ICAP Code of Ethics

1.   Public Sector bidding for auditors

Enquiry:

For the purpose of appointment of external auditors for the public sector entity against the tender for the financial year 2017-18, few chartered accountant firms has quoted fee for financial year 2017-18 lower than as charged by our outgoing auditors, our revenue, expenses & balance sheet size has also increased for the financial year 2017-18.

As per ICAP Code of Ethics for Chartered Accountants:

“Fee quoted lower than that charged by the chartered accountants in practice previously carrying out the audit be regarded as undercutting.”

You are therefore requested to kindly guide us whether can we avail the professional services for the financial 2017-18 from those chartered accountant firms who have quoted fee lower than as charged by our outgoing auditors or otherwise.

Opinion:

The Committee would like to clarify that the entity making appointment of the auditor is responsible to appoint the auditor in accordance with legal and regulatory provisions applicable to such entity.

It is pertinent to mention that the Code of Ethics for Chartered Accountants (the Code) issued by ICAP applies to the members of the Institute.

Section 240.1 of the Code recognizes that audit fee is a commercial matter to be agreed between the auditor and the appointing entity. When entering into negotiation regarding professional services, an auditor may quote whatever fee is appropriate in commensuration with the nature and service to be rendered. However, the quantum and scope of audit work are important and relevant factors in the determination of auditor’s fee. In accordance with requirements of the Code if the scope and quantum of audit work does not materially differ from the work carried out by the previous auditor, the audit fee lower than the fee charged by the previous auditor could be regarded as undercutting.

Based on the information provided in your enquiry the revenue, expenses and financial position of the company has improved/increased from the previous audited year.

In accordance with section 240.1 of the Code, it is not permissible for the incoming auditor to accept an audit engagement at a fee lower than that charged by the previous year external auditor unless the scope and quantum of audit work has reduced compared to the previous audited year. However, the provision of the relevant information (such as the fee being charged by the previous auditor, the scope and quantum of work, the changes in scope and quantum of work etc.) by the appointing entity, prior to the submission of the proposal, to the proposing auditor for determining/ quoting audit fee is also to be given consideration.

It is advisable that the appointing entity’s management or those charged with governance may engage in a dialogue with the proposed auditor(s) to ensure that the auditor(s) have the complete information (such as the previous year audit fee, quantum and scope of the current year’s audit work etc.), necessarily required for the determination of the audit fee. This approach will help in avoiding any miscommunication and/or misunderstanding in relation to the determination and agreement of audit fee. Accordingly, the reporting entity may proceed in the matter in accordance with the guidelines provided by section 240.1 of the Code, the legal and regulatory provisions and the procurement policies and rules applicable in the circumstances.

(May 09, 2018)

2.  Query on statutory positions

Enquiry:

Mr. ZAMS is a qualified Chartered Accountant and holds following positions in a same group:

• Head of Internal Audit, Risk and Compliance in a Listed Modaraba, (on its payroll, dedicated function);
• Head of Internal Audit (acting as coordinator to a outsourced auditor’s firm) of an Investment Bank;
• Head of Internal Audit (acting as coordinator to a outsourced auditor’s firm) and Compliance Officer of a brokerage house; and
• Head of Internal Audit (acting as coordinator to an outsourced auditor’s firm) of an asset management fund and its three associated funds.

Does COCG allow one person to hold multiple statutory positions?

Opinion:

The Committee considered the requirements given in the Code of Corporate Governance, 2012 (the Code) and the requirements given in the Companies Act, 2017.

The Code

The revised ICAP Code of Ethics for Chartered Accountants 2015 (the Code of Ethics) institutes the fundamental principles of professional ethics and provides a conceptual framework for applying those principles. One of the basic elements of the framework is ‘Independence’. It is important to note that independence of mind and in appearance is necessary to enable the chartered accountants to enable them to perform their functions without bias, conflict of interest or undue influence.

Your attention is drawn to the following sections of Part C of the Code of Ethics relating to Chartered Accountants in Business:

300.6 A chartered accountant in business shall not knowingly engage in any business, occupation, or activity that impairs or might impair integrity, objectivity or the good reputation of the profession and as a result would be incompatible with the fundamental principles.

310.1 A chartered accountant in business may be faced with a conflict of interest when undertaking a professional activity. A conflict of interest creates a threat to objectivity and may create threats to the other fundamental principles. Such threats may be created when:

• The chartered accountant undertakes a professional activity related to a particular matter for two or more parties whose interests with respect to that matter are in conflict; or
• The interests of the chartered accountant with respect to a particular matter and the interests of a party for whom the chartered accountant undertakes a professional activity related to that matter are in conflict.

A party may include an employing organization, a vendor, a customer, a lender, a shareholder, or another party.

A chartered accountant shall not allow a conflict of interest to compromise professional or business judgment.

310.3 When identifying and evaluating the interests and relationships that might create a conflict of interest and implementing safeguards, when necessary, to eliminate or reduce any threat to compliance with the fundamental principles to an acceptable level, a chartered accountant in business shall exercise professional judgment and be alert to all interests and relationships that a reasonable and informed third party, weighing all the specific facts and circumstances available to the chartered accountant at the time, would be likely to conclude might compromise compliance with the fundamental principles.

In view of the above, the Committee is of the view that the Head of Internal Audit of one group company of a listed company can hold similar position in any other listed company of the same group, only where independence is not impaired and conflict of interest is not created while performing his/her statutory responsibilities with the other role.

Further, appropriate safeguards should be applied, when necessary, to eliminate the threats to compliance with the fundamental principles created by the conflict of interest or reduce them to an acceptable level.

The Companies Act, 2017

You are advised to ensure compliance, to the extent applicable in your case, with the related definitions and sections of the Companies Act, 2017 which have been reproduced below for reference: (underline is ours)

2(45) “officer” includes any director, chief executive, chief financial officer, company secretary or other authorised officer of a company;

206.  Interest of officers. (1) Save as provided in section 205 in respect of directors, no other officer of a company who is in any way, directly or indirectly, concerned or interested in any proposed contract or arrangement with the company shall, unless he discloses the nature and extent of his interest in the transaction and obtains the prior approval of the board, enter into any such contract or arrangement.

