the basis for the Board's conclusions are discussed in paragraphs 3-7 and 37-46. The other components of the conceptual framework are intended to help independence decision makers apply the definition to a wide variety of auditor independence issues. Is the definition appropriate? If not, what changes would you suggest, and why?

2.1 We suggest that the definition is made the same as that in the IFAC Code of Ethics when finalised. The proposed IFAC Code of Ethics draws attention to the danger of using the word 'independence' on its own as that may lead to an unrealistic expectation that there is some state of absolute independence.

Goal of auditor independence

The proposed conceptual framework states that the goal of auditor independence is "to support user reliance on the financial reporting process and to enhance capital market efficiency." The goal and the basis for the Board's conclusions are discussed in paragraphs 8-9 and 47-48. Is the goal appropriate? If not, what changes would you suggest, and why?

2.2 A conceptual framework for financial reporting necessarily addresses the purpose of financial statements. It is only by establishing the purpose of such reports that a suitable frame of reference can be created to allow accounting standards consistent with it to determine an appropriate form and content for reporting. The purpose of independence is, however, bound up with the purpose of auditing which is in turn bound up with the purpose of financial reporting. The proposed Statement suggests that the goal of independence is 'to support user reliance on the financial reporting process and to enhance capital market efficiency.' This goal could equally apply to auditing itself and, arguably, to the issue of financial statements.

Concepts and basic principles of auditor independence

The proposed conceptual framework contains basic principles related to four concepts of auditor independence: threats, safeguards, independence risk, and significance of threats/effectiveness of safeguards. The concepts, basic principles, and the basis for the Board's conclusions are discussed in paragraphs 10-32 and 49-60. The concepts and basic principles contained in the proposed framework are intended to serve as guidelines for independence decision makers to analyze and resolve independence issues. Are the concepts and basic principles appropriate and sufficiently operational? If not, what changes would you suggest, and why?

2.3 We consider the four concepts in the proposed Statement to be valid. However, while there is an obvious need for the concepts of threat and safeguard, we consider independence risk and the significance of threats/effectiveness of safeguards to be derived concepts and to be of little practical worth over and above their natural descriptive language. Threats and safeguards are important classes of objects and are worthy of enumeration. The other two concepts are not necessary. A semantic argument could be advanced that 'independence risk' is equivalent to 'independence threat' and so presenting the two as separate invites confusion. The IFAC Code of Ethics deals only with 'risks to independence' and 'safeguards'.

Paragraphs 49-53 describe the elements of a risk model for auditor independence in which independence risk is a function of the significance of threats to auditor independence and the effectiveness of safeguards to auditor independence. What are your views on the appropriateness of the independence risk model? Is there research that the Board should be made aware of that would be helpful in expanding the model or otherwise making it more useful for independence decision makers? If so, please describe that research.

2.4 We support ISB's view (expressed in paragraph 52) that it is appropriate to think in terms of independence risk rather than in terms of the existence or non-existence of independence. However, we are concerned by the statement at paragraph 49 that 'An auditor is independent when independence risk is at an acceptably low level, as determined by a particular independence decision maker'. This raises the prospect of decision makers disagreeing as to whether an auditor is independent only because they have differing viewpoints.

2.5 The proposed IFAC Code of Ethics focuses on the judgement of a reporting accountant and utilises terminology to draw attention to certain levels of independence risk:

• Risks are clearly insignificant
  
  
• The effect of risks and safeguards together fall below a level which would make acceptance or continuation of an engagement appropriate (ie. The risk to independence is at an acceptable level)
  
  and
  
  
• There are insufficient safeguards to reduce risks below the level which would allow acceptance or continuation of an engagement such that refusal is necessary (refusal is seen as a safeguard).

2.6 We have not carried out or commissioned research which would be helpful in expanding the model or otherwise making it more useful for independence decision makers.

Back to top