Fees charged to audit clients

The new revisions substantially revise and expand Section 410 of the Code, setting out requirements and application material to assist professional accountants in applying the conceptual framework to identify, evaluate and address potential threats to independence arising from fees charged to audit clients.

New Section 410.3.A2 emphasises the heightened expectations of stakeholders, in circumstances where the audit client is a public interest entity (PIE); and notes the importance of transparency and disclosure of fee related information to those charged with governance and stakeholders generally.

In particular, the revisions introduce:

1. a structured risk assessment framework, which enhances objectivity and uniformity in evaluating and addressing potential threats to independence;
2. a new explicit 15% fee dependency threshold for audit clients which are PIEs;
3. mandatory fee disclosures to enhance transparency and to enable a more informed evaluation of auditor independence; and
4. stricter safeguards for non-audit services, reducing variability in practice and which strengthens the ethical framework for managing potential conflicts of interest.

Evaluation of threats

New section 410.4.A1 notes that when fees are negotiated with and paid by an audit client, this creates a self-interest threat and might create an intimidation threat to independence.

New section 410.4 A2 notes that the application of the conceptual framework requires that:

1. before accepting an audit or other engagement for an audit client, a firm or network firm should determine whether any threats to independence created by the fees proposed to the client are at an acceptable level; and
2. where facts and circumstances change during the engagement period, the firm should re-evaluate such threats.

New section 410.4.A3 sets out a range of factors which are relevant to evaluating the level of threats created when fees for an audit or other engagement are paid by the audit client. These include:

1. the level of fee, including in the context of the service to be provided and the extent of any dependencies between the level of the fee and the outcome of the service, and whether the level of fee is set by an independent third party (such as a regulatory body);
2. any linkage between fees charged for the audit and those charged for other services (and the relative size of both elements);
3. whether the fee is for services to be provided by the firm or a network firm;
4. the operating structure and the compensation arrangements of the firm and network firms;
5. the significance of the client or third party referring the client, to the firm, network firm, partner or office;
6. the nature of the client (eg, if the client is a PIE);
7. the relationship of the client to the related entities to which services other than audit are provided;
8. the involvement of those charged with governance in appointing the auditor and agreeing fees; and 
9. whether the quality of the firm’s audit work is subject to review by an independent third party (such as an oversight body).

New section 410.4.A4 also notes that the existence of a quality management system and associated policies and procedures might also impact the evaluation of whether threats are at an acceptable level.

New section 410.5.A2 identifies the following factors as being relevant to evaluating the level of self-interest and intimidation threats created by the audit fee:

1. the firm’s commercial rationale for the audit fee; and
2. whether undue pressure has been, or is being, applied by the client to reduce the audit fee.

New section 410.5.A3 sets out examples of safeguarding actions to address such threats, including:

1. assessment of the reasonableness of the fee by an appropriate reviewer (who does not take part in the audit engagement); and
2. review of the work performed by an appropriate reviewer (who does not take part in the audit engagement).

Impact of other services provided by an audit client

New section R410.6 provides that a firm shall not allow the audit fee to be influenced by the provision of services other than audit, to an audit client. New section 410.6.A1 emphasises that the provision of other services to an audit client is not an appropriate consideration when determining the audit fee.

However, section R410.7 allows a firm to take into account the cost savings achieved as a result of experience derived from the provision of services other than audit, to an audit client.

Total fees (non-audit services and the audit fee)

New section 410.11.A1 notes that the level of self-interest threat might be impacted when a large proportion of fees charged to the audit client by the firm or network firm is generated from services other than audit. Further, such circumstances might also create an intimidation threat. Where there is a perception that the firm or network firm focuses on the non-audit relationship, this might create a threat to the auditor’s independence.

New section 410.11.A2 sets out factors which are relevant to the evaluation of the level of such threats. These include:

1. the ratio of fees for services other than audit, to the audit fee;
2. the length of time during which a large proportion of fees for services other than audit has existed; and
3. the nature, scope and purposes of the services other than audit (including whether they are recurring services and whether law or regulation mandates to services to be provided by the firm).

New section 410.11.A3 provides examples of safeguarding actions to address such threats, including:

1. review of the audit work by an appropriate reviewer not involved in the audit or non-audit service; and
2. reducing the extent of services other than audit which are provided to the audit client.

Total fees (overdue fees)

New section 410.12.A1 notes that the level of self-interest threat might be impacted if the fees payable by an audit client for the audit (or services other than audit) are overdue during the period of the client engagement.

New section 410.12.A3 sets out factors which are relevant to evaluating the level of such threats. These include:

1. the significance of the overdue fees to the firm;
2. the length of time the fees have been overdue; and
3. the firm’s assessment of the ability and willingness of the audit client to pay the overdue fees.

New section 410.12.A4 sets out examples of safeguarding actions which may address such threats. These include:

1. obtaining partial payment of overdue fees; and
2. review of the audit work by an appropriate reviewer who did not take part in the audit engagement.

