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Drafting ConventionsDrafting Conventions

IESBA CAG March 2009IESBA CAG March 2009

Ken Dakdduk, TF ChairKen Dakdduk, TF Chair

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Project StatusProject Status

• Exposure draft issued July 2008Exposure draft issued July 2008

• CAG discussion Sept and Nov 2008CAG discussion Sept and Nov 2008

• IESBA discussion Dec 2008 and Feb 2009IESBA discussion Dec 2008 and Feb 2009

• Approval targeted April 2009 Approval targeted April 2009

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Activities since November CAGActivities since November CAG

• Considered:Considered:– Exception clauseException clause– Inadvertent violationsInadvertent violations– DocumentationDocumentation– Effective dateEffective date– Use of “shall”Use of “shall”– Response letter commentsResponse letter comments

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Exception clauseException clause

• IESBA considered exception clause under IESBA considered exception clause under three categories:three categories:– Catastrophic eventsCatastrophic events

• Natural disastersNatural disasters• Terrorist actsTerrorist acts

– Mergers and acquisitionsMergers and acquisitions• Audit client acquires another entity or is acquired by Audit client acquires another entity or is acquired by

another entityanother entity

– All other situationsAll other situations

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Category 1 – Catastrophic eventsCategory 1 – Catastrophic events

• Code not written for such situationsCode not written for such situations• Regulators/member bodies responded in the Regulators/member bodies responded in the

pastpast– e.g., audit firms allowed to assist clients to re-e.g., audit firms allowed to assist clients to re-

create data lost because of terrorist actcreate data lost because of terrorist act

• IESBA believes regulators and member IESBA believes regulators and member bodies would respond if similar situation bodies would respond if similar situation were to occurwere to occur

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Category 2 – Mergers and acquisitionsCategory 2 – Mergers and acquisitions

• Audit client may merge with, acquire, or be Audit client may merge with, acquire, or be acquired by an entity that is not a clientacquired by an entity that is not a client– Transactions are outside control of firmTransactions are outside control of firm– May happen quicklyMay happen quickly– Firm needs to identify and address interests and Firm needs to identify and address interests and

relationships creating independence issuesrelationships creating independence issues

• IESBA believes Code should address such IESBA believes Code should address such situationssituations

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Category 3 – All other situationsCategory 3 – All other situations

• Examples to date were not compellingExamples to date were not compelling

• Concern over a general exception clauseConcern over a general exception clause– Would weaken the CodeWould weaken the Code– Could be abusedCould be abused

• IESBA did not support providing a specific IESBA did not support providing a specific exemption for such situationsexemption for such situations

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

• Board believes consultation with a member Board believes consultation with a member body or regulator would be appropriatebody or regulator would be appropriate– Agreed to include a sentence in Code to that Agreed to include a sentence in Code to that

effecteffect• Helpful to the accountant and the member Helpful to the accountant and the member

body/regulator to know that board would approve of body/regulator to know that board would approve of consultationconsultation

• Particularly important when Particularly important when – The Code is not the regulator’s CodeThe Code is not the regulator’s Code– The regulator or member body does not respondThe regulator or member body does not respond

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Consultation clauseConsultation clause

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

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Mergers and acquisitionsMergers and acquisitions

• Task Force consulted with independence Task Force consulted with independence specialists to understand:specialists to understand:– Types of interests and relationships that create Types of interests and relationships that create

independence issues in an M&A situationindependence issues in an M&A situation– Time typically available to address issuesTime typically available to address issues– Process of identifying new related entitiesProcess of identifying new related entities– Safeguards that can be put in placeSafeguards that can be put in place

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Related entitiesRelated entities

• Code requires firm and network firms to be Code requires firm and network firms to be independent of the “audit client”independent of the “audit client”

• When audit client is a listed entityWhen audit client is a listed entity– Need to be independent of all related entities Need to be independent of all related entities

• When audit client is not a listed entityWhen audit client is not a listed entity– Need to be independent of related entities the Need to be independent of related entities the

client controlsclient controls

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Interests and relationshipsInterests and relationships