(2) ………………………

208. Related party transactions. (1) A company may enter into any contract or arrangement with a related party only in accordance with the policy approved by the board, subject to such conditions as may be specified, with respect to-

a) to e) ……………………………
f) such related party’s appointment to any office or place of profit in the company, its subsidiary company or associated company:

Provided that where majority of the directors are interested in any of the above transactions, the matter shall be placed before the general meeting for approval as special resolution:

Explanation.- In this sub-section:

(a) the expression “office of profit” means any office:

(i) …………….
(ii) where such office is held by an individual other than a director or by any firm, private company or other body corporate, if the individual, firm, private company or body corporate holding it receives from the company anything by way of remuneration, salary, fee, commission, perquisites, any rent-free accommodation, or otherwise;

(c) the expression “related party” includes-

(i) a director or his relative;
(ii) a key managerial personnel or his relative;……………….

(July 07, 2017)

3.  Appointment of Auditors

Enquiry:

Background Information:

1- Audit Firm issued quotation of audit fee against a request from Private Limited Company.
2- The Company appointed them as their auditors in AGM, without complying with the requirements of Section 253 of the Companies Ordinance, 1984.
3- On intimation of appointment from Company, the new Auditors inquired, if the Company has complied with the requirements of Section 253 of the Companies Ordinance, 1984 and wrote to retiring Auditor for professional clearance.
4- Retiring Auditor responded that due to non-compliance by the Company, they believe new appointment is invalid and question of professional clearance does not arise.
5- On receiving information from the Company, regarding non-compliance with section 253, the new auditors sought views of SECP and ICAP on the matter, who suggested that the new appointment is valid.
6- Views of SECP and ICAP were shared with retiring Auditors, whereas no response was received thereafter, despite several reminders.

Queries:

A) Would the new auditor be guilty of professional misconduct in terms of clause 7 & 8 of Part 1 of 1st Schedule to Chartered Accountants Ordinance, 1961, if he accepts the appointment, even after obtaining attached clarification from SECP and ICAP;

B) If the Institute believes that accepting this engagement would lead to a professional misconduct, would the new auditor be required to resign from the position (since Company believes, based on SECP opinion, that they have appointed the auditors) or should he simply refrain from accepting the engagement (since, the appointment has not yet been accepted by the new Auditors);

C) If the new auditor resign, and the Company fills in casual vacancy by appointment of another firm other than retiring auditors, would that other firm be guilty of professional misconduct in terms of Clause 8 of Part 1 of 1st Schedule to Chartered Accountants Ordinance, 1961;

D) If the new auditor refuses to accept the appointment, based on non-serving of notice and Commission appoints them again u/s 252(6) of the Companies Ordinance, 1984 or SECP appoints any firm other than retiring auditors, would the new auditor appointed by the Commission be guilty of professional misconduct, if they accept the engagement.

Opinion:

The Committee discussed your enquiry and its views on each of the questions are as follows:

On Query A, B & C, the Committee is of the view that provisions related to professional misconduct in case of acceptance of appointment of auditor by practicing member are appropriately covered in Schedule 1 of Part 1 of the Chartered Accountants Ordinance, 1961 and under section 210 ‘Professional Appointment’ of the revised ICAP Code of Ethics 2015.

On Query D, the Committee is of the view that an auditor appointed under section 252(6) is also required to communicate in writing with the outgoing auditor before accepting the appointment.

(February 06, 2017)

4. Conflict of Interest

Enquiry:

Our firm has been appointed by Communication & Works Department, Government of the Punjab (GOPb) to carry out the assignment relating to M/s. ABC Private Limited (“the company”), which has undertaken a road project on Build Operate Transfer (BOT) basis, for the following scope of work:

a) to review and certify, monthly statement of transactions undertaken from the project maintenance/escrow account in accordance with the provisions of the agreement related to the project.
b) To audit and certify, the basis and computation of the claim by the RBOC related to compensation for cost resulting from changes in design in accordance with the provisions of the agreement related to the project.
c) To audit and certify, the basis and computation of the claim by the RBOC or GOPb related to request for the revision of toll rates and for an appropriate amendment in the toll escalation rules and where necessary in accordance with the provisions of the agreement related to the project.
d) To audit and verify the claim of loss by RBOC and provide amount due and payable with respect of the claim in accordance with the provisions of the agreement related to the project.
e) To audit and verify the basis of computation of any other claims under this agreement filed by RBOC or the GOPb as defined in clause 33.2.1 of the agreement related to the project.
f) To review any and all audit reports issued by the RBOC auditor for correctness and compliance in accordance with the provisions of the agreement related to the project.

The period relating to the above assignment is from October, 2003 to September, 2028. The financial statements of the company are audited by another firm M/s. XYZ & Co. Chartered Accountants. Our partners, Mr. G & Mr. F were partners of M/s. XYZ & Co. Chartered Accountants till May 2006. During the period, the financial statements of the company for the half year ended Dec 31, 2004 & year ended June 30 2005 were audited by M/s. XYZ & Co. Chartered Accountants as per accounts provided by M/s. ABC Private Limited and the audit reports were signed by Mr. G.

In the light of the above, kindly give us Committee’s opinion if there is a conflict of interest under either of the following circumstances:

i. Partner who remained the partners in M/s. XYZ & Co. is engagement partner of the assignment.
ii. Another partner of M/s. XYZ & Co. who never remained part of M/s. XYZ & Co. is engagement partner of the assignment.

Opinion:

We would like to refer revised ICAP Code of Ethics for Chartered Accountants (the Code) which institutes the fundamental principles of professional ethics and provides a conceptual framework for applying those principles. One of the basic elements of the framework is ‘Independence’. It is important to note that independence of mind and in appearance is necessary to enable the practicing chartered accountants to enable them to express a conclusion, without bias, conflict of interest or undue influence.

