Drafting Conventions

1
Drafting Conventions

• IESBA CAG March 2009
• Ken Dakdduk, TF Chair

2
Project Status

• Exposure draft issued July 2008
• CAG discussion Sept and Nov 2008
• IESBA discussion Dec 2008 and Feb 2009
• Approval targeted April 2009

3
Activities since November CAG

• Considered
• Exception clause
• Inadvertent violations
• Documentation
• Effective date
• Use of shall
• Response letter comments

4
Exception clause

• IESBA considered exception clause under three
  categories
• Catastrophic events
• Natural disasters
• Terrorist acts
• Mergers and acquisitions
• Audit client acquires another entity or is
  acquired by another entity
• All other situations

5
Category 1 Catastrophic events

• Code not written for such situations
• Regulators/member bodies responded in the past
• e.g., audit firms allowed to assist clients to
  re-create data lost because of terrorist act
• IESBA believes regulators and member bodies would
  respond if similar situation were to occur

6
Category 2 Mergers and acquisitions

• Audit client may merge with, acquire, or be
  acquired by an entity that is not a client
• Transactions are outside control of firm
• May happen quickly
• Firm needs to identify and address interests and
  relationships creating independence issues
• IESBA believes Code should address such
  situations

7
Category 3 All other situations

• Examples to date were not compelling
• Concern over a general exception clause
• Would weaken the Code
• Could be abused
• IESBA did not support providing a specific
  exemption for such situations

8
Consulting with a member body or regulator for
Category 1 and 3 situations

• Board believes consultation with a member body or
  regulator would be appropriate
• Agreed to include a sentence in Code to that
  effect
• Helpful to the accountant and the member
  body/regulator to know that board would approve
  of consultation
• Particularly important when
• The Code is not the regulators Code
• The regulator or member body does not respond

9
Consultation clause

• When a professional accountant encounters
  circumstances that are so unusual that the
  application of a specific requirement of the Code
  would result in a disproportionate outcome or an
  outcome that may not be in the public interest,
  the professional accountant is recommended to
  consult with a member body or the relevant
  regulator.

10
Mergers and acquisitions

• Task Force consulted with independence
  specialists to understand
• Types of interests and relationships that create
  independence issues in an MA situation
• Time typically available to address issues
• Process of identifying new related entities
• Safeguards that can be put in place

11
Related entities

• Code requires firm and network firms to be
  independent of the audit client
• When audit client is a listed entity
• Need to be independent of all related entities
• When audit client is not a listed entity
• Need to be independent of related entities the
  client controls

12
Interests and relationships

• Issues can be created by any of the interests or
  relationships covered by the Code
• Many can be safeguarded/terminated without
  significant difficulty
• Financial interests in a liquid market
• Some pose challenges
• No one can immediately take over potentially
  lengthy period to find another provider,
  negotiate, and transfer arrangement
• Payroll services or software support services
• A contingent fee arrangement that needs to be
  renegotiated

13
Time to address independence issue

• Sufficient time is needed to
• Identify relevant related entities and interests
  and relationships
• Apply safeguards or terminate interests or
  relationships
• What is sufficient depends on the situation
• Size and number of related entities
• Types of interests and relationships
• Difficulty in terminating
• Whether more time is needed to find another
  service provider or participant for a business
  relationship

14
Time to address independence issues

• Considered in context of a business environment
  more typical than recent times
• Large acquisitions
• Generally have advance notice, but extent varies
• Typically involve listed entities
• Other acquisitions
• Can have less notice
• Sometimes find out after the fact
• Lack of contact throughout the year

15
Process of attaining independence

• 1. Identify entities that will become related
  entities
• Can be lengthy process for client and firm
• Can require several weeks for large companies
• Particularly for some financial services
  companies
• Need to determine whether entities meet the
  definition of a related entity
• Control upstream, downstream, and common
  (listed entities) downstream (nonlisted
  entities)
• Materiality of client to upstream controlling
  entities (listed entities)
• Significant influence and materiality

16
Process of attaining independence

• 2. Identify interests and relationships
• Firm and network firm interests and relationships
• Information about non-assurance services to
  non-assurance clients generally not maintained at
  the network level
• Can be a lengthy process for the client and firm
• 3. Terminate interests and relationships that are
  not permitted under the Code
• 4. Apply safeguards, where necessary, for other
  interests or relationships