• Issues can be created by any of the interests or Issues can be created by any of the interests or relationships covered by the Coderelationships covered by the Code

• Many can be safeguarded/terminated without significant Many can be safeguarded/terminated without significant difficultydifficulty

– Financial interests in a liquid marketFinancial interests in a liquid market

• Some pose challengesSome pose challenges– No one can immediately take over; potentially lengthy period to No one can immediately take over; potentially lengthy period to

find another provider, negotiate, and transfer arrangementfind another provider, negotiate, and transfer arrangement• Payroll services or software support services Payroll services or software support services

– A contingent fee arrangement that needs to be renegotiated A contingent fee arrangement that needs to be renegotiated

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Time to address independence issueTime to address independence issue

• Sufficient time is needed to:Sufficient time is needed to:– Identify relevant related entities and interests and Identify relevant related entities and interests and

relationshipsrelationships– Apply safeguards or terminate interests or relationshipsApply safeguards or terminate interests or relationships

• What is sufficient depends on the situationWhat is sufficient depends on the situation– Size and number of related entities Size and number of related entities – Types of interests and relationshipsTypes of interests and relationships

• Difficulty in terminatingDifficulty in terminating• Whether more time is needed to find another service provider Whether more time is needed to find another service provider

or participant for a business relationship or participant for a business relationship

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Time to address independence issuesTime to address independence issues

• Considered in context of a business environment Considered in context of a business environment more typical than recent timesmore typical than recent times

• Large acquisitionsLarge acquisitions– Generally have advance notice, but extent variesGenerally have advance notice, but extent varies

– Typically involve listed entitiesTypically involve listed entities

• Other acquisitionsOther acquisitions– Can have less noticeCan have less notice

– Sometimes find out after the fact Sometimes find out after the fact • Lack of contact throughout the yearLack of contact throughout the year

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Process of attaining independenceProcess of attaining independence

1.1. Identify entities that will become related entitiesIdentify entities that will become related entities– Can be lengthy process for client and firmCan be lengthy process for client and firm– Can require several weeks for large companiesCan require several weeks for large companies

• Particularly for some financial services companiesParticularly for some financial services companies

– Need to determine whether entities meet the Need to determine whether entities meet the definition of a related entitydefinition of a related entity

• Control – upstream, downstream, and common (listed Control – upstream, downstream, and common (listed entities); downstream (nonlisted entities)entities); downstream (nonlisted entities)

• Materiality of client to upstream controlling entities (listed Materiality of client to upstream controlling entities (listed entities)entities)

• Significant influence and materialitySignificant influence and materiality

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Process of attaining independenceProcess of attaining independence

2.2. Identify interests and relationships:Identify interests and relationships:– Firm and network firm interests and relationshipsFirm and network firm interests and relationships– Information about non-assurance services to non-Information about non-assurance services to non-

assurance clients generally not maintained at the assurance clients generally not maintained at the network levelnetwork level

– Can be a lengthy process for the client and firmCan be a lengthy process for the client and firm

3.3. Terminate interests and relationships that are not Terminate interests and relationships that are not permitted under the Codepermitted under the Code

4.4. Apply safeguards, where necessary, for other Apply safeguards, where necessary, for other interests or relationshipsinterests or relationships

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IESBA PositionIESBA Position

• Provide guidance to deal with client M&AProvide guidance to deal with client M&A– Reinforce requirement to comply with CodeReinforce requirement to comply with Code– Guide firms and clients when additional time Guide firms and clients when additional time

after effective date is needed to terminate an I/Rafter effective date is needed to terminate an I/R• 12 respondents to the ED recommended Code 12 respondents to the ED recommended Code

include such guidanceinclude such guidance– Particularly in light of proposed new drafting conventionsParticularly in light of proposed new drafting conventions

• Not in public interest for firms to resign as auditor Not in public interest for firms to resign as auditor in every casein every case

