SMSF auditors: independence and code of ethics

Announcer:
Hello and welcome to the CPA Australia podcast, your weekly source for accounting education, career and leadership discussion.

Josephine Haste:
Thank you to our members for joining us today for CPA Australia's podcast addressing independence issues for auditors of self-managed superfunds. My name is Josephine Haste and I'm CPA Australia's policy advisor for ethics and professional standards. Joining me today, it is my great pleasure to welcome Channa Wijesinghe, chief executive officer of the Accounting Professional & Ethical Standards Board and Kellie Grant, director of SMSF risk and strategy for the Australian Taxation Office. Welcome Channa and Kellie and thank you for joining me today to discuss this most significant emerging issue for public practitioners.

Channa Wijesinghe:
Thank you, Jo, to you and CPA Australia for providing this opportunity to discuss the restructured code as well as auditor independence matters that impact on the SMSF sector.

Kellie Grant:
Yes, likewise. Thanks, Jo and to the CPA. It's really a pleasure to be here today providing some more guidance on this very important topic for industry.

Josephine Haste:
Great. Well without any further ado let's get started. First question is to you, Channa. The restructured code of ethics came into effect on 1st of January, 2020. Although the independence requirements remain relatively unchanged, requirements have been clarified for auditors, especially those of non-PIEs, which include SMSFs. Channa, would you please be able to take us through the major changes to the restructured code which are relevant to auditors of non-PIEs?

Channa Wijesinghe:
Jo, this is the most comprehensive restructure of the code in the last two decades. There's a new user guide on how to apply the code. There's a revised glossary and additional explanations on the key terms, but the most significant change is that the requirements are now separate to the guidance material, which means it will be easier for the accountants to implement as well as for enforcement action by regulators. There have been significant refinements to enhance the conceptual framework which now makes it explicit that, in certain circumstances, the only option available to you is to disengage or not carry out that activity. The auditor independence provisions have also been recharacterised as independent standards to emphasise the importance of auditor independence. The restructured code also incorporates the audit partner rotation requirements, as well as the … provisions in the new drafting format.

Josephine Haste:
Thanks very much, Channa. That's a very comprehensive introduction to the changes to the code, which, as you point out, are the most significant probably in the last 20 years with respect to the code. Channa, there have been a number of articles published recently which refer to the concept of routine or mechanical perhaps being relevant for determining whether a practice can continue to complete both the accounting and audit. However, the code has a prohibition with respect to an auditor undertaking a management responsibility which looks to be the first hurdle to overcome. Is this correct? If so, could you please explain this prohibition a little bit further to us?

Channa Wijesinghe:
That is correct, Jo. At section 600 of the code, it deals with the provision of non-insurance services to audit clients and there's a clear, explicit prohibition on an auditor undertaking a management responsibility. Further, to avoid the auditor assuming a management responsibility, the auditor or firm needs to be satisfied that, when providing another service, the client management makes all judgments and decisions that are the proper responsibility of management. For example, in a normal audit process, there will be the financial controller or CFO who can take that responsibility. If the client does not have a person who can oversee an assumed management responsibility, then the auditor cannot undertake the other service.

Josephine Haste:
That's very interesting, Channa. From your explanation about management prohibitions, it is clear that regardless of there being separation of duties between accounting or advisory division and audit division in the same firm, Chinese walls no longer can be applied where the accounting or advisory division is essentially acting as the manager for the trustee of the SMSF. Would you please explain to our listeners how providing either accounting and bookkeeping services, or advice on compliance with the SIS Act and regulations may impact on a firm providing the same client with audit services for an SMSF?

Channa Wijesinghe:
Yes Jo. I think we need to go back to a fundamental concept in auditing, which is this three party relationship in an audit engagement. You first get the intended users, which is generally the board on behalf of the shareholders or, in the SMSF case, it's the trustee. Then you have, second you have a responsible party, in most cases that is management which undertakes all the transactions that happen during the year. Then thirdly you get the auditor who comes in and provides an opinion on the financial statements based on what management has done during the year, as well as proper oversight from the board.

Channa Wijesinghe:
In an SMSF context, if the same firm prepares the accounting information and undertakes compliance activities on behalf of the SMSF during the year, then they are, in effect, undertaking the role of management, which is that second role we discussed. The code strictly prohibits an auditor or the firm undertaking a management responsibility for an audit plan because it creates a conflict between the role of the second party in the relationship and the third party, who has to provide an opinion. This becomes particularly problematic in circumstances where the client or the trustee may not have the requisite financial knowledge, skills, or the expertise.