Practicing chartered accountants are expected to provide an assurance and variety of non-assurance services that are consistent with their skills and expertise. While rendering other services to an audit client, practicing chartered accountants are required to apply the conceptual framework to identify threats to compliance with the fundamental principles and assess their significance and implication.

The onus of evaluation of such threats to compliance with the fundamental principles rests on the practicing chartered accountants and they should consider qualitative as well as quantitative factors while performing such evaluation. Such obligation on the part of a practicing chartered accountant becomes more critical in a situation where the applicable guidelines or regulations do not clearly prohibit any specific service. Relationships should be avoided which allow prejudice, bias or influences of others to override objectivity.

In this connection, the Committee would also like to refer the following paras of section 220 ‘Conflict of Interest’ of the Code which states:

220.1 A chartered accountant may be faced with a conflict of interest when undertaking a professional activity. A conflict of interest creates a threat to objectivity and may create threats to the other fundamental principles. Such threats may be created when:

• The chartered accountant provides a professional service related to a particular matter for two or more clients whose interests with respect to that matter are in conflict; or
• The interests of the chartered accountant with respect to a particular matter and the interests of the client for whom the chartered accountant provides a professional service related to that matter are in conflict. (Underline is ours)

A chartered accountant shall not allow a conflict of interest to compromise professional or business judgment. When the professional service is an assurance service, compliance with the fundamental principle of objectivity also requires being independent of assurance clients in accordance with Sections 290 or 291 as appropriate.”

220.3 When identifying and evaluating the interests and relationships that might create a conflict of interest and implementing safeguards, when necessary, to eliminate or reduce any threat to compliance with the fundamental principles to an acceptable level, a chartered accountant in practice shall exercise professional judgment and take into account whether a reasonable and informed third party, weighing all the specific facts and circumstances available to the chartered accountant at the time, would be likely to conclude that compliance with the fundamental principles is not compromised.”

220.5 If the threat created by a conflict of interest is not at an acceptable level, the chartered accountant in practice shall apply safeguards to eliminate the threat or reduce it to an acceptable level. If safeguards cannot reduce the threat to an acceptable level, the chartered accountant shall decline to perform or shall discontinue professional services that would result in the conflict of interest; or shall terminate relevant relationships or dispose of relevant interests to eliminate the threat or reduce it to an acceptable level.”

220.6 Before accepting a new client relationship, engagement, or business relationship, a chartered accountant in practice shall take reasonable steps to identify circumstances that might create a conflict of interest, including identification of:

• The nature of the relevant interests and relationships between the parties involved; and
• The nature of the service and its implication for relevant parties.

The nature of the services and the relevant interests and relationships may change during the course of the engagement. This is particularly true when a chartered accountant is asked to conduct an engagement in a situation that may become adversarial, even though the parties who engage the chartered accountant may not initially be involved in a dispute. The chartered accountant shall remain alert to such changes for the purpose of identifying circumstances that might create a conflict of interest.”

In the light of above, the Committee views on your queries are as follows:

1. To avoid a risk of conflict of interest, the Code requires that safeguards should be applied, when necessary, to eliminate or reduce any threat to compliance with the fundamental principles to an acceptable level. In Committee’s view, there is a self-review threat for partners, Mr. G & Mr. F as their previous firm has done external audit for the half year ended 31 December, 2004 and year ended 30 June, 2005. Therefore, they should not act as engagement partners or technical/ quality review partners for those years.

The Committee is also of the view that it is the duty of the incoming auditor to guard against independence/ familiarity threats, if any, including the cooling-off period of the outgoing partner(s). Section 290.149 of the Code requires cooling off period of two years for clients who are public interest entities. For private companies no such requirement is given. However, firms may have longer cooling-off periods as per their respective partnership arrangements

2. No apparent conflict of interest arises in the inquired situation.

(November 25, 2016)

5. Performing accounting and audit of Public Interest Entity

Enquiry:

The Public Interest Entity (PIE) floated a tender inviting bid from CA firms for accounting and audit work. There was no mention in the tender document that firms could apply in consortium/ JV for the assignment. Moreover, as per text of the terms of reference of the bid only technically and financially qualified firm (singular connotation) is to be selected for the above mentioned services. Keeping in view the above scenario, we request to provide technical advice on the following matters:

1. For PIE, is a firm allowed to undertake both accounting work and audit of financial statements.

2. If not allowed, then can conflict of interest be avoided in either of the following circumstances:

a. In response to the tender, one firm submits bid for the providing both accounting and auditing work in its own name. To avoid conflict of interest it mentions in the bid documents that it has entered into an agreement (internal agreement) with another firm that either of the assignments shall be performed by one of them. Although, the responsibility for the execution of both assignments would rest on the applicant firm.

b. Two firms submit one bid by forming JV/ consortium for both the assignments together and enter into agreement (internal agreement) between themselves defining the allocation of the work. Can conflict of interest be avoided under such an arrangement, whereas submission of joint bid implies that both the firms shall be jointly responsible for both the assignments.

It is requested to kindly provide technical guidance on each of the scenario stated above.

Opinion:

The ICAP revised Code of Ethics for Chartered Accountants 2015 (the Code) provides a conceptual framework for applying fundamental principles of professional ethics, one of which is ‘Independence’.

A practicing chartered accountant is required to apply the conceptual framework to identify threats to compliance with the fundamental principles and assess their significance and implication. The responsibility of evaluation of such threats to compliance with the fundamental principles rests on the practicing chartered accountants and they should consider qualitative as well as quantitative factors while performing such evaluation. In case where practicing chartered accountants render such services which may coincide with management functions and management decision making, the threat of “Self Review” could exist.

In this connection the Committee would also like to refer the paragraphs 290.164 – 290.167 of the Code which states:

Preparing Accounting Records and Financial Statements

General Provisions

290.164 Management is responsible for the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework. These responsibilities include:
• Originating or changing journal entries, or determining the account classifications of transactions; and
• Preparing or changing source documents or originating data, in electronic or other form, evidencing the occurrence of a transaction (for example, purchase orders, payroll time records, and customer orders).”