By new section R410.13, when a significant part of fees from an audit client remains unpaid for a long time, the firm shall determine:

1. whether the overdue fees might be equivalent to a loan to the client (in which case, the requirements and application material set out in section 511 is applicable); and
2. whether it is appropriate for the firm to be re-appointed or to continue the audit engagement.

Total fees (fee dependency thresholds)

New section 410.14.A1 notes that when the total fees generated from an audit client by the firm expressing the audit opinion, represent a large proportion of the total fees of that firm, the dependence on fees from that client (and concern about their potential loss) will impact the level of the self-interest threat and create an intimidation threat.

New sections 410.14.A3 to 410.14.A7 set out a range of factors which are relevant in evaluating the level of the threat; and safeguarding actions to address such threats. Such actions include the use of an appropriate reviewer; reducing the extent of service other than audit which are provided; increasing the client base of the firm to reduce dependency on the client; and increasing the extent of services provided to other clients.

Audit clients that are not PIEs

Where, for each of five consecutive years, the total fees from a (non-PIE) audit client represent (or are likely to represent) more than 30% of the total fees received by the firm, new section R410.15 requires a firm to determine whether the following safeguarding actions might reduce the threats to an acceptable level:

1. review of the fifth-year audit work by a professional accountant who is not a member of the firm, prior to issue of audit opinion on the fifth year’s financial statements; and
2. review of the fifth-year audit work by a professional accountant who is not a member of the firm, after the issue of the audit opinion on the fifth year financial statements, and before the audit opinion on the sixth year’s financial statements.

By section R410.16, if the total fees continue to exceed 30%, the firm shall determine each year, whether to apply the safeguarding actions outlined above to the relevant year’s engagement.

By section R410.17, when two or more firms are engaged to conduct an audit of the client’s financial statements, the involvement of the other firm in the audit may be regarded each year as a safeguarding action equivalent to review by a professional accountant who is not a member of the firm.

However, this is subject to certain exemptions set out in that section, including that only one of the firms must be receiving fees which are more than 30% of total fees over the five-year period; and that each firm performs sufficient work to take full individual responsibility for the audit opinion.

Audit clients that are PIEs

Where, for each of two consecutive years, the total fees from an audit client that is a PIE client represent (or are likely to represent) more than 15% of the total fees received by the firm, new section R410.18 requires the firm to determine whether performing a “pre-issuance review” , prior to the audit opinion being issued on the second year’s financial statements, might be a safeguarding action that can reduce the threats to an acceptable level.

In terms, a “pre-issuance review” is a review (consistent with the objective of an engagement quality review) performed by a professional accountant who is not a member of the firm expressing the opinion on the financial statements.

By section R410.19, where two or more firms are engaged to conduct an audit of the firm’s financial statements, the involvement of the other firm in the audit may be regarded each year as equivalent to a pre-issuance review.

However, this is subject to certain exemptions set out in that section, including that only one of the firms must be receiving fees which are more than 15% of total fees over the two-year period; and that each firm performs sufficient work to take full individual responsibility for the audit opinion.

By section R410.20, if the firm continues to receive fees from the audit client which represent more than 15% of the total fees received by the firm, for five consecutive years, the firm shall cease to be the auditor of the PIE audit client after the audit opinion for the fifth year is issued.

However, new section R410.21 provides an exception to this requirement. A firm may continue to be the auditor after five consecutive years if there is a compelling reason to do so, having regard to the public interest; and provided that:

1. the firm consults with a regulatory or professional body in the relevant jurisdiction, and that body concurs that it would be in the public interest for the firm to continue as auditor to the PIE client; and
2. before the audit opinion on the sixth and any subsequent year’s financial statements is issued, the firm engages a professional accountant who is not a member of the firm, to undertake a pre-issuance review.

New section 410.21.A1 states that a factor which might give rise to a compelling reason is the lack of viable alternative firms to carry out the audit engagement, having regard to the nature and location of the client’s business.

Enhanced transparency requirements for PIEs

New section 410.22.A1 notes that communication by the firm with those charged with governance about fee-related information (for audit and services other than audit) assists in the assessment of the firm’s independence.

By new section R410.23, a firm shall communicate in a timely manner with those charged with governance of a PIE audit client in relation to:

1. fees paid (or payable) to the audit firm or network firm for the audit of the financial statements on which the opinion is expressed; and
2. whether the threats created by the level of those fees are at an acceptable level, and if not, any actions the firm has taken or proposes to take, to reduce the threats to an acceptable level.

New section 410.23.A1 notes that the objective of such communication is to provide the background and context to the fees for the audit, and to enable those charged with governance to consider the independence of the firm. The section notes that the nature and extent of matters to be communicated will depend on the facts and the circumstances and sets outs examples. These include adjustments to fees quoted or charged during the audit period; changes to laws, regulations and relevant professional standards which might impact on fees; and general considerations affecting the level of fees such as scale, complexity and geographical spread of the clients operations etc.