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Addressing interests and relationshipsAddressing interests and relationships

• Firms shall identify and evaluate previous Firms shall identify and evaluate previous and current interests and relationships with and current interests and relationships with the related entitythe related entity

• Take necessary steps to terminate by Take necessary steps to terminate by effective date any current interests and effective date any current interests and relationships that are not permitted by the relationships that are not permitted by the CodeCode

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If interest/relationship cannot reasonably be If interest/relationship cannot reasonably be terminated terminated

• Evaluate significance of the threatEvaluate significance of the threat• More significant the threat, more likely firm cannot More significant the threat, more likely firm cannot

continue as auditorcontinue as auditor• Significance depends on:Significance depends on:

– Nature & significance of relationshipNature & significance of relationship• Type of non-assurance service or business relationshipType of non-assurance service or business relationship

– Nature & significance of related entity relationshipNature & significance of related entity relationship• Parent, subsidiary, or sister entityParent, subsidiary, or sister entity

– Length of time until interest or relationship can reasonably be Length of time until interest or relationship can reasonably be terminatedterminated

• The evaluation is discussed with those charged with The evaluation is discussed with those charged with governancegovernance

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““Cannot reasonably be terminated”Cannot reasonably be terminated”

• Firm and client should make all reasonable efforts to Firm and client should make all reasonable efforts to terminate the interest or relationshipterminate the interest or relationship

• Cannot delay termination merely because it is inconvenientCannot delay termination merely because it is inconvenient• Factors considered by Task Force:Factors considered by Task Force:

– Disruption of service would be harmful to those who rely on the Disruption of service would be harmful to those who rely on the service service

• As might be the case in payroll and related tax services or software As might be the case in payroll and related tax services or software support servicessupport services

– Related entity needs time after the effective date to identify Related entity needs time after the effective date to identify alternative service providers and contract with new provideralternative service providers and contract with new provider

• Firm needs time to transition to new service providerFirm needs time to transition to new service provider

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Period of timePeriod of time

• If interest or relationship cannot reasonably be If interest or relationship cannot reasonably be terminated by effective dateterminated by effective date– Terminate as soon as possible within next 6 monthsTerminate as soon as possible within next 6 months– In no event may interest or relationship continue for In no event may interest or relationship continue for

more than 6 months after effective datemore than 6 months after effective date• Limited period of time and transitional measures Limited period of time and transitional measures

provides appropriate balance between:provides appropriate balance between:– Need for firm to comply as soon as possible to protect Need for firm to comply as soon as possible to protect

public interest; andpublic interest; and– Avoiding needless costs, including market disruption, Avoiding needless costs, including market disruption,

because of forced, unplanned change of auditorsbecause of forced, unplanned change of auditors

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Other requirementsOther requirements

• No individual with the interest or No individual with the interest or relationship may be member of engagement relationship may be member of engagement team for the audit or the QC reviewer team for the audit or the QC reviewer – Includes any individual providing the non-Includes any individual providing the non-

assurance service assurance service

• Transitional measures to be considered and Transitional measures to be considered and applied as necessary.applied as necessary.

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

• Not necessary to terminate the interest or relationship if all Not necessary to terminate the interest or relationship if all of the following conditions are met:of the following conditions are met:

– Client requests firm to remain as auditor;Client requests firm to remain as auditor;– Firm will remain as auditor only for a short period of time and Firm will remain as auditor only for a short period of time and

only until the next audit report is issued;only until the next audit report is issued;– No individuals with such interest or relationship are members of No individuals with such interest or relationship are members of

the engagement team or the QC reviewer for the audit;the engagement team or the QC reviewer for the audit;• Includes any individual providing the non-assurance service; Includes any individual providing the non-assurance service;

– Transitional measures are applied as necessary;Transitional measures are applied as necessary;– The matter is discussed with those charged with governanceThe matter is discussed with those charged with governance

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Transitional measuresTransitional measures

• Review of audit or non-assurance work by a Review of audit or non-assurance work by a professional accountantprofessional accountant