290.165 Providing an audit client with accounting and bookkeeping services, such as preparing accounting records or financial statements, creates a self-review threat when the firm subsequently audits the financial statements.”

Para 290.166 – 67 describes the activities that are considered to be a normal part of the audit process and do not, generally, create threats to independence.

Para 290.168 of the Code allows the audit firm that may provide accounting related services only in case of audit clients that are not public interest entities, subject to applying certain safeguards. Such services are considered to be of a routine or mechanical nature, so long as any self-review threat created is reduced to an acceptable level. This relaxation does not exist for audit clients that are public interest entities.

In the light of above, the Committee views on your queries are as follows:

1. Audit firm is not allowed to undertake both accounting work and audit of financial statements of public interest entities simultaneously.

2. The independence of mind and in appearance is necessary to enable the practicing chartered accountants to express a conclusion, without bias, conflict of interest or undue influence. Therefore, in Committee’s view, the fundamental principle of ‘Independence’ will be impaired in both the given circumstances.

(December 15, 2016)

6. Notice U/S 161/205 of the Income Tax Ordinance, 2001 issued to Corporation for Tax Year 2013-14

Enquiry:

This query is related to ABC Corporation on which FBR had some observations related to code of ethics compliance for tax year 2013-14.

Background:

ABC Corporation is established in China as a state-owned hydropower project contractor during the 1950s. It has dynamic network including regional divisions and offices in Asia, Africa, Oceania, South America and Europe, supervising 113 overseas branches / representative offices in 84 countries. In Asia, their head office is located in Islamabad. ABC Corporation Limited is listed as a registered taxpayer.

Extract of FBR observation on audit firm of Corporation, M/s XYZ & Company, Chartered Accountants, is reproduced below:

“…..It is further pertinent to mention that not only your firm, M/s XYZ & Company, Chartered Accountants, prepared the Financial Statements and Audited Accounts of the company, in fact they are also the engaging partner of the concerned company which shows either professional incompetence of the firm or deliberate attempt aiming at misleading the undersigned.
It has also been observed that preparation of financial statements and conducting of audit by the same firm and simultaneously representing the taxpayer being tax attorney before the Inland Revenue Authorities is not only morally wrong but also against the professional ethics and the best international practice in vogue all across the world. In Pakistan, after realizing the same, SECP has changed this practice for public listed companies.”

Opinion:

The relevant Committee of the Institute (the Committee) has considered the matter and would like to inform you that in 1990 the Institute adopted the International Federation of Accountants’ (IFAC) Code of Ethics for Professional Accountants for the first time with some amendments so that the services provided by its members should be in accordance with the internationally accepted norms and principles. Since then the Institute is following IFAC’S Code. In April 2015, the International Ethics Standards Board for Accountants (IESBA) of IFAC issued a revised Code of Ethics for Professional Accountants, clarifying requirements for all professional accountants and significantly strengthening the independence requirements of auditors in providing their services, which was adopted by the Institute subject to some changes as per local regulatory requirements.

The Committee would like to refer the following paragraphs of ICAP Code of Ethics (the Code) issued in 2008, as the query relates to tax year 2013-14:

290.159 The potential threats to independence will most frequently arise when a non-assurance service is provided to a financial statement audit client. ……. Threats to independence, however, may also arise when a firm provides a non-assurance service related to the subject matter information, of a non- financial statement audit assurance engagement. In such cases, consideration should be given to the significance of the firm’s involvement with the subject matter information, of the engagement, whether any self-review threats are created and whether any threats to independence could be reduced to an acceptable level by application of safeguards, or whether the engagement should be declined. ……..

290.164 The provision of certain non-assurance services to financial statement audit clients may create threats to independence so significant that no safeguard could eliminate the threat or reduce it to an acceptable level. However, the provision of such services to a related entity, division or discrete financial statement item of such clients may be permissible when any threats to the firm’s independence have been reduced to an acceptable level by arrangements for that related entity, division or discrete financial statement item to be audited by another firm or when another firm reperforms the non-assurance service to the extent necessary to enable it to take responsibility for that service.

290.165 Assisting a financial statement audit client in matters such as preparing accounting records or financial statements may create a self-review threat when the financial statements are subsequently audited by the firm.

290.166 It is the responsibility of financial statement audit client management to ensure that accounting records are kept and financial statements are prepared, although they may request the firm to provide assistance. If firm, or network firm, personnel providing such assistance make management decisions, the self-review threat created could not be reduced to an acceptable level by any safeguards. Consequently, personnel should not make such decisions. Examples of such managerial decisions include:

• Determining or changing journal entries, or the classifications for accounts or transaction or other accounting records without obtaining the approval of the financial statement audit client;
• Authorizing or approving transactions; and
• Preparing source documents or originating data (including decisions on valuation assumptions), or making changes to such documents or data.

In addition to above, please refer the safeguards provided in the paragraph 290.162 of the Code when non-assurance services are provided to assurance clients.

Financial Statements Audit Clients that are Not Listed Entities

290.169 The firm, or a network firm, may provide a financial statement audit client that is not a listed entity with accounting and bookkeeping services, including payroll services, of a routine or mechanical nature, provided any self-review threat created is reduced to an acceptable level.

Examples of such services include:
• Recording transactions for which the audit client has determined or approved the appropriate account classification;
• Posting coded transactions to the audit client’s general ledger;
• Preparing financial statements based on information in the trial balance; and
• Posting the audit client approved entries to the trial balance.

The significance of any threat created should be evaluated and, if the threat is other than clearly insignificant, safeguards should be considered and applied as necessary to reduce the threat to an acceptable level. Such safeguards might include:

• Making arrangements so such services are not performed by a member of the assurance team;
• Implementing policies and procedures to prohibit the individual providing such services from making any managerial decisions on behalf of the audit client;
• Requiring the source data for the accounting entries to be originated by the audit client;
• Requiring the underlying assumptions to be originated and approved by the audit client; or
• Obtaining audit client approval for any proposed journal entries or other changes affecting the financial statements.