Josephine Haste:
Thanks very much, Channa. It seems fairly straightforward really that, where there is a management responsibility, then in effect you're acting on behalf of the client, so therefore independence may be an issue. Channa, as the SMSF auditor provides an opinion on both the financial statements and the SMSF's compliance with the SIS Act and regulations, are you saying that any services the audit firm provides cannot stray into taking on management responsibility for either of these areas and that's not just limited to accounting services?

Channa Wijesinghe:
That is right Jo, because even in the compliance engagement they are providing an opinion. They should not undertake any activities that can be seen as undertaking a management responsibility.

Josephine Haste:
Great. If we look specifically at accounting services, the restructured code states that an auditor may provide an accounting or bookkeeping service that is routine or mechanical, but under very limited circumstances. Could you please explain to our listeners what it means, what that means, that concept of routine or mechanical means and whether it is a valid consideration for SMSFs?

Channa Wijesinghe:
Generally the restructured code has a prohibition on an auditor undertaking bookkeeping accounting services, whether you are a public interest entity, or PIE as we call them, or a non-PIE. An SMSF would be considered to be a non-PIE. However, for non-PIE audit clients there's a limited exception. The limited exception applies in circumstances where, one, there is a party who can take management responsibility. As I said before, in a company it would be a CFO, financial controller and in an SMSF it would generally fall to the trustee. Secondly, the service is routine or mechanical and thirdly that you can implement an appropriate safeguard, such as getting another team who can do the work.

Channa Wijesinghe:
From an SMSF context, if a firm is undertaking the accounting work and the trustees are not financially literate, then the firm is in effect functioning in the role of management. The consideration of whether it's routine or mechanical is largely irrelevant as the firm would not be able to overcome the management responsibility prohibition. The first important hurdle is the management responsibility prohibition and, if you can't overcome that, then you don't even have to worry about the routine or mechanical, because that is a secondary consideration. In circumstances where the trustee of an SMSF is financially literate and has the necessary skills, expertise and has the ability to understand and oversee the transactions that are occurring in the SMSF, they may be able to take management responsibility. In these circumstances you will then need to consider whether the accounting and bookkeeping services provided are routine or mechanical.

Channa Wijesinghe:
Accounting and bookkeeping services that are routine or mechanical in nature require little or no professional judgement . For example, let's say you are posting transactions quoted by the client into the general ledger or you're posting client approved entries to the trial balance. Another example is if you're preparing financial statements based on information in the client approved trial balance and preparing related notes based on client approved records. In summary, you have to first establish whether you can address the management responsibility prohibition and, in an SMSF context, you would only be able to do it if the trustee is financially literate, has the level of knowledge and skills to understand what is happening within the SMSF.

Josephine Haste:
Thanks, Channa. That's a great explanation and I think really highlights to our listeners that the first hurdle is management responsibility rather than this concept of routine and mechanical. We really need to focus on who has the ultimate management responsibility for that SMSF. Channa, let's delve a little bit further into that. Paragraph 600.7a3 and 600.7a4 of the code provides examples of management responsibilities and exemptions as to what actions perhaps are not considered to be assuming management responsibility. Examples of these exceptions include providing advice and recommendations to assist the management of an audit client in discharging responsibilities. Could it be argued that the advice provided by the accountant or the firm, with respect to the account preparation and the compliance, falls under this exemption?

Channa Wijesinghe:
Jo, providing advice or recommendation to management of the audit client, which then enables management, or in this case the trustee to assess and evaluate the options available, make decisions and undertake implementation action of what the trustee thinks is appropriate is a possible exception. This will only be possible, as I said before, where the trustee has the requisite financial skills, knowledge and expertise. However, if the firm is providing the advice and then preparing the financial statements for the SMSF and the trustee has limited knowledge, then it will not be possible to say that they are providing advice or recommendations which enable "management" to discharge the responsibilities when the trustee has very limited knowledge.

Josephine Haste:
That makes perfect sense, Channa. For the majority of funds where the trustees are relying on their accountant for this advice regarding the compliance of the fund and the accounting policies of the fund, then it's quite clear that the accountant is providing more, services akin more to those management responsibilities?

Channa Wijesinghe:
Yes, that's correct, Jo.

Josephine Haste:
Kellie, from Channa's explanation of the relevant provisions in the code, it appears that there are very limited circumstances in which a firm could provide both the accounting and audit services to an SMSF client. Would you please explain to our listeners how the ATO has interpreted the concept of routine or mechanical, and could you explain to our listeners whether the types of assets in a fund has any bearing on the determination of accounting services as routine or mechanical?