• Review equivalent to an EQCR performed by a Review equivalent to an EQCR performed by a professional accountant not a member of the firm professional accountant not a member of the firm signing the opinionsigning the opinion

• Evaluation of results of non-assurance service by Evaluation of results of non-assurance service by another firm or another firm re-performs non-another firm or another firm re-performs non-assurance service to extent necessary to take assurance service to extent necessary to take responsibility for serviceresponsibility for service

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Discussion with those charged with Discussion with those charged with governancegovernance

• Reasons why any interest or relationship Reasons why any interest or relationship will not be terminated by the effective datewill not be terminated by the effective date

• Transitional measures, if any, to be appliedTransitional measures, if any, to be applied

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Overall considerationOverall consideration

• Even if all the foregoing requirements can Even if all the foregoing requirements can be metbe met– Firm shall determine whether threats created by Firm shall determine whether threats created by

previous and current interests and relationships previous and current interests and relationships would remain so significant that independence would remain so significant that independence would be compromisedwould be compromised

• If so, firm shall resign as auditorIf so, firm shall resign as auditor

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DocumentationDocumentation

• Any interests or relationships that will not Any interests or relationships that will not be terminated by the effective datebe terminated by the effective date

• The reasons why the interest or relationship The reasons why the interest or relationship will not be terminatedwill not be terminated

• Transitional measures, if any, to be appliedTransitional measures, if any, to be applied

• Results of discussion with those charged Results of discussion with those charged with governancewith governance

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Other mattersOther matters

• Interest or relationship must be terminated as soon Interest or relationship must be terminated as soon as reasonably possible within next 6 monthsas reasonably possible within next 6 months– If not terminated, firm would not be independentIf not terminated, firm would not be independent

• New information about an interest or relationship New information about an interest or relationship may surface after the end of the 6-month periodmay surface after the end of the 6-month period– Should be addressed in the same way as other Should be addressed in the same way as other

inadvertent violationsinadvertent violations

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Inadvertent violationsInadvertent violations

• Under ¶290.34, if an inadvertent violation occurs, Under ¶290.34, if an inadvertent violation occurs, it will generally not be deemed to compromise it will generally not be deemed to compromise independence if:independence if:– Firm has appropriate quality control policies and Firm has appropriate quality control policies and

procedures in place to maintain independence;procedures in place to maintain independence;

– Once discovered violation is corrected promptly; andOnce discovered violation is corrected promptly; and

– Any necessary safeguards are applied to eliminate the Any necessary safeguards are applied to eliminate the threat or reduce it to an acceptable levelthreat or reduce it to an acceptable level

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Inadvertent violations (cont’d)Inadvertent violations (cont’d)

• This paragraph was not changed as part of This paragraph was not changed as part of the drafting conventions projectthe drafting conventions project

• One respondent (IOSCO) commented on itOne respondent (IOSCO) commented on it– Recommended introducing a materiality testRecommended introducing a materiality test

• Such a revision would be beyond the scope of this Such a revision would be beyond the scope of this projectproject

• However, materiality is likely be part of the However, materiality is likely be part of the assessment to determine appropriate safeguards to assessment to determine appropriate safeguards to applyapply

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Inadvertent violations (cont’d)Inadvertent violations (cont’d)

• Respondent also recommended that Respondent also recommended that “inadvertent” be defined“inadvertent” be defined

• IESBA view:IESBA view:– Definition is not needed; meaning is consistent Definition is not needed; meaning is consistent

with general usage (e.g., “unintentional,” “in with general usage (e.g., “unintentional,” “in error,” “by mistake”)error,” “by mistake”)

– Any changes to the inadvertent violation clause Any changes to the inadvertent violation clause would go beyond claritywould go beyond clarity

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Inadvertent violations (cont’d)Inadvertent violations (cont’d)

• ISQC1 requires firms to establish policies ISQC1 requires firms to establish policies and procedures to provide reasonable and procedures to provide reasonable assurance that independence is maintainedassurance that independence is maintained– Paragraph will be clarified by explicit reference Paragraph will be clarified by explicit reference

to ISQCto ISQC• i.e., “. . .appropriate QC policies and procedures . . . i.e., “. . .appropriate QC policies and procedures . . .

equivalent to those required by International equivalent to those required by International Standards on Quality ControlStandards on Quality Control to maintain to maintain independence . . .”independence . . .”

