striving for absolute independence – will the prohibition of non-audit services result in better...
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Striving for Absolute Independence – Will the Prohibition of Non-Audit Services Result in Better Audits?
Hardld RINGVice President,Institut der WirtschaftspruferGermany
Harald RingHarald RingPresident of the Institut der President of the Institut der
Wirtschaftspruefer, GermanyWirtschaftspruefer, Germany
Harald RingHarald RingPresident of the Institut der President of the Institut der
Wirtschaftspruefer, GermanyWirtschaftspruefer, Germany
Striving for Absolute Independence Will the Prohibition of Non-audit Services Result in Better
Audits?
Striving for Absolute Independence Will the Prohibition of Non-audit Services Result in Better
Audits?
3
Introduction (1)Introduction (1)
Accountants: a profession that is bound to very strict ethical standards Responsibility not limited to satisfy the client’s
needs Rather, acceptance of a particular responsibility
to the public Particularly, when accountants act as auditors
Today: new debate about auditor independence Intensified by the Enron collapse and other
accounting scandals One key issue: Scope of services the auditor may
provide to his audit client
Accountants: a profession that is bound to very strict ethical standards Responsibility not limited to satisfy the client’s
needs Rather, acceptance of a particular responsibility
to the public Particularly, when accountants act as auditors
Today: new debate about auditor independence Intensified by the Enron collapse and other
accounting scandals One key issue: Scope of services the auditor may
provide to his audit client
4
Introduction (2)Introduction (2)
Opposing views as to the scope of permitted services Far going prohibition of non-audit services (“audit-
only approach”) No general prohibition of non-audit services Both approaches can be found in current rule sets
Opposing views as to the scope of permitted services Far going prohibition of non-audit services (“audit-
only approach”) No general prohibition of non-audit services Both approaches can be found in current rule sets
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Overview over the different rule sets (1)
Overview over the different rule sets (1)
IFAC Code of Ethics/EU Commission’s Recommendation on Auditor Independence Principles-based approach
Catalogue of possible independence risks and safeguards to mitigate the risks
Individual evaluation of each audit engagement is needed
Amended by “specific circumstances” (examples how to apply the principles-based approach in frequently occurring situations where independence may be compromised)
IFAC Code of Ethics/EU Commission’s Recommendation on Auditor Independence Principles-based approach
Catalogue of possible independence risks and safeguards to mitigate the risks
Individual evaluation of each audit engagement is needed
Amended by “specific circumstances” (examples how to apply the principles-based approach in frequently occurring situations where independence may be compromised)
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Overview over the different rule sets (2)
Overview over the different rule sets (2)
Provision of non-audit services Permitted if general safeguards (independent of
the specific service) and specific safeguards (dependent of the specific service) exist
Application illustrated for different kinds of services (e.g., preparation of accounts and financial statements, design and implementation of financial information systems, valuation services, …)
Prohibition of the service only as an ultimate safeguard
Provision of non-audit services Permitted if general safeguards (independent of
the specific service) and specific safeguards (dependent of the specific service) exist
Application illustrated for different kinds of services (e.g., preparation of accounts and financial statements, design and implementation of financial information systems, valuation services, …)
Prohibition of the service only as an ultimate safeguard
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Overview over the different rule sets (3)
Overview over the different rule sets (3)
Sarbanes-Oxley-Act in the U.S. Eliminated the exceptions and conditions of Rule
2-01 of Regulation S-X which could result in the admissibility of a non-audit service
Uniformly prohibits the following services Bookkeeping or other services related to the
accounting records or financial statements of the audit client
Financial Information systems design and implementation
Actuarial services
Sarbanes-Oxley-Act in the U.S. Eliminated the exceptions and conditions of Rule
2-01 of Regulation S-X which could result in the admissibility of a non-audit service
Uniformly prohibits the following services Bookkeeping or other services related to the
accounting records or financial statements of the audit client
Financial Information systems design and implementation
Actuarial services
8
Overview over the different rule sets (4)
Overview over the different rule sets (4)
Appraisal or valuation services, fairness opinions or contribution-in-kind reports
Internal audit out-sourcing services Management functions or human resources
services Broker or dealer, investment adviser, or
Investment banking services Legal services and expert services unrelated to
the audit Any other service that the PCAOB determines
impermissible Shift towards an “audit-only approach“
Appraisal or valuation services, fairness opinions or contribution-in-kind reports
Internal audit out-sourcing services Management functions or human resources
services Broker or dealer, investment adviser, or
Investment banking services Legal services and expert services unrelated to
the audit Any other service that the PCAOB determines
impermissible Shift towards an “audit-only approach“
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Deficiencies of an “Audit-only Approach” (1)
Deficiencies of an “Audit-only Approach” (1)
Absolute versus relative independence Legislators’ view: absolute independence as the
ideal state that should be strived for However, auditor independence as a concept of
relative independence Insufficient consideration of client-specific
knowledge as the basis of today’s audit Improving independence is not automatically
equivalent to improving audit quality Increasingly complex and rapidly changing
business environment
Absolute versus relative independence Legislators’ view: absolute independence as the
ideal state that should be strived for However, auditor independence as a concept of
relative independence Insufficient consideration of client-specific
knowledge as the basis of today’s audit Improving independence is not automatically
equivalent to improving audit quality Increasingly complex and rapidly changing
business environment
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Deficiencies of an “Audit-only Approach” (2)
Deficiencies of an “Audit-only Approach” (2)
Non-audit services assist the auditor in obtaining the knowledge required for high-quality audits
Negative impacts on auditor quality and recruiting Audit quality depends on auditor quality Non-audit services assist the auditor in recruiting
“high potentials” Inseparability of audit and certain non-audit
services Lack of empirical evidence as to negative trade-offs
between non-audit services and audit quality
Non-audit services assist the auditor in obtaining the knowledge required for high-quality audits
Negative impacts on auditor quality and recruiting Audit quality depends on auditor quality Non-audit services assist the auditor in recruiting
“high potentials” Inseparability of audit and certain non-audit
services Lack of empirical evidence as to negative trade-offs
between non-audit services and audit quality
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ConclusionConclusion
Non-audit services have the potential of impairing auditor independence and these risks must be eliminated
However, a general ban on a wide range of non-audit services is not an appropriate solution Independence risks primarily depend on the
circumstances of the individual case Thus, an “audit-only approach” may remove “non-existent”
independence risks, thereby encumbering audit quality Rather, a flexible concept like the one pursued by
the IFAC Code or the EU Recommendation is needed
Non-audit services have the potential of impairing auditor independence and these risks must be eliminated
However, a general ban on a wide range of non-audit services is not an appropriate solution Independence risks primarily depend on the
circumstances of the individual case Thus, an “audit-only approach” may remove “non-existent”
independence risks, thereby encumbering audit quality Rather, a flexible concept like the one pursued by
the IFAC Code or the EU Recommendation is needed