New section 410.23.A2 emphasises that the firm is encouraged to provide this information as soon as practicable and to communicate any proposed adjustments “as appropriate”.

New section R410.24 provides exceptions to the requirement to communicate this information to those charged with governance of an entity that is (directly or indirectly) wholly owned by another PIE. However, the exception only applies where the entity is consolidated into group financial statements prepared by the other PIE; and the firm (or network firm) expresses an opinion on those group financial statements.

Stricter safeguards for non-audit services

By new section R410.25, a firm shall communicate in a timely manner with those charged with governance of a PIE audit client in relation to:

1. fees charged to the client for provision of other services by the firm or network firm, during the period covered by the financial statements on which the firm expresses an opinion; and
2. whether the threats created by the level of those fees are at an acceptable level, and if not, any actions the firm has taken or proposes to take, to reduce the threats to an acceptable level.

New section 410.25.A1 notes that the objective of such communication is to provide the background and context to the fees for other services, and to enable those charged with governance to consider the independence of the firm. The section notes that the nature and extent of matters to be communicated will depend on the facts and the circumstances and sets out examples. These include the amount of fees for other services that are required by law or regulation; the nature of other services provided and their associated fees; information on the nature of the services provided under a general policy approved by those charged with governance and associated fees; and the proportion of fees for other services to the aggregate of the audit fees charged by the firm and network firms.

By new section 410.26, in the communication about fees for other services, the firm shall include fees charged to any other related entities over which the audit client has direct or indirect control for the provision of services by the firm (or network firm), when the firm knows, or has reason to believe, that such fees are relevant to the evaluation of the firm’s independence.

New section 410.26.A1 sets out a number of factors which might indicate relevance to the evaluation of the firm’s independence. These include the extent of the audit client’s involvement in the appointment of the firm (or network firm) for the provision of other services; the significance of the fees paid by the other related entities to the firm or a network firm; and the proportion of fees from the other related entities to the fees paid by the client.

New section R410.27 provides an exception to the requirement to communicate this information to those charged with governance of an entity that is (directly or indirectly) wholly owned by another PIE. However, the exception only applies where the entity is consolidated into group financial statements prepared by the other PIE; and the firm (or network firm) expresses an opinion on those group financial statements.

Fee dependency

By section R410.28, where the total fees from an audit client that is a PIE represent (or are likely to represent) more than 15% of the total fees received by the firm, the firm shall communicate this to those charged with governance and inform them whether this situation is likely to continue.

In addition, the firm shall communicate the safeguards that it has applied to address the threats created (including the use of “pre-issuance reviews”, where relevant); and any proposal to continue as auditor on the grounds that there is a compelling reason to do so, having regard to the public interest.

Public disclosure of fee-related information

New section R410.30 provides that where laws and regulations do not require an audit client to disclose information about audit fees, fees for other services (paid or payable) and fee dependency, the firm shall discuss with those charged with governance of a PIE audit client:

1. the benefits to the client’s stakeholders of making such disclosures in an appropriate manner; and
2. the information that might enhance the users’ understanding of the fees paid or payable, and their impact on the firm’s independence.

New section 410.30.A1 provides examples of information which might enhance user understanding, including comparative information relating to prior year fees for audit and other services; the nature of the services and their associated fees; and safeguards applied when the total fees from the client represent (or are likely to represent) more than 15% of the total fees received by the firm.

New section R410.31 provides that after the discussion has been held, to the extent that the PIE audit client does not make the relevant disclosure, the firm itself shall publicly disclose information about:

1. fees paid or payable for the audit;
2. fees charged to the client for other services;
3. fees charged to any other related entities over which the audit client has direct or indirect control for the provision of services by the firm (or network firm), when the firm knows, or has reason to believe, that such fees are relevant to the evaluation of the firm’s independence; and
4. (if applicable) that fact that total fees received from the audit client represent or are likely to represent more than 15% of the total fees received by the firm for two consecutive years, and the year that this situation first arose.

New section 410.31.A3 provides that the firm may disclose fee information “in a manner deemed appropriate, taking into account the timing and accessibility of the information to stakeholders”. This may include publishing information on the firm’s website, in the firm’s Transparency Report; in an audit quality report; via targeted communication to specific stakeholders such as a letter to shareholders; and in the Auditor’s Report.

However, new section R410.31 provides an exception to disclosure by the firm, where that information relates to:

1. a parent entity that also prepares group financial statements (provided that the firm or a network firm expresses an opinion on the group financial statements); or
2. an entity (directly or indirectly) wholly owned by another PIE (provided that that entity is consolidated into group financial statements prepared by the other PIE and the firm or a network firm expresses an opinion on the group financial statements.