17
IESBA Position

• Provide guidance to deal with client MA
• Reinforce requirement to comply with Code
• Guide firms and clients when additional time
  after effective date is needed to terminate an
  I/R
• 12 respondents to the ED recommended Code include
  such guidance
• Particularly in light of proposed new drafting
  conventions
• Not in public interest for firms to resign as
  auditor in every case

18
Addressing interests and relationships

• Firms shall identify and evaluate previous and
  current interests and relationships with the
  related entity
• Take necessary steps to terminate by effective
  date any current interests and relationships that
  are not permitted by the Code

19
If interest/relationship cannot reasonably be
terminated

• Evaluate significance of the threat
• More significant the threat, more likely firm
  cannot continue as auditor
• Significance depends on
• Nature significance of relationship
• Type of non-assurance service or business
  relationship
• Nature significance of related entity
  relationship
• Parent, subsidiary, or sister entity
• Length of time until interest or relationship can
  reasonably be terminated
• The evaluation is discussed with those charged
  with governance

20
Cannot reasonably be terminated

• Firm and client should make all reasonable
  efforts to terminate the interest or relationship
• Cannot delay termination merely because it is
  inconvenient
• Factors considered by Task Force
• Disruption of service would be harmful to those
  who rely on the service
• As might be the case in payroll and related tax
  services or software support services
• Related entity needs time after the effective
  date to identify alternative service providers
  and contract with new provider
• Firm needs time to transition to new service
  provider

21
Period of time

• If interest or relationship cannot reasonably be
  terminated by effective date
• Terminate as soon as possible within next 6
  months
• In no event may interest or relationship continue
  for more than 6 months after effective date
• Limited period of time and transitional measures
  provides appropriate balance between
• Need for firm to comply as soon as possible to
  protect public interest and
• Avoiding needless costs, including market
  disruption, because of forced, unplanned change
  of auditors

22
Other requirements

• No individual with the interest or relationship
  may be member of engagement team for the audit or
  the QC reviewer
• Includes any individual providing the
  non-assurance service
• Transitional measures to be considered and
  applied as necessary.

23
If firm will be replaced as auditor shortly after
the merger or acquisition

• Not necessary to terminate the interest or
  relationship if all of the following conditions
  are met
• Client requests firm to remain as auditor
• Firm will remain as auditor only for a short
  period of time and only until the next audit
  report is issued
• No individuals with such interest or relationship
  are members of the engagement team or the QC
  reviewer for the audit
• Includes any individual providing the
  non-assurance service
• Transitional measures are applied as necessary
• The matter is discussed with those charged with
  governance

24
Transitional measures

• Review of audit or non-assurance work by a
  professional accountant
• Review equivalent to an EQCR performed by a
  professional accountant not a member of the firm
  signing the opinion
• Evaluation of results of non-assurance service by
  another firm or another firm re-performs
  non-assurance service to extent necessary to take
  responsibility for service

25
Discussion with those charged with governance

• Reasons why any interest or relationship will not
  be terminated by the effective date
• Transitional measures, if any, to be applied

26
Overall consideration

• Even if all the foregoing requirements can be met
• Firm shall determine whether threats created by
  previous and current interests and relationships
  would remain so significant that independence
  would be compromised
• If so, firm shall resign as auditor

27
Documentation

• Any interests or relationships that will not be
  terminated by the effective date
• The reasons why the interest or relationship will
  not be terminated
• Transitional measures, if any, to be applied
• Results of discussion with those charged with
  governance

28
Other matters

• Interest or relationship must be terminated as
  soon as reasonably possible within next 6 months
• If not terminated, firm would not be independent
• New information about an interest or relationship
  may surface after the end of the 6-month period
• Should be addressed in the same way as other
  inadvertent violations

29
Inadvertent violations

• Under 290.34, if an inadvertent violation
  occurs, it will generally not be deemed to
  compromise independence if
• Firm has appropriate quality control policies and
  procedures in place to maintain independence
• Once discovered violation is corrected promptly
  and
• Any necessary safeguards are applied to eliminate
  the threat or reduce it to an acceptable level

30
Inadvertent violations (contd)

• This paragraph was not changed as part of the
  drafting conventions project
• One respondent (IOSCO) commented on it
• Recommended introducing a materiality test
• Such a revision would be beyond the scope of this
  project
• However, materiality is likely be part of the
  assessment to determine appropriate safeguards to
  apply

31
Inadvertent violations (contd)

• Respondent also recommended that inadvertent be
  defined
• IESBA view
• Definition is not needed meaning is consistent
  with general usage (e.g., unintentional, in
  error, by mistake)
• Any changes to the inadvertent violation clause
  would go beyond clarity

32
Inadvertent violations (contd)

• ISQC1 requires firms to establish policies and
  procedures to provide reasonable assurance that
  independence is maintained
• Paragraph will be clarified by explicit reference
  to ISQC
• i.e., . . .appropriate QC policies and
  procedures . . . equivalent to those required by
  International Standards on Quality Control to
  maintain independence . . .

