Introduction and background
These ethical concepts have always enjoyed an element of interaction. In ICAEW’s 1987 Guide to Professional Ethics (now known as the Code of Ethics) the Statement on Professional Independence described it as a ‘concept fundamental to the accountancy profession’ and ‘an attitude of mind characterised by integrity and an objective approach’. This clearly explains objectivity as being part of independence.
In ICAEW’s 1997 Guide to Professional Ethics Statement 1.201 on Integrity, Objectivity and Independence referred to Objectivity as ‘independence of mind’.
Other more recent comments on the interaction have included independence being considered as ‘a measure of objectivity’, or to independence ‘enabling’ an objective conclusion. As we can see there is an element of circularity here.
Here we set out an analysis of current definitions, provide some practical illustrations of how they currently interact and share ICAEW’s thoughts on independence, drawing attention to ICAEW’s principles-based framework for resolving ethical problems.
Current definitions and requirements
In the current IESBA Code of Ethics 120.1 Objectivity ‘imposes an obligation on all professional accountants not to compromise their professional or business judgement because of bias, conflict of interest or the undue influence of others’.
The current IESBA Code of Ethics definition of Independence explains it as being made up of two elements: ‘Independence of mind’ and ‘independence of appearance’. The former is still defined to include integrity, objectivity and scepticism. The latter is defined as being free from ‘facts and circumstances’ that would lead a reasonable and informed third party to conclude that integrity, objectivity or scepticism was compromised.
This has been the extant definition for a number of years which perhaps explains why auditor independence is now largely viewed through the lens of compliance, with detailed rules to be followed rather than a more principles based threats and safeguards approach. Indeed, in contrast to what the 1987 document suggests, independence is now something that is only really a relevant consideration for an auditor or assurance provider, with the rest of profession concerned with objectivity.
As indicated above, independence has very much become a matter of regulatory compliance, where a checklist approach such as that illustrated below tends to be adopted to ensure that the auditor is free from (or at least manages) a prescribed list of circumstances under which independence is perceived to be compromised. The approach to auditor independence has increasingly become rules based rather than principles based.
Objectivity, on the other hand, is much more concerned with reasons and motivations behind certain decisions or behaviour. It is concerned with internal thought processes rather than lists of prohibitions. As such a framework such as the ICAEW framework for resolving ethical problems is more suitable for assessing objectivity than a checklist.
If we take the IESBA definition of independence, and regard objectivity and ‘independence of mind’ to be closely aligned (as was explicitly stated in early Guides to Professional Ethics) it stands to reason that both of the tools above are necessary to fully assess auditor independence.
Example of auditor independence checklist approach
(this is an example of an approach that has been adopted by some. It is not intended to be an exhaustive independence checklist and should not be treated as such).
- Do staff have any direct/indirect financial interests in the audited entity? (290.102)
- Do any partners or staff have personal, family or business relationships with officers or employees of the audited entity? (290.123 – 290.131)
- Is there actual/threatened litigation between the firm and the audited entity? (290.228)
- Have any staff received non-trivial gifts or hospitality from the audited entity or its staff? (290.227)
- Are there any urgent reporting deadlines that may lead to resourcing issues and pressure from the management of the audited entity?
- Does the audited entity have informed management? (290.163)
- Has the audit fee exceeded 15% of the firm’s income for two consecutive years? (290.217)
- Are there significant overdue fees from the audited entity? (290.220)
- Is the firm adequately resourced to perform the audit?
The scenarios below illustrate the distinction (and interaction) between the concepts of independence and objectivity as defined by the IESBA Code of Ethics.
Phedra is an audit manager for a medium sized accounting firm. She has recently taken on a new engagement auditing Theseus plc, the parent company of a tech group. She is always diligent in her work and has proven very skilled in identifying and dealing with ethical threats appropriately. Her father in law recently passed away. Her husband’s inheritance includes a small shareholding in Theseus plc. Phedra is unaware of the existence of this shareholding.
It would be difficult to suggest that Phedra is not objective since we are told that she responds to ethical threats appropriately. While we cannot necessarily rely on past performance there is no suggestion in the scenario that she is biased when it comes to Theseus plc.