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DocumentationDocumentation

• In December, the IESBA discussed the In December, the IESBA discussed the requirement to document threats “at the requirement to document threats “at the margin”margin”

• IESBA was concerned the proposed IESBA was concerned the proposed language was too broadlanguage was too broad

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DocumentationDocumentation

• When safeguards are required to reduce a threat to an When safeguards are required to reduce a threat to an acceptable level, the documentation shall include the nature acceptable level, the documentation shall include the nature of the threat and the safeguards that reduce the threat to an of the threat and the safeguards that reduce the threat to an acceptable levelacceptable level

• When a threat is such that the professional accountant When a threat is such that the professional accountant considered whether safeguards were necessary and considered whether safeguards were necessary and concluded that they were not because the threat was concluded that they were not because the threat was already at an acceptable level, the documentation shall already at an acceptable level, the documentation shall include theinclude the

– Nature of the threatNature of the threat– Conclusion that safeguards were not necessaryConclusion that safeguards were not necessary– Rationale for the conclusionRationale for the conclusion

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Effective dateEffective date

• Exposure draft proposed point in time Exposure draft proposed point in time effective dateeffective date– Effective December 15, 2010, subject to Effective December 15, 2010, subject to

transitional provisions, with earlier adoption transitional provisions, with earlier adoption encouragedencouraged

• Effective date based on proposed June 2009 Effective date based on proposed June 2009 release release

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ED comments on effective dateED comments on effective date

• Majority supported point in time effective dateMajority supported point in time effective date• Minority believe that effective date should be Minority believe that effective date should be

linked to the client’s fiscal periodlinked to the client’s fiscal period• One respondent preferred an earlier effective date One respondent preferred an earlier effective date

– Wants IT1 & IT2 to be applied soonerWants IT1 & IT2 to be applied sooner

• One respondent recommended that effective date One respondent recommended that effective date of Jan 1, 2011 would be easier to implementof Jan 1, 2011 would be easier to implement

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IESBA Position – effective dateIESBA Position – effective date

• Point in time appropriate for most of the Point in time appropriate for most of the CodeCode

• Simpler to move effective date to January 1, Simpler to move effective date to January 1, 2011, with non-assurance services to be 2011, with non-assurance services to be completed by July 1, 2011completed by July 1, 2011

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IESBA Position – effective date (cont’d)IESBA Position – effective date (cont’d)

• Partner rotationPartner rotation– One respondent’s comments suggest it is not clear how One respondent’s comments suggest it is not clear how

the point in time effective date would applythe point in time effective date would apply

– KAP (other than engagement partner/QC reviewer) KAP (other than engagement partner/QC reviewer) would be required to rotate on December 15, 2011would be required to rotate on December 15, 2011

• Can the KAP complete the 2011 audit in 2012?Can the KAP complete the 2011 audit in 2012?

• Is 2010 the KAP’s last year-end audit? Is 2010 the KAP’s last year-end audit?

