Auditor independence and non-audit services - ICAEW

2.2 Current regulatory frameworks: chapter 3Six auditor independence frameworks are reviewed, those for the UK, the US (SEC),Australia, EC, IFAC and Ontario. Apart from the US framework, which ispredominantly rule-based, with a set of prohibitions, a principles-based approach istaken. (The SEC framework sets out principles but these are outside the actual rules.)Independence is seen as a risk continuum, rather than an absolute, and judgmentsabout the seriousness of the threat to independence are balanced against theeffectiveness of the safeguards available. Five threats are identified: self-interest, selfreview,advocacy, familiarity or trust, and intimidation. There are four main sourcesof safeguards: the regulatory framework, the audit firm’s internal quality controls, theclient company’s corporate governance and refusal to act. Where no safeguard couldbe deemed adequate (such as an auditor taking management decisions) theframeworks contain a prohibition. In relation to the provision of NAS the threats areseen as wide-ranging. Only intimidation does not appear as a relevant threat. There isless convergence among the frameworks about the level of threat which arises frominternal audit and the installation of financial information systems than exists for theother threats. With the exception of the UK framework, where the recommendedupper level of economic dependence for a firm is defined (10% of total firm income,including NAS from one listed company client), the frameworks are generallyimprecise about an acceptable level of economic dependence for a firm, a specificoffice of a firm or an individual partner.With the exception of SEC which is directed only at listed companies, the frameworksrecognise that flexibility is needed in applying the principles to the auditors of smallentities.The frameworks all identify the importance of both independence in fact (i.e.independent behaviour) and independence in appearance (i.e. the belief that auditorsare independent). The current benchmark for measuring independence in appearanceis what a well-informed investor or third party would believe. The threats andsafeguards do not distinguish between the defence of independence in appearance andindependence in fact.2.3 Descriptive studies of the amount and type of NAS: chapter 5In some jurisdictions and time periods, there has been no requirement for companiesto disclose the total amount of NAS purchased from their auditor. Even where this is arequirement, there is generally no breakdown of the total by service type (e.g. UK). Inthese circumstances, evidence is collected via company surveys. This generates lessreliable data, due to the risk of response bias. In the UK, the ratio of non-audit to auditfees paid to the incumbent auditor has risen to 300% for the FTSE 100 companies (upfrom 98% in 1996). There is some evidence that taxation services predominate andthat the overall ratio of NAS to audit fees is higher in the UK than in the US.2.4 Determinants of the purchase decision: chapter 6Researchers have investigated three aspects of the NAS purchase decision: the choicebetween the incumbent auditor or another provider; the types of service purchased;and the absolute and relative amounts of NAS. A major argument is that thosexi