33
Documentation

• In December, the IESBA discussed the requirement
  to document threats at the margin
• IESBA was concerned the proposed language was too
  broad

34
Documentation

• When safeguards are required to reduce a threat
  to an acceptable level, the documentation shall
  include the nature of the threat and the
  safeguards that reduce the threat to an
  acceptable level
• When a threat is such that the professional
  accountant considered whether safeguards were
  necessary and concluded that they were not
  because the threat was already at an acceptable
  level, the documentation shall include the
• Nature of the threat
• Conclusion that safeguards were not necessary
• Rationale for the conclusion

35
Effective date

• Exposure draft proposed point in time effective
  date
• Effective December 15, 2010, subject to
  transitional provisions, with earlier adoption
  encouraged
• Effective date based on proposed June 2009
  release

36
ED comments on effective date

• Majority supported point in time effective date
• Minority believe that effective date should be
  linked to the clients fiscal period
• One respondent preferred an earlier effective
  date
• Wants IT1 IT2 to be applied sooner
• One respondent recommended that effective date of
  Jan 1, 2011 would be easier to implement

37
IESBA Position effective date

• Point in time appropriate for most of the Code
• Simpler to move effective date to January 1,
  2011, with non-assurance services to be completed
  by July 1, 2011

38
IESBA Position effective date (contd)

• Partner rotation
• One respondents comments suggest it is not clear
  how the point in time effective date would apply
• KAP (other than engagement partner/QC reviewer)
  would be required to rotate on December 15, 2011
• Can the KAP complete the 2011 audit in 2012?
• Is 2010 the KAPs last year-end audit?
• IESBA position - tie to clients fiscal year
• Fiscal periods beginning on or after December 15,
  2011

39
ED transitional provisions

• Partner rotation one extra year for those
  individuals that previously were not required to
  rotate (new key audit partners)
• Public Interest Entities one extra year for
  entities that are not public interest entities
• Provision of non-assurance services an extra
  six months to complete newly prohibited
  non-assurance services that were contracted for
  before the effective date

40
ED comments on transitional provisions

• Majority supported transitional provisions
• Minority views
• Transitional provision for partner rotation is
  not necessary
• Transitional provision for non-assurance services
  is not necessary
• Transitional provision for non-assurance services
  should allow 12 months to complete in exceptional
  circumstances
• Should be a fresh-start for provisions when PIE
  fees gt15
• Concern with transitional periods that produce
  different effective dates

41
IESBA Position Transitional provisions

• Fees exceed 15
• Without a fresh-start the change would be
  applied retroactively
• Should be explicit that a fresh-start approach
  is to be taken
• Should also be linked to the clients fiscal year
• Assuming a client had a Dec 31st year-end, a
  pre-or post issuance review would be required in
  relation to the 2012 audit if fees exceed 15 for
  2011 and 2012

42
IESBA Position Transitional provisions

• ED proposed that early adoption be encouraged
• Some respondents stated effective date was
  ambitious
• Some member bodies and firms may need the full 18
  months to effect an orderly implementation of the
  changes
• Preferable to have the more neutral statement
  that early adoption is permitted

43
Principles/Rule and use of shall

• In December, IESBA agreed Task Force should
  review usage of shall with view to determining
  that each usage is appropriate
• Task Force reviewed Code and proposed limited
  changes to use shall only to denote a
  requirement
• IESBA agreed with Task Forces proposal

44
Re-exposure Due process requirements

• After approving revised content, IESBA required
  to assess whether there is substantive change
  that warrants re-exposure. For example
• Changes arising from matters not aired in the ED
• Commentators have not had an opportunity to make
  views known
• Changes arising from matters not previously
  deliberated by the IESBA

45
Re-exposure IESBA preliminary discussion

• Many Board members expressed the view that
  re-exposure is not warranted
• Many respondents expressed view Code should
  address MA
• Board is doing so
• MA clause provides pragmatic guidance
• Generally codifies best practice
• In most cases firms will be able to terminate
  I/R by effective date
• MA clause is not likely to be used in every MA
  case

46
Discussion