• IESBA position - tie to client’s fiscal yearIESBA position - tie to client’s fiscal year– Fiscal periods beginning on or after December 15, 2011Fiscal periods beginning on or after December 15, 2011

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ED transitional provisionsED transitional provisions

• Partner rotation – one extra year for those Partner rotation – one extra year for those individuals that previously were not required to individuals that previously were not required to rotate (new key audit partners)rotate (new key audit partners)

• Public Interest Entities – one extra year for entities Public Interest Entities – one extra year for entities that are not public interest entitiesthat are not public interest entities

• Provision of non-assurance services – an extra six Provision of non-assurance services – an extra six months to complete newly prohibited non-months to complete newly prohibited non-assurance services that were contracted for before assurance services that were contracted for before the effective datethe effective date

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ED comments on transitional provisionsED comments on transitional provisions

• Majority supported transitional provisionsMajority supported transitional provisions• Minority views:Minority views:

– Transitional provision for partner rotation is not necessaryTransitional provision for partner rotation is not necessary– Transitional provision for non-assurance services is not necessaryTransitional provision for non-assurance services is not necessary– Transitional provision for non-assurance services should allow 12 Transitional provision for non-assurance services should allow 12

months to complete in exceptional circumstancesmonths to complete in exceptional circumstances– Should be a “fresh-start” for provisions when PIE fees >15%Should be a “fresh-start” for provisions when PIE fees >15%– Concern with transitional periods that produce different effective Concern with transitional periods that produce different effective

datesdates

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IESBA Position – Transitional provisionsIESBA Position – Transitional provisions

• Fees exceed 15%Fees exceed 15%– Without a “fresh-start” the change would be applied Without a “fresh-start” the change would be applied

retroactivelyretroactively

– Should be explicit that a “fresh-start” approach is to be Should be explicit that a “fresh-start” approach is to be takentaken

– Should also be linked to the client’s fiscal yearShould also be linked to the client’s fiscal year

– Assuming a client had a Dec 31Assuming a client had a Dec 31stst year-end, a pre-or post year-end, a pre-or post issuance review would be required in relation to the issuance review would be required in relation to the 2012 audit if fees exceed 15% for 2011 and 20122012 audit if fees exceed 15% for 2011 and 2012

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IESBA Position – Transitional provisionsIESBA Position – Transitional provisions

• ED proposed that early adoption be encouragedED proposed that early adoption be encouraged• Some respondents stated effective date was Some respondents stated effective date was

ambitiousambitious• Some member bodies and firms may need the full Some member bodies and firms may need the full

18 months to effect an orderly implementation of 18 months to effect an orderly implementation of the changesthe changes

• Preferable to have the more neutral statement that Preferable to have the more neutral statement that early adoption is permittedearly adoption is permitted

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Principles/Rule and use of “shall”Principles/Rule and use of “shall”

• In December, IESBA agreed Task Force In December, IESBA agreed Task Force should review usage of “shall” with view to should review usage of “shall” with view to determining that each usage is appropriatedetermining that each usage is appropriate

• Task Force reviewed Code and proposed Task Force reviewed Code and proposed limited changes to use “shall” only to limited changes to use “shall” only to denote a requirementdenote a requirement

• IESBA agreed with Task Force’s proposalIESBA agreed with Task Force’s proposal

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Re-exposure – Due process requirementsRe-exposure – Due process requirements

• After approving revised content, IESBA required After approving revised content, IESBA required to assess whether there is substantive change that to assess whether there is substantive change that warrants re-exposure. For example: warrants re-exposure. For example: – Changes arising from matters not aired in the EDChanges arising from matters not aired in the ED

• Commentators have not had an opportunity to make views Commentators have not had an opportunity to make views knownknown

– Changes arising from matters not previously Changes arising from matters not previously deliberated by the IESBAdeliberated by the IESBA

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Re-exposure – IESBA preliminary discussionRe-exposure – IESBA preliminary discussion

• Many Board members expressed the view that re-Many Board members expressed the view that re-exposure is not warrantedexposure is not warranted– Many respondents expressed view Code should address Many respondents expressed view Code should address

M&AM&A• Board is doing soBoard is doing so

– M&A clause provides pragmatic guidanceM&A clause provides pragmatic guidance• Generally codifies best practiceGenerally codifies best practice

– In most cases firm’s will be able to terminate I/R by In most cases firm’s will be able to terminate I/R by effective dateeffective date

• M&A clause is not likely to be used in every M&A caseM&A clause is not likely to be used in every M&A case

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DiscussionDiscussion