Kellie Grant:
Yeah, I can Jo. In doing so, we've tried to stay true to the code. As Channa mentioned, the code actually provides some examples of what is considered to be routine or mechanical at paragraph 601.4a1. Now that's where it says that the accounting and bookkeeping services are routine and mechanical in nature if they require little or no professional judgement . Some of those examples that have been provided in that paragraph that are relevant in the context of preparing the accounts for an SMSF are where the accountant posts transactions coded by the trustee to general ledger or post trustee approved entries to the trial balance. It also includes situations where your accountant prepares some financial statements baseline information in that trustee approved trial balance or prepares related notes based on the trustee approved records.

Kellie Grant:
To meet this requirement, Jo, when we'll be reviewing auditor's files we'll expect to see that the auditor can show evidence in that file that the trustee took on full responsibility for the preparation and fair presentation of those financial statements. As we've said, this goes beyond the trustee just signing the trustee declaration in the financial statements, or saying in their trustee representation letter that they provide their auditor with that they've prepared those financial statements. It really does mean the trustee being able to show they created all the fund transactions and have basically provided a trial balance to their fund administrator to then upload it into their system. Then any financial statements they produce will be based on the trial balance figures prepared by the trustee, so that the accountant, you can clearly see that they made no judgement then as to how certain items should be classified in the funds accounts.

Kellie Grant:
We really don't think there'd be too many trustees that would have the knowledge, skills and experience to take on the responsibility of the financial statements in this way and that's why we suspect quite a few accounting firms who conduct in-house audits will need to look at restructuring, I think, in order to be able to avoid the breach of this independence standard. I should point out though, Jo, too that some of the industry have actually argued that financial statements prepared on the basis of recurring transactions, such as data feeds, can meet the routine or mechanical requirement since they've argued that no judgement is exercised by the accountant and they're preparing the fund's accounts using those data feeds. Others have also argued, as you mentioned before, if the fund has simple investments like listed shares and cash, then account preparation would surely be routine or mechanical.

Kellie Grant:
However, just because the fund is mainly invested in assets that are on data feeds through SMSF specific software or have simple investments, the key thing is the trustee still needs to show they've taken on the responsibility for those financial statements by pre approving every single fund transaction and the appropriate account classification for that transaction, rather than looking to approve them after the fact. Also, we often find the firms are also responsible for setting up the accounting software which classifies the transactions from the data feeds. Of course we all know that mistakes can still be made in those data feeds that normally the firm would be taking responsibility for rather than the trustee. The firm would also need to demonstrate that they're not acting in that management capacity and taking on any other decision making for the fund, which Channa mentioned before.

Kellie Grant:
We often do find though that SMSF administration firms who prepare the accounts for the funds, even via data feeds, are still in fact making those decisions on behalf of the funds, such as devising certain tax strategies for the fund, or helping them with fund compliance. For instance, a lot of those firms might advise on how a trustee can go about maximising their concessional and non-concessional contribution limits, or they might advise on when's the best time for the trustee member to commence a pension. They might also develop structures and strategies to enable trustees to make investments in unrelated or related parties in order to avoid breaching the in-house asset rules or the sole purpose test or the non arms length incomes rule. It's those types of management decisions that are going to create those self review threats if the auditor in the same firm then reviews the firm's financial statements.

Josephine Haste:
Thanks, Kellie. I think that gives our members a very clear indication of what they can and can't do. Really it's not just about educating their clients so they can take responsibility, because in that case, what are our clients paying us to do? They're paying us for that advice, so really that shows where the member is caught with respect to that management responsibility, or the fact that those transactions are not really routine or mechanical. Thank you. I think that makes that really clear for our members. Kellie, given that accountants have relied on the concept of ethical or, as we've previously known them, Chinese walls in multi-partner practises to reduce self-review threats to an acceptable level and those walls have been relied upon for many years in the past, this is perhaps a significant shift for practises to manage. How will the ATO be assisting members during this transition phase?

Kellie Grant:
Well Jo, look, unfortunately we can't clearly identify all the firms that are conducting in-house audits and that's actually because the SMSF annual return requires the auditor and the tax agent for the fund to be reported on it. Sometimes the tax agent who prepares the fund's annual return may not be the same person who actually prepared the fund accounts. In fact we'd like to change the SMSF annual return in the future so that we can capture the details of who prepared the accounts for the fund, as well as who did the audit.

