Enquiry:

We would like to obtain an opinion regarding the indebtedness of external auditors of a
banking company, where the firm has obtained an unfunded facility from that banking company.

Relevant Requirements of Companies Ordinance 1984

Clause (d) of sub section 3 section 254 states that a person who is indebted to the Company shall not be appointed as auditor of a company.

Sub section 3A clarifies that a person shall not be deemed indebted to the company if a person who owes:

(a) a sum of money not exceeding five hundred thousand rupees to a credit card issuer: or
(b) a sum to a utility company in form of unpaid dues for a period not exceeding ninety days

ICAP Code of ethics for Chartered Accountants (revised April 28, 2015)

Loans and Guarantees

290.117 states that “a loan, or a guarantee of a loan, to a member of the audit team, or a member of that individual’s immediate family, or the firm from an audit client that is a bank or a similar institution may create a threat to independent. If a loan or guarantee is not made under normal lending procedures, terms and conditions, a self-interest threat would be created that would be so significant that no safeguards could reduce the threat to an acceptable level. Accordingly, neither a member of the audit team, a member of that individual’s immediate family, nor a firm shall accept such a loan or guarantee.”

290.118 states that “if a loan to a firm from an audit client that is a bank or similar institution is made under normal lending procedures, terms and conditions and it is material to the audit client or firm receiving the loan, it may be possible to apply safeguards to reduce the self-interest threat to an acceptable level. An example of such a safeguard is having the work reviewed by a chartered accountant from a network firm that is neither involved with the audit nor received the loan.”

290.119 states that “a loan, or a guarantee of a loan, from an audit client that is a bank or a similar institution to a member of the audit team, or a member of that individual’s immediate family, does not create a threat to independence if the loan or guarantee is made under normal lending procedures, terms and conditions. Examples of such loan include home mortgages, bank overdrafts, car loans and credit card balances.”

Dictionary meaning

As per Oxford Dictionary:

– indebtedness: the condition of owing money
– indebted: owing money
(source: http://www.oxforddictionaiers.com/definition/english/indebtedness )

Our queries

Considering the above requirements of law and ICAP Code of Ethics for Chartered Accountants, we would like to have an opinion of the Committee on:

Would a firm be deemed indebted to a banking company in following cases:

a. If firm has obtained and utilized unfunded facility (guarantee) only?
b. If firm has obtained funded facility from the banking company but has not utilized that facility?

Opinion:

The Committee would like to draw your attention to the section 254(3) of Companies Ordinance, 1984 and section 290.117 to 290.118 of revised ICAP Code of Ethics for Chartered Accountants (the Code), already reproduced in your query. These sections of the Code explain scenario and safeguards where loan or guarantee of loan is obtained under normal lending terms or not. However, the requirements of section 254(3)(d) of the Companies Ordinance, 1984 are stricter than the Code and disqualify a person to become an auditor if he/she is indebted to client.

With regard to your queries, the Committee is of the view that if a firm has obtained and utilized unfunded facility that is guarantee, a liability has been created; hence it appears to create indebtedness to firm. In this case, the Committee is of the view that self-interest threat would be created that would be so significant that no safeguards could reduce the threat to an acceptable level. Accordingly, a firm should not accept such guarantee.

For second query, the Committee is of the view that loan comes under funded facility and therefore, guidance can be taken from requirements of section 290.117-290.119 of the Code. In this scenario, as non-utilization of a funded facility is temporary and the facility is obtained with the objective of availing it, therefore, it would also create indebtedness and a risk to self-interest threat as soon as it is utilized. Therefore, the firm should avoid taking such banking facilities from the banking clients in both the scenarios.

Note: In addition to above, the enquirer was also advised to take opinion from legal advisor as it could have legal implications.

(November 09, 2015)