However she is not independent. 290.104 of the IESBA code says that the immediate family of an audit team member shall not have a direct financial interest in a client. Immediate family member includes spouse. The fact that she doesn’t know about the shareholding is irrelevant, as is her relative seniority and the size of the shareholding.
Geralt is a senior manager auditing Velen plc. Velen is a diverse group with activities ranging from pharmaceuticals to food products. This is his first year on this audit. He does not have any direct or indirect financial interests in the Velen group, nor do any of his family or friends work for Velen.
During the course of the audit Geralt discovers practices within the pharmaceuticals division that upset him, since he doesn’t agree with testing on animals. He then becomes more challenging of the Directors and goes out of his way to find problems, no matter how material, with the divisional accounts and controls.
Geralt is independent in appearance. The information in the scenario tells us that he is free from facts and circumstances that might lead a reasonable and informed third party to conclude that his objectivity is compromised.
However he is not acting objectively as he is not free from bias, and therefore not independent of mind per the IESBA definition of independence. That said, in a jurisdiction that takes an entirely compliance based approach to independence the answer could be B.
Kim works as an audit manager for a small firm. The firm has just taken on the audit of Dynamo Co, a small marketing company, and he has been selected to manage the engagement.
Kim has no prior association with Dynamo or its employees, and no direct or indirect financial interests. During the audit he is diligent and sceptical but ultimately finds no real issues. On the final day before signing off the accounts the Finance Director invites Kim for lunch at a local, family run restaurant. He accepts.
Based on the information we are given Kim appears to be independent. The question of whether he is objective and independent of mind depends on the extent to which the lunch with the Finance Director would create bias.
There are a number of clues suggesting that it might not. Firstly, the audit work has been completed, no contentious issues have arisen and it is likely that sign off is now a mere formality. Therefore the meal is unlikely to influence the audit opinion.
Secondly, we are not given the impression that this is an expensive restaurant and seems to have been selected for its convenient location. Therefore the value is more likely to be considered trivial and inconsequential.
In the circumstances above it is reasonable to conclude that Kim is both independent and objective. However the value, purpose and timing of any gifts and/or hospitality offered to an auditor must be considered on a case by case basis and assessed against 290.227 of the IESBA code.
Auditor independence is, however, often an issue that finds its way into domestic legislation, and some countries take a slightly different (in some cases entirely rules based) approach. The different approach taken by countries to independence is illustrated in the following examples.
The UK FRC Ethical Standard defines independence as ‘freedom from conditions and relationships which, in the context of an engagement, would compromise the integrity or objectivity of the firm or covered persons’ (paragraph I23). It is described as underpinning objectivity but sufficiently distinct from it being concerned with the circumstances surrounding the relationship rather than the auditor’s state of mind.
This approach to independence is therefore very much more concerned with ‘independence of appearance’ rather than ‘independence of mind’, with a number of detailed regulatory requirements designed to ensure the former.
In Japan, independence requirements derive from the Japanese Institute of Certified Public Accountants (JICPA) Code and statute. They lay out detailed rules concerning financial interests, personal interests, scope of non-audit services and rotation of audit partners. The JICPA supplements this with some self-regulatory provisions however overall compliance is assessed by reference to a rules based approach.
The Swedish Auditors Act requires auditors to be independent, but the approach is very different and is much more principles based. The Act requires auditors to carry out a threats and safeguards analysis such that sufficient measures are taken to ensure that independence would not be questioned. There are five absolute prohibitions, far fewer than in the regulations of many other countries. The approach to auditor independence is therefore largely achieved through a principles based framework.
ICAEW advocates a framework approach to independence that:
- Sets out fundamental ethical principles;
- Provides a reasoned analysis of the possible threats to these principles; and
- Gives guidance on the safeguards which may be necessary to mitigate these threats.
In short, we believe that this represents a more rigorous means of ensuring auditor independence. The most effective way to ensure the reality of independence is to provide guidance centered around a framework of principles rather than a detailed set of rules that can be complied with to the letter but circumvented in substance. Absolute requirements and prohibitions only have a place where no acceptable safeguard could reasonably be applied.
For example, a blanket prohibition on the provision of non-audit services to audit clients can be inefficient for the client and is neither necessary to ensure independence, nor helpful in contributing to the knowledge necessary to ensure the quality of the audit.