In the light of above, the Code allows unlisted company’s auditor to prepare financial statements and also to perform audit, provided safeguards are in place.

With regard to providing tax related advisory services, the Committee would also like to draw your attention to para 290.176 of the Code:

290.176 The firm may be asked to provide taxation services to a financial statement audit client. Taxation services comprise a broad range of services, including compliance, planning, provision of formal taxation opinions and assistance in the resolution of tax disputes. Such assignments are generally not seen to create threats to independence.

The Committee is of the opinion that the external auditor may engage in tax advisory services. However, certain tax services may also pose a threat in the form of self-review and/or advocacy for which the auditor needs to take care of by applying the necessary safeguards.

In addition to above, the Committee would also like you to refer section 290.175-290.188 pertaining to the taxation services of the revised ICAP Code of Ethics 2015 which is effective for audits of financial statements for periods beginning on or after July 01, 2015. In section 290.179-290.180, the revised Code distinguishes between the requirements for listed and unlisted clients, otherwise it allows external auditor to perform varied taxation services that are mentioned in the Code.

The full copy of the ICAP Code of Ethics can be accessed at:

http://www.icap.net.pk/wp-content/uploads/2013/12/Code-of-Ethics-2008.pdf
http://www.icap.net.pk/wp-content/uploads/2013/12/ICAP-revised-Code-of-Ethics-2015.pdf

(May 09, 2016)

7. Indebtedness of Auditors

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)

8. Appointment of Consultant for Internal Audit Assignments

Enquiry:

ABC Ltd (hereinafter referred to as ‘Company’) is a Public Sector Enterprise listed at all Stock Exchanges of Pakistan. The Company complies with Code of Corporate Governance 2012 and Public Sector (Corporate Governance) Rules 2013, both issued by Securities and Exchange Commission (SECP) of Pakistan.

The Company has a well-equipped Internal Audit Department, headed by a Qualified Professional (FCA), and the Department carries out all Internal Audit Assignments in-house, except for few third party audits which are outsourced, keeping in view availability of staff resources.

Public Sector (Corporate Governance) Rules 2013 (hereinafter referred to as ‘Rules 2013’) requires all Public Sector Enterprises to implement, as far as practicable, International Standards for the Professional Practice of Internal Auditing (the Standards) issued by the Institute of Internal Auditors (the IIA).

External Quality Assessment Review: The Board Audit Committee (BAC) of the Company decided to conduct an External Quality Assessment Review (QAR) of Internal Audit Department, keeping in view the provisions of the IIA Standard 1312. The objective of this review was to assess the effectiveness of Audit Function, and to identify areas where improvement can take place. Furthermore, another objective of this review was to obtain independent assurance that all legal and regulatory requirements associated with Internal Audit Function are being complied with and that sufficient procedures exists within the Internal Audit Department to ensure that Quality work is performed.

Draft Internal Audit Manual: The Internal Audit Department has also prepared a Draft Internal Audit Manual, detailing procedures that should be implemented in the Audit Department, so as to achieve more efficiency and standardization of audit work. The procedures are in draft form, and are different from existing procedures being followed. Keeping in view that an External QAR may take place, it was envisaged that results of QAR are likely to impact the Draft Procedures which may require amendment/ improvement. Therefore, it was decided that results of QAR will be incorporated in the draft Manual, so that its implementation will not cause any inconsistency with the results and recommendations of QAR.

Scheme of Work:

For this purpose, Internal Audit Department wants to appoint a Consultant, to broadly cover the following work:

1. Carry out QAR in line with guidelines of the Standards issued by IIA, and produce a report highlighting areas in Internal Audit Department where improvement is sought, including the blend of staff and core competencies required, scope of work, effectiveness of existing procedures, etc.

2. To take the results of QAR and review the Draft Audit Manual and ensure that the draft procedures are in line with the results and recommendations of QAR. Where any inconsistency is noted, the Consultant will be required to make suitable amendments or additions in draft procedures to bring them in line with results of QAR.

Question:

The Management of the Company is evaluating whether the above scheme of work raises any question of ‘Conflict of Interest’ or ‘Independence’ if the work of QAR and Revalidation of Draft Audit Manual is given to a single consultant. The Management has the following questions:

1. If the Consultant who is carrying out QAR is also required to revalidate the Draft Procedures, will it create a ‘Conflict of Interest’, keeping in view the requirements of IIA Standard?

2. Does QAR falls under the ‘Attribute’ Standards, and Review of Manual falls under ‘Performance’ Standards, and if so, do the Standards require that these work be carried out mandatorily by two separate consultants?

Internal Audit Department of the Company has reviewed the Standards in detail, including Practice Advisory on QAR (1312-1) and finds that no such conflict of interest prevails if a single consultant is required to carry out QAR and revalidation of draft Internal Audit Manual. Furthermore, QAR covers compliance of all Standards, and not just Attribute standards, and review of existing procedures is also part of such QAR.

Request to ICAP Committee:

The Committee is requested to kindly provide its view on the questions 1 and 2 noted above. The opinion of honorable Committee will assist the Company in opting a way forward.

Opinion:

The Committee has considered your enquiry and would like to state in the beginning that the Committee primarily deals with matters related to accounting, auditing, governance and related laws and regulations. Accordingly, the knowledge and expertise of standards issued by the Institute of Internal Auditors are not available with the Committee and accordingly we are constrained to issue any views and opinions on these standards.

However, since the matter relates to practicing members of the Institute, the Committee is expressing its views in accordance with the ICAP Code of Ethics, as applicable in Pakistan, which is obligatory on ICAP members.

Accordingly, we are expressing views on question 1 only.

Based on the available information the Committee considers that conflict of interest situation does not appear to arise when both the engagements are performed by a single consultant.

However, the Committee would like to emphasize that one of the primary responsibilities of the Audit Committee is to assess independence while approving engagement of consultants. The Audit Committee must take into account relevant facts, including an inquiry from prospective consultants regarding their own independence assessment of the engagement, and firm level risk mitigation and threat safeguard procedures to be adopted by the firm.