Kellie Grant:
Look, we do, however, suspect that there are a large number of firms out there conducting in-house audits with a large number of funds involved. This is why, Jo, we're using this financial year to try and get the message out there to industry and educate these firms conducting these in-house audits on this independence standard and advise them they should be looking to restructure their engagements if they think they can't comply with it. The reason we're using this particular, giving everyone a particular year is there is a lot going on for them at the moment as well with other issues, such as dealing with some of the COVID relief and whatnot there, so we think a year should be enough for everyone to get on top of this. We're also now planning to write to all auditors, and not just those we suspect are conducting in-house audits, to provide some further guidance on this issue as well.

Josephine Haste:
Fantastic Kellie, I think that will be welcomed by our members so that there is some clear guidance around what the ATO's position is. Kellie, you mentioned the ATO can pick up from the SMSF annual return who the auditor and tax agent are for the fund. Where the auditor also prepares the tax return for the fund, does this create independence threats?

Kellie Grant:
Well where the auditor or their firm acts as a tax agent for the auditing client and nearly prepares as a self-managed superfund annual return which the client takes on responsibility for, then this situation shouldn't create an independence threat, but that's of course assuming the financial statements also weren't prepared by the tax agent's firm or, if they were, that the trustee took full responsibility for them and, of course, they were considered to be routine or mechanical. However, where the tax agent might provide other services to the audit client involving tax advice or calculations that go beyond what is needed just for the preparation of the annual return, for instance they might go more towards what is needed for the financial statements such as current deferred tax liabilities, then that's when those selfreview threats can arise. In that situation, the auditor will need to consider applying appropriate safeguards to reduce those threats, such as using a non auditing team member to perform the tax services or having an appropriate reviewer who wasn't involved in the tax services to review that audit or tax work.

Josephine Haste:
Once again, it seems pretty clear that it really depends on the type of tax work that the member is engaged in delivering to that client.

Kellie Grant:
Correct.

Josephine Haste:
Kellie, members will need to now consider whether they disengage from either the accounting or audit service provided to clients where previously the firm has conducted both. Where a firm disengages from the audit service, what are the considerations that the firm must manage with respect to the code, such as reciprocal arrangements and fee dependency issues? Do you have any suggestions for our members for managing these structural issues to ensure compliance with the code?

Kellie Grant:
Yeah, sure Jo. When a firm is looking to restructure their audit engagements, of course they need to be careful of not creating other independence issues which can easily happen. For example, they need to ensure they don't enter into reciprocal auditing arrangements where both firms just end up [inaudible 00:24:24] each other's clients and that can cause them to rely on the one referral source. This type of arrangement can inappropriately, of course, influence the auditor's judgement or behaviour if the auditing firm is also dependent on just those fees. The auditor may also be reluctant to issue adverse findings in that situation, if there's a risk and because they might feel that they'll lose their entire client base. Yes, these reciprocal auditing arrangements, you need to be mindful you're not entering into those because they can create those self-interest, familiarity and intimidation threats.

Kellie Grant:
Paragraphs, I think it's 410.3 to 410.31a1 of the code actually state that these independence threats can be reduced however to an acceptable level by putting in place appropriate safeguards, such as spreading out the referral clients to a number of different SMSF auditors, which would, of course, minimise that dependence on the one source. Another appropriate safeguard of course could be to have a reviewer who didn't take part in the audits review the work, or include the external quality control reviews, or even use external consultation on some of those key audit judgments. Again, if the circumstances creating those threats just can't be eliminated and appropriate safeguards can't be applied, then really the auditor should look to decline that engagement.

Kellie Grant:
Another thing auditors need to be aware of, Jo, they can't just go out and set up their own firm and then accept audits from that firm if they were previously a consultant partner or employee of that firm. That's because threats may exist that the auditor may not appropriately evaluate the results of previous judgments made or advice provided to clients of that firm from when the auditor was a partner of that firm. Due to the previous relationship, there is a threat that the auditor may be too accepting of the work, I suppose, of the firm they previously worked at, particularly, Jo, if minimal time has passed since they left, such as within a 12 month period.

Kellie Grant:
Independence threats arising from these types of outsourcing arrangements can be eliminated though if the auditors in the firm undertake the audits, or the auditor can get an appropriate reviewer, again being someone who is not from the firm providing the accounting and tax work to the client to review the audit. If there are no other auditors to take on this work, the updated independence guide suggests that, after a two year period, any independence threat should generally no longer exist, so that's a good benchmark to you there. However, in all cases the auditor should still apply the reasonable, informed third party test to determine if any threats to independence exist at the time they take on the engagement.

Josephine Haste:
Great. Thanks Kellie. That gives our members a really clear indication of other considerations that they need to look at when they're considering their structure and how they might structure their firm going forward. Channa and Kellie, for members wanting to explore further resources on this issue, are you able to identify where these might be able to be found?

Channa Wijesinghe:
Sure, Jo. As you know, in May, 2020 APESB, in collaboration with the three accounting bodies including CPA Australia, developed this fifth edition of the independence guide. This provides a good guide on how to apply the independence standards. In chapter eight it specifically deals with the SMSF issues that SMSF auditors need to be aware of. In August, 2020 APESB issued a publication, APES 110 code prohibitions. This provides a useful guide on services that are permissible for auditors to provide an audit client.

Josephine Haste:
Fantastic, Channa. We'll put links to those publications in the show notes of this podcast. Kellie?

Kellie Grant:
Yeah, look Jo, I mean given the independence guide is really quite a comprehensive, very helpful document, the ATO hasn't, as yet, published any additional guidance other than just a short article on our website that does alert auditors to our concerns around in-house audits. Look, however, as mentioned before though, we certainly plan to write to auditors by the end of this year providing them with some further guidance on this issue and what we consider to be routine or mechanical. That guidance will also include some advice around what types of alternative arrangements they'll need to be acceptable and those which won't be acceptable.

Kellie Grant:
We're actually starting to get a few questions, Jo, from SMSF administration firms on what type of alternative structures would be acceptable. We're planning to incorporate some of those questions and some of the guidance we're giving there in part of this more general guidance as well that will go out to all auditors. We also of course have some guidance on our website advising against reciprocal auditing arrangements, which I mentioned before, involving two professional accountants looking to audit each other's clients. You can go to that on our website as well to have it look at what we say about those.

Josephine Haste:
Great. Thanks Kellie and Channa. I'd like to highlight to members that CPA Australia has written an article on this issue which was published in the July edition of INPRACTICE. We also published an article on independence more broadly in the April edition of INTHEBLACK. Those resources are available to members via our website. In addition to this podcast, CPA Australia recently conducted a webinar on the revised independence guide. If you missed that webinar, look out in CPA Update for the link to the webinar recording. Channa and Kellie, your guidance with respect to the independence of SMSF auditors has been invaluable. To sum up, would you have one closing remark for our members to take away?

Channa Wijesinghe:
Yes, Jo. In the SMSF context, taking into consideration the knowledge, skills and expertise of trustees, my sense is that only in very limited circumstances will an auditor or firm be able to overcome the management responsibility prohibition in the code where they're also providing accounting and other services to SMSF audit client. Secondly, the requirement to ensure compliance audit report, that the SMSF complied with SIS legislation and other compliance requirements during the year creates an additional independence threat that needs to be considered. Finally, when you consider the public interest element that these audits are an independent check on a client's retirement savings, the best approach for an audit firm to adopt is to focus on performing audits and let another external party provide accounting and other services to the SMSF audit client.

Josephine Haste:
Thanks, Channa. Kellie?

Kellie Grant:
Yeah, look, I agree with what Channa said. I think the ATO's view on this whole issue, Jo, is that we feel that industry need to approach it by just accepting that gone are the days of the in-house audits and Chinese walls. It's just too difficult for in-house auditing firms to try and fall within that routine or mechanical exception because of those management responsibilities that would normally come with a self-managed superfund client. A self-managed superfund client, again, who is also unlikely to have that requisite knowledge, skills, and experience to make decisions that normally management would make, in which case in-house auditing firms at the moment should just be thinking about how they could restructure their auditing engagements in order to meet these global, independence standards, which potentially in five years time may not even have a routine or mechanical exemption anymore. Our advice is it's best to get prepared now rather than later.

Josephine Haste:
Many thanks, Channa and Kellie, for your closing remarks. From myself, I think with the increasing focus on perceived and actual independence, both domestically and globally, the key message for our members to take away from this podcast is that firms need to disengage from providing accounting and audit services to the one client, especially where the accountant is assuming management responsibility. There's really nowhere for them to go in those circumstances. Regardless of what type of entity the services are being provided to, regardless of the types of assets that are contained within the fund, all of that is really just white noise. All the while, members need to carefully consider that other ethical challenges such as fee dependency and reciprocal arrangements may arise from the restructuring of businesses.

Josephine Haste:
Kellie and Channa, on behalf of CPA Australia and our members I would like to thank you both for joining me today to discuss what is required by members going forward with respect to SMSF audit independence. Many thanks to you both for joining us today. Members, links to additional resources to assist you navigate these changes will be included in the show notes. Thanks for joining us.

Channa Wijesinghe:
Thanks, Jo.

Kellie Grant:
Thanks, Jo.

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