5.2 Six Threats to Independence and Compliance

Six Threats to Independence and Compliance

1. Independence in Assurance Engagements: Mind vs. Appearance

Independence is the hallmark of the auditing profession. Without independence, the auditor's report carries no value for shareholders, lenders, regulators, or the public. The ICAB Code of Ethics and ISA 200 (Overall Objectives of the Independent Auditor) demand that auditors maintain independence in two distinct dimensions:

1. Independence of Mind: The state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism.
2. Independence in Appearance: The avoidance of facts and circumstances that are so significant that a reasonable and informed third party would be likely to conclude that a firm's or an audit team member's integrity, objectivity, or professional skepticism had been compromised.

Threats to independence can compromise both mind and appearance. The ICAB/IESBA Code identifies six major categories of threats that auditors must systematically evaluate.

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2. Comprehensive Analysis of the Six Ethical Threats

1. Self-Interest Threat

A Self-Interest Threat occurs when a financial or other interest inappropriately influences a professional accountant's judgment or behavior. The auditor or firm benefits financially or personally from the audit client.

Primary Triggers and Examples in Audit Practice:

• Direct Financial Interest: An audit team member or their immediate family member owns shares, bonds, or mutual fund units issued by the audit client. ICAB Rule: Direct financial interests in an audit client are strictly prohibited regardless of materiality.
• Fee Dependency: A firm relies heavily on total fees generated from a single audit client or client group. Under IESBA rules and ICAB guidelines, if total fees from a Public Interest Entity (PIE) exceed 15% of the firm's total revenue for two consecutive years, a self-interest and intimidation threat is created.
• Overdue Audit Fees: Audit fees from the prior year remain unpaid when the current year's audit work commences. Overdue fees act as an implicit loan from the audit firm to the client, creating a self-interest threat because the auditor may soft-pedal audit findings to secure payment.
• Contingent Fees: Charging fees calculated on a percentage of profits, loan approval, or tax savings. ICAB Rule: Contingent fees for audit and assurance engagements are strictly prohibited.
• Gifts and Hospitality: Accepting gifts, lavish entertainment, or discounted goods from an audit client unless the value is trivial and inconsequential.

2. Self-Review Threat

A Self-Review Threat occurs when a professional accountant evaluates the results of a previous judgment made or a service performed by the accountant, or by another individual within the accountant's firm, on which the audit team will rely when forming a conclusion on the subject matter.

Primary Triggers and Examples in Audit Practice:

• Bookkeeping and Financial Statement Preparation: Preparing accounting records, maintaining general ledgers, or drafting financial statements for a client, and subsequently auditing those same financial statements.
• Valuation Services: Performing property, plant, and equipment valuations or actuarial calculations that are subsequently incorporated into the financial statements subject to audit.
• Design and Implementation of IT Systems: Installing or customizing accounting software (e.g., ERP systems) that generates financial statement data.
• Internal Audit Services: Providing internal audit outsourcing services to an external audit client.

3. Advocacy Threat

An Advocacy Threat occurs when a professional accountant promotes a client's position or opinion to the point that the accountant's objectivity is compromised. The auditor becomes an advocate for the client rather than an independent evaluator.

Primary Triggers and Examples in Audit Practice:

• Promoting Shares or Securities: Acting as a syndicate manager, underwriter, or placement agent for an audit client's Initial Public Offering (IPO) on the Dhaka Stock Exchange (DSE) or Chittagong Stock Exchange (CSE).
• Tax Disputes and Appellate Representation: Representing an audit client in legal litigation or formal adversarial tax appeals against the National Board of Revenue (NBR) before tax tribunals or courts.
• Lobbying: Publicly advocating on behalf of an audit client in legislative disputes or regulatory negotiations.

4. Familiarity Threat

A Familiarity Threat occurs when, due to a long or close relationship with a client or employing organization, a professional accountant becomes too sympathetic to their interests or too accepting of their work.

Primary Triggers and Examples in Audit Practice:

• Long Association of Senior Personnel: An audit partner or senior manager auditing the same client for many consecutive years. Over time, the auditor may develop personal trust, cease testing controls rigorously, and unthinkingly accept management explanations.
• Family and Personal Relationships: A member of the audit team having an immediate family member (spouse, child, parent) or close family member (sibling) serving as a director, officer, or finance manager of the audit client.
• Employment with Audit Client: A former audit partner or manager leaving the CA firm to take up a position as CFO or Chief Executive Officer of the audit client within a short timeframe (creating a "revolving door" threat).

5. Intimidation Threat

An Intimidation Threat occurs when a professional accountant is deterred from acting objectively because of threats, actual or perceived, including attempts to exercise undue influence over the accountant.

Primary Triggers and Examples in Audit Practice:

• Threat of Dismissal or Replacement: Client management threatening to terminate the audit engagement or replace the CA firm at the next AGM if the auditor insists on a modified audit opinion or unrecorded tax adjustment.
• Pressure to Reduce Fee / Scope: Client demanding a reduction in audit fees while simultaneously restricting the time or audit procedures necessary to complete the audit per ISAs.
• Aggressive Management Behavior: A dominant Chief Executive Officer or CFO physically or verbally intimidating junior audit assistants during field work in factory premises.
• Threat of Litigation: Client threatening legal action against the audit firm for alleged breach of duty if an unfavorable report is issued.

6. Management Threat

A Management Threat occurs when an audit firm or a member of the audit team assumes a management responsibility for an audit client. In such a situation, the auditor becomes part of the entity's control and decision-making apparatus, completely destroying independence.

Primary Triggers and Examples in Audit Practice:

• Authorizing or executing transactions on behalf of the client;
• Deciding which recommendations of the audit firm should be implemented;
• Setting policy, strategic direction, or oversight of client employees;
• Approving journal entries or changing ledger codes without prior management authorization.

Strict ICAB/IESBA Rule: A CA firm must never assume a management responsibility for an audit client. Safeguards cannot reduce a management threat to an acceptable level.

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3. Comprehensive Summary Table of Ethical Threats

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4. Statutory Independence Provisions in Bangladesh

In addition to the ICAB Code of Ethics, statutory legislation in Bangladesh lays down explicit rules regarding auditor independence:

Companies Act, 1994 (Section 212 Disqualifications)

Under Section 212(3) of the Companies Act, 1994, none of the following persons shall be qualified for appointment as auditor of a company:

1. An officer or employee of the company;
2. A person who is a partner, or who is in the employment, of an officer or employee of the company;
3. A body corporate (i.e., a limited liability company cannot act as a statutory auditor; only a partnership firm of chartered accountants or a sole proprietor registered with ICAB);
4. A person who is indebted to the company for an amount exceeding statutory limits.

BSEC Corporate Governance Code 2018 Prohibitions

Under Condition 7(1) of the Bangladesh Securities and Exchange Commission (BSEC) Corporate Governance Code 2018 (Notification No. BSEC/CMRRCD/2006-158/207/Admin/80, dated 3 June 2018), a listed issuer shall not engage its external or statutory auditors to perform the following services:

• Appraisal or valuation services or fairness opinions;
• Financial information systems design and implementation;
• Bookkeeping or other services related to accounting records or financial statements;
• Broker-dealer services;
• Actuarial services;
• Internal audit services;
• Any other service that the Audit Committee determines;
• Audit or certification services on compliance with the Corporate Governance Code; and
• Any other service that creates a conflict of interest.

Condition 7(2) additionally bars a partner or employee of the audit firm from holding shares in the company they audit during the tenure of the audit assignment.