(April 22, 2014)

9. Appointment of External Auditors for FATCA Implementation Advisory Services

Enquiry:

Public sector is seeking FATCA implementation advisory services. The Consultant will be responsible for performing a detailed FATCA assessment followed by development of remediation plans and provision of implementation advisory for assisting the Bank in its timely compliance with FATCA requirements. The TOR of FATCA requirements are given below:

Introduction

Recent developments in the international. efforts for preventing tax evasion including introduction of the Foreign Account Tax Compliance Act (FATCA) by the US Internal Revenue Service (IRS) aimed primarily at facilitating global information exchange have impacted the financial sector including banks across the globe. As a response to these developments, financial institutions are required to align their customer due diligence/ Identification and reporting practices to be able to play their part in facilitating information exchange with US under FA TCA.

The governmental, regulatory and other stakeholders in Pakistan are engaged in joint efforts to respond to challenges arising out of the developments at international level. The State Bank of Pakistan has advised Financial Institutions/ Banks to initiate necessary actions and preparation to comply with FA TCA as per the timelines in order to protect the financial sector from negative implications.

In pursuance to SBP instructions, National Bank of Pakistan (NBP) is engaged in preparatory efforts for ensuring timely compliance with F ATCA requirements while a formal regulatory framework and issuance of necessary implementation guidelines and circulars by SBP are in progress. As a part of these efforts, NBP intends to put in place the required internal framework/ system for ensuring ongoing and consistent fulfillment of its role towards information exchange and introduce focused enhancements to functional aspects, structures, systems as well as processes to provide a sound basis for implementing the framework/ system under SBP instructions and in accordance with FA TCA regulations.

Key Components of FATCA Exercise

The following are some key elements of the exercise:

• Legal entity analysis and documentation of the Bank’s expanded affiliate group structure (EAG) covering all subsidiaries/ related entities and all foreign branches.
• Developing a detailed FATCA governance framework including governance responsibilities/ structure, responsibilities for regulatory returns, roles and responsibilities with respect to collection, screening and submission of information etc. Developing a FA TCA project governance and management structure for efficient management of different aspects of the project

With respect to NBP Pakistan Operations:

Collection of relevant information/ documentation for assessment of the existing state of affairs in relation to readiness for FA TCA implementation (including documentation of processes, products, policies, systems and controls in-scope for FA TCA implementation) Assessment of existing! as-is state of operating models/ policy and procedural documentation and practices, templates, tools, checklists, organizational structures, data management structure, systems and MIS/ reporting frameworks to identify gaps/ departures from readiness for implementation of FATCA regulations both for new and pre-existing accounts.

• Development of detailed remediation! implementation plans for remediating the gaps identified to provide blue prints of tasks/ initiatives to be undertaken during the implementation stage including the following:

../ Future state data framework identifying relevant information capturing parameters/ fields, fields to be introduced, dropdowns/ LoVs etc .
../ Future state system functionalities/ capabilities including account opening information flow dynamics, scrutiny/ authorization matrix automation, centralized quality assurance review, submission and authorization queuing functionalities etc.
../ Pre-existing account screening to provide stepwise tasks/ initiatives to be undertaken for screening/ due diligence of pre-existing accounts, method for their classification as per FATCA treatment, development of documentation/ cure procedures for positive screening of accounts etc.
../ Identifying the required enhancement to existing MIS; reporting framework of the Bank and development of future state data reporting process flow;
../ Future state system functionalities/ capabilities including information flow dynamics for monitoring and reporting purposes, MIS generation etc .
../ Transaction monitoring/ KYC/ reporting alignments including FATCAI indicia scenario development and automation, trigger setting and devising procedures for trigger follow ups
../ Updation/ enhancement of existing policy and procedural documentation of the Bank including operations manual, compliance manual and other relevant documentation
../ Development of templates including F ATCA compliant workflow for client onboarding, documentation and cure procedures/ requirements, documentation and operational checklists development, enhancement or relevant templates including account opening, KYC/ CDD, change in customer circumstances and other relevant templates, customer correspondences/notices etc.
../ Development of a process for registration with the IRS; initial and ongoing management of registration aspects
../ Implementation guidelines/ advisory for a defined period in relation to future state models/ remediation/ implementation plans to meet the requirements of FATCA
• With respect to foreign branches and foreign subsidiaries, technical (local Oil-line based) advice/ feedback on various matters pertaining to compliance with FATCA will be required.
The Bank intends to undertake the required tasks to be compliant while doing everything in its power to minimize the impact of FATCA upon its customer service, as far as possible. The Bank would attempt to ensure minimum possible impact on customer service standards, TATs of the processes and compliance to other regulatory requirements etc.

In this connection we seek your advice whether services of external auditors of the bank can be hired for the FATCA implementation and conflict of interest will not arise in such case.

Opinion:

The Audit Committee of the Bank will need to assess the appointment of external audit for the FATCA assessment engagement in relation to the prohibitions placed under clause 2 and 9 of prohibited services mentioned below. The auditor of a listed company is prohibited from providing financial information technology system design and implementation services to the listed audit clients which may be significant to overall financial statements and performing management functions or decisions.

The Committee would like to draw your attention to the following guidance provided in Code of Corporate Governance 2012 and ICAP Code of Ethics:

1. Revised Code of Corporate Governance 2012 read with clause 29-C of KSE Listing Regulations:

“(xxxvi) No listed company shall appoint its auditors to provide services in addition to audit except in accordance with the regulations and shall require the auditors to observe applicable IFAC guidelines in this regard and shall ensure that the auditors do not perform management functions or make management decisions, responsibility for which remains with the Board of Directors and management of the listed company.” (underlining is ours)

“29-C (i) No Listed company shall, appoint or continue to retain any person as an auditor who is engaged by the company to provide services that are prohibited.

