Comments by the Auditing Standards Committee of the Auditing Section of the American Accounting Association on the IESBA ED Release (August 14, 2014), Proposed Changes to Certain Provisions of the Code Addressing the Long Association of Personnel with an Audit or Assurance Client: Participating Committee Members: Free

The International Ethics Standard Board for Accountants (IESBA) recognizes the complexity of the effect that a long term association of the same firm personnel with an assurance client may have on independence and/or audit effectiveness. On one hand, the use of the same personnel over a long period of time could create familiarity and self-interest threats (for instance, relating to complacency, professional skepticism, and economic bonding) that may impair independence; while on the other hand, the knowledge and experience of the client's business, management, and internal controls gained through such an association contribute positively to being able to identify and evaluate audit risk areas necessary for the performance of high-quality audits. Because of the concern by some stakeholders of the right balance between addressing the familiarity and self-interest threats to independence with the relevant knowledge and experience to support effective audits, the IESBA considers it important, and in the public interest, to revisit the Code (IFAC 2014b) to consider whether the partner rotation requirement provisions, as a whole, remain appropriate for addressing issues related to a long association. The following presents a number of responses or suggestions by the Committee to requests for specific comments posed by the IESBA in the Exposure Draft Release (August 14, 2014) addressing the long association of firm personnel (IFAC 2014a).

• Question 5:

  Do respondents agree with the proposal to extend the cooling-off period to five years for the engagement partner on the audit of PIEs? If not, why not, and what alternatives, if any, could be considered?

• Question 6:

  If the cooling-off period is extended to five years for the engagement partner, do respondents agree that the requirement should apply to the audits of all PIEs?

• Question 7:

  Do respondents agree with the cooling-off period remaining at two years for the engagement quality control review partner (EQCR) and other KAPs on audits of PIEs? If not, do respondents consider that the longer cooling-off period (or a different cooling-off period) should also apply to the EQCR and/or other KAPs?

The consensus of the AAA Auditing Standards Committee (we) is that there is a need to improve the balance between the familiarity threat that comes by a long association with the client and the need to maintain appropriate knowledge and experience to support audit quality. As a basis for the proposal, the IESBA evaluates whether the current time-on/time-off period of 7/2 remains appropriate to address the threat of a long association for key audit partners (KAPs) of a public interest entity (PIE). We agree with the IESBA of the need to propose changes to increase the cooling-off period for KAPs of PIEs, after all, under the current Code of Ethics an individual can serve as a KAP for up to 14 out of 16 consecutive years assuming that the KAP returned to the audit after the cooling-off period. While the long association relative to the short time-off period may have a positive impact on audit effectiveness due to auditor learning and knowledge, there is the potential negative impact because of the risk of familiarity threats (such as complacency and reduced professional skepticism) that increase with length of time as a KAP.

The IESBA considers the significance of the familiarity threat by a long association to be greater for an engagement partner (EP) than for other KAPs, like the engagement quality control review partner (EQCR), and we concur. This is reasonable given that the EQCR, for instance, does not meet the client, nor does s/he participate in the engagement or make decisions for the engagement team. Therefore, we are in agreement with the proposal of the IESBA to extend the cooling-off period to five years for the engagement partner on the audit of PIEs. The extension of the period from two to five years is likely to reduce the familiarity threat to an acceptable level and, as discussed by the IESBA, provide an effective fresh look by the incoming partner and truly remove the influence of the outgoing partner. The IESBA considered three years as not making any significant difference, and four years was not used by many jurisdictions and would lead to greater implementation challenges. The time-on/time-off period of 7/5 would replace the current 7/2 for EPs of PIE audits, resulting in EPs serving up to 14 out of 19 consecutive years rather than the current 14 out of 16 consecutive years. Since the EQCR and other KAPs on the audits of PIEs do not pose as much a familiarity threat as EPs, we agree that the cooling-off period should remain at two years (i.e., time-on/time-off period of 7/2). While there is greater regulatory oversight of publicly listed companies, we agree with the IESBA that there is little justification for distinguishing between listed companies and other PIEs, as they are all entities of public interest. Thus, the 7/5 rotation requirement for EPs should apply to the audits of all PIEs.

• Question 8:

  Do respondents agree with the proposal that the engagement partner be required to cool off for five years if he or she has served any time as engagement partner during the seven-year period as the KAP?