Explanation:

For the purposes of this regulation the services that are prohibited shall mean the following:

1. Preparing financial statements, accounting records and accounting services;
2. Financial information technology system design and implementation, significant to overall financial statements;
3. Appraisal or valuation services for material items of financial statements;
4. Acting as an Appointed Actuary within the meaning of the term defined by the Insurance Ordinance, 2000;
5. Actuarial advice and reviews in respect of provisioning and loss assessments for an insurance entity;
6. Internal audit services related to internal accounting controls, financial systems or financial statements;
7. Human resource services relating to:-
i. Executive recruitment;
ii. Work performed (including secondments) where management decision will be made on behalf of a listed audit client;
8. Legal Services;
9. Management functions or decisions;
10. Corporate finance services, advice or assistance which may involve independence threats such as promoting, dealing in or underwriting of shares of audit clients.
11. Any exercise or assignment for estimation of financial effect of a transaction or event where an auditor provides litigation support services as identified in paragraph 9.187 of Code of Ethics for Chartered Accountants.
12. Share Registration Services (Transfer Agents)” (underlining is ours)

2. ICAP Code of Ethics for Chartered Accountants

The Committee would also like to refer the Code of Ethics for Chartered Accountants which institutes the fundamental principles of professional ethics and provides a conceptual framework for applying those principles. One of the basic elements of the framework is ‘Independence’. It is important to note that independence of mind and in appearance is necessary to enable the practicing chartered accountants to enable them to express a conclusion, without bias, conflict of interest or undue influence.

As a value addition, practicing chartered accountants are expected to provide a variety of non-assurance services that are consistent with their skills and expertise, subject to the requirement of applicable regulations including those which are stated above. While rendering other services to an audit client, practicing chartered accountants are required to apply the conceptual framework to identify threats to compliance with the fundamental principles and assess their significance and implication.

The onus of evaluation of such threats to compliance with the fundamental principles rests on the practicing chartered accountants and they should consider qualitative as well as quantitative factors while performing such evaluation. Such obligation on the part of a practicing chartered accountant becomes more critical in a situation where the applicable guidelines or regulations do not clearly prohibit any specific service. In case where practicing chartered accountants render such services which may coincide with management functions and management decision making, the threat of “Self Review” could exist.

In this connection the Committee would also like to refer the following paras of section 290 of Part B of Code of Ethics for Chartered Accountants which states:

290.183 The provision of services by a firm or network firm to a financial statement audit client that involve the design and implementation of financial information technology systems that are used to generate information forming part of a client’s financial statements may create a self-review threat.

290.184 The self-review threat is likely to be too significant to allow the provision of such services to a financial statement audit client unless appropriate safeguards are put in place ensuring that:

(a) The audit client acknowledges its responsibility for establishing and monitoring a system of internal controls;
(b) The audit client designates a competent employee, preferably within senior management, with the responsibility to make all management decisions with respect to the design and implementation of the hardware or software system;
(c) The audit client makes all management decisions with respect to the design and implementation process;
(d) The audit client evaluates the adequacy and results of the design and implementation of the system; and
(e) The audit client is responsible for the operation of the system (hardware or software) and the data used or generated by the system.

290.185 Consideration should also be given to whether such non-assurance services should be provided only by personnel not involved in the financial statement audit engagement and with different reporting lines within the firm.

290.186 The provision of services by a firm, or network firm, to a financial statement audit client which involve either the design or the implementation of financial information technology systems that are used to generate information forming part of a client’s financial statements may also create a self-review threat. The significance of the threat, if any, should be evaluated and, if the threat is other than clearly insignificant, safeguards should be considered and applied as necessary to eliminate the threat or reduce it to an acceptable level.”

Based on the TOR of FATCA implementation provided to us, the Committee believes that following services by the external auditor, may give rise to conflict of interest, unless the management of the bank in accordance with the requirements of para 290.184 of the Code of Ethics take ownership and responsibility of the work performed and decide on recommendations made by the consultant (auditor) and/or the data and information generated by the consultant (auditor) is not material to the financial statements.:

Management functions or decisions and financial information technology system design & implementation services

• Developing a detailed FATCA governance framework including governance responsibilities/ structure, responsibilities for regulatory returns, roles and responsibilities with respect to collection, screening and submission of information etc. Developing a FATCA project governance and management structure for efficient management of different aspects of the project.

• Collection of relevant information/ documentation for assessment of the existing state of affairs in relation to readiness for FATCA implementation (including documentation of processes, products, policies, systems and controls in-scope for FATCA implementation).
• Assessment of existing/ as-is state of operating models/ policy and procedural documentation and practices, templates, tools, checklists, organizational structures, data management structure, systems and MIS/ reporting frameworks to identify gaps/ departures from readiness for implementation of FATCA regulations both for new and pre-existing accounts.

Following remediation/ implementation plans may come under clause 2 ‘management functions or decisions’ and/ or which may come under clause 9 ‘financial information technology system design and implementation services’ of prohibited services:

• Identifying the required enhancement to existing MIS; reporting framework of the Bank and development of future state data/ reporting process flow;

• Future state system functionalities/ capabilities including information flow dynamics for monitoring and reporting purposes, MIS generation etc.

• Updation/ enhancement of existing policy and procedural documentation of the Bank including operations manual, compliance manual and other relevant documentation.

• Development of templates including FATCA compliant workflow for client onboarding, documentation and cure procedures/ requirements, documentation and operational checklists development, enhancement or relevant templates including account opening, KYC/ CDD, change in customer circumstances and other relevant templates, customer correspondences/notices etc.

(May 13, 2014)

10. Professional Clearance Letter

Enquiry:

We are a firm of chartered Accountant and this letter aims at requiring a professional advice regarding the following situation:

Our firm has been appointed as auditors of the company and as per the requirements of code of ethics, a professional clearance letter has been sent to previous auditor. However, no response is received from previous auditor’.

Based on the above situation, kindly guide us the procedures we are required to perform if there is no response from previous auditor on this matter despite a reminder has also been sent to them.

Opinion:

We would like to draw your attention to the following paragraphs of the ICAP Code of Ethics for Chartered Accountants: (underline is ours)

210.16 A chartered accountant in practice will ordinarily need to obtain the client’s permission, preferably in writing, to initiate discussion with an existing accountant. Once that permission is obtained, the existing accountant should comply with relevant legal and other regulations governing such requests. The existing accountant should promptly transfer to the new chartered accountant in practice all books and papers of the client, which are or may be held after the change in appointment has been effected and should advise the client accordingly, unless he has a legal right to withhold them. Where the existing accountant provides information, it should be provided honestly and unambiguously. If the proposed accountant is unable to communicate with the existing accountant, the proposed accountant should try to obtain information about any possible threats by other means such as through inquiries of third parties or background investigations on senior management or those charged with governance of the client.
210.17 Where the threats cannot be eliminated or reduced to an acceptable level through the application of safeguards, a chartered accountant in practice should, unless there is satisfaction as to necessary facts by other means, decline the engagement.

Conclusion:

he Committee emphasize that it is a professional and moral obligation for a Chartered Accountant, especially one in practice, to respond to communication from other Chartered Accountants. However, in case such a response is not forthcoming, a Chartered Accountant should take account of section 210.16 and 210.17 referred above.

(November 08, 2013)

11. Removal of Auditor before completion of their term and acceptance of appointment by the Proposed Auditors

Enquiry:

We seek your technical opinion and guidance in the following circumstances for accepting the appointment of Auditor of a Private Limited Company.

The existing auditors of the company were removed by a special Resolution of the Board of Directors of the Company before completion of their term (This being first year of operation of the company) and the proposed firm of Chartered Accountants was offered appointment as statutory Auditors for the referred year. Resultantly, in compliance with requirements of revised code of ethics 210.10, the proposed auditors sent letter through URGENT MAIL SERVICE asking for NOC from existing auditors. The existing Auditor did not respond to the proposed auditor even after the laps of 30 days.

Your opinion is sought in this respect that what options does the proposed auditor will have and what procedure should be adopted by the proposed Auditors in above mentioned circumstances.

Opinion:

We would like to draw your attention to the following paragraphs of the ICAP Code of Ethics for Chartered Accountants, explaining the procedures where existing auditor is removed before completion of his term: (underline is ours)

210.19 Where an existing chartered accountant is removed by the proprietors of the business before he has completed the audit and submitted his report, the existing chartered accountant must immediately inform the Institute with relevant facts about his removal.

210.20 The proposed chartered accountant in practice should not only follow the procedure detailed in the preceding paragraphs of this Section, he should also inform the Institute about the offer of appointment.

210.21 The proposed chartered accountant in practice should not accept the offer without prior clearance from the Institute, which clearance shall not be unreasonably withheld. Provided however, in case the Institute refuses to give its clearance, it shall communicate its decision within 15 (fifteen) days with reasons therefore.

210.16 …. If the proposed accountant is unable to communicate with the existing accountant, the proposed accountant should try to obtain information about any possible threats by other means such as through inquiries of third parties or background investigations on senior management or those charged with governance of the client.

210.17 Where the threats cannot be eliminated or reduced to an acceptable level through the application of safeguards, a chartered accountant in practice should, unless there is satisfaction as to necessary facts by other means, decline the engagement.

The Committee advices all practicing accountants that where an auditor has been removed before completion of the audit both the removed auditor and the proposed auditor must inform the Institute about relevant facts. Furthermore, the proposed auditor must not accept an audit if clearance from Institute has not been obtained in such cases.

The Committee emphasize that it is a professional and moral obligation for a Chartered Accountant, especially one in practice, to respond to communication from other Chartered Accountants. However, in case such a response is not forthcoming, a Chartered Accountant should take account of section 210.16 and 210.17 referred above.

(November 08, 2013)

12. External Auditor Conflict of Interest on review work directly related to subject matter of Assurance Engagement

Enquiry:

A brief synopsis of the matter and our query is as follows:

• The external auditors have been engaged by management for review work (agreed upon procedures) on a matter that is directly related to the subject matter of the assurance engagement and the auditor’s report/opinion.

• The Chairman Audit Committee has stated to the CFO that this is a conflict of interest viz a vis the external auditor and Internal Audit has been corresponding with the CFO to provide Management’s representation on the engagement of the external auditors for this review work prior to Audit Committee decision/approval. Internal Audit had requested the CFO to provide the following information;

a. Representation from external auditor stating safeguards taken for providing non audit services that directly affect the subject matter of the assurance engagement;

b. Clarification from ICAP on non-audit work assigned to the external auditor that directly affects the subject matter of the assurance engagement to ensure compliance with applicable Code and Guidelines (i.e., Code of Ethics etc.);

c. Clarification on what work the external auditor has been engaged for and a copy of the ‘agreed upon procedures’ engagement letter between the Company and the external auditor;

d. Legal opinion (management stated that it obtained two legal opinions to validate the action of the Company) and statement of facts submitted for obtaining the legal opinion. Internal Audit communicated to the CFO (all correspondence on this has been with the CFO) that representation from external auditor on safeguards for conflict of interest/threat mitigation and clarifications obtained from Regulators (SECP, ICAP) viz a viz Code of Corporate Governance and Code of Ethics etc. is more appropriate rather than legal opinion as the latter is only an opinion on the interpretation of laws and regulations.

• Chairman Audit Committee and Internal Audit’s view has been that where an external auditor is engaged for a financial statement audit and in the same period provides non audit services that directly affect that subject of the engagement and the auditor opinion/report, there is an inherent conflict of interest and self-review/independence threat. This however may be minimized to an acceptable level and/or mitigated against by putting in place safeguards (as also stated in the Code of Ethics for Chartered Accountants) and these representations i.e. Management and external auditor be discussed with the Audit Committee and the latter shall then decide if the external auditor can be engaged for the review work.

• However, management responded stating that ‘after due discussions with experts/professionals had decided to assign the work’ to the external auditor and ‘has also obtained an independent legal opinion which confirms that there is no conflict of interest for external auditors to carry out such assignment related to audit services’. Management has been requested to provide the above listed information but it has not provided the above as yet and has responded that that ‘there is no conflict of interest and will