The AAA Auditing Standards Committee does not agree with the proposal that the engagement partner (EP) be required to cool off for five years if he or she has served any time as the engagement partner during the seven-year period as a KAP. The proposal that the KAP who serves any time as the EP be required to cool off for a period of five years, while easy to apply, does not appear to be reasonable, fair, or appropriate, especially when considering that other KAPs have a two-year cooling-off period. It would seem, for instance, that an EP serving a client, say, for three or four years or less, would not pose as much of a familiarity threat to independence as one serving the full time-on period of seven years. Perhaps the IESBA should consider a three-year timeoff for four years as an EP; and two-year timeoff for a KAP serving as the EP for three years or less. Hence, for an EP the time-on/time-off tier approach would be as follows:

• 5–7/5:

  serve a minimum of 10 out of a consecutive 15 years and a maximum of 14 out of a consecutive 19 years;

• 4/3:

  serve 8 out of a consecutive 11 years; and

• < 4/2:

  serve a minimum 2 out of a consecutive 4 years and a maximum 6 out of a consecutive 8 years.

Such a tier consideration would appear to be consistent with balancing the familiarity threat and the need to maintain the knowledge and experience to support audit quality. This may not be so difficult or costly to implement. Given start-up costs, including the costs associated with auditor learning, it would seem advantageous for firms to run the full seven-year time-on period. Firms will appropriately evaluate the cost of having an EP serving a shorter time period on audit effectiveness and changing of the EP. For those instances where firms are not able to run the full time-on period, or for whatever reason (such as the illness of an EP) decide to replace the EP before completion of the seven-year period, then the tiered approach would apply. With this system, a KAP serving as an EP for less than four years will have the same cooling-off period as other KAPs.

• Question 10:

  After two years of the five-year cooling-off period has elapsed, should an engagement partner be permitted to undertake a limited consultation role with the audit team and audit client?

• Question 11:

  Do respondents agree with the additional restrictions placed on activities that can be performed by a KAP during the cooling-off period? If not, what interaction between the former KAP and the audit team or audit client should be permitted and why?

The Committee agrees with the proposed changes to restrictions placed on activities of the KAP during the time-off period—to ensure that the outgoing partner cannot influence the incoming partner or the ongoing audit during the cooling-off period. Specifically, we concur that an EP who is, or becomes, primarily responsible for consulting on technical or industry-specific issues may provide such consultation to the engagement team or client after two years has elapsed, provided the issues consulted on were not previously considered when acting as an EP. During the cooling-off period it is also reasonable, as stipulated by the IESBA, that the KAP should not be overseeing the firm's relationship with the audit client or undertake any other role with respect to the audit client, including the provision of nonassurance services, that would result in the KAP having significant or frequent interaction with senior management or those charged with corporate governance, or exerting direct influence on the outcome of the audit engagement.

• Question 14:

  Do respondents agree with the analysis of the impact of the proposed changes? In the light of the analysis, are there any other operational or implementation costs that the IESBA should consider?

As discussed above under the “Disagreement with Specific Provision of Paragraph 290.150A” section, while the proposal with respect to an EP serving for part of the seven-year period was chosen by the IESBA as being the least complex option, there may be other options not too difficult or costly to implement and that are reasonable and equitable. We believe that the tiered approach, as suggested above, or some variation of it, is one such option.

The IESBA ED proposes a change to increase the cooling-off period for KAPs of PIEs based on evaluation of whether the existing Code's time-on/time-off period of 7/2 remains appropriate to address the threat of a long association of firm personnel. The ED also proposes restricting activities with respect to audits by former KAPs during the cooling-off period. The IESBA considers five years to be the preferred option for extending the cooling-off period. No other jurisdictions currently apply a 7/5 years rotation approach solely for the engagement partner, and only three large jurisdictions (the U.S., U.K., and Canada) that participated in the benchmarking survey have a five-year cooling-off period for the lead engagement partner and the EQCR on a listed company audit. The current time-on/time-off period for a KAP in the U.S. is 5/5. Therefore, the proposed change by the IESBA of extending the cooling-off period for EPs (for a rotation requirement of 7/5) appears to be more in alignment with the current U.S. rotation requirement aimed at reducing the familiarity threat to an acceptable level, while ensuring a fresh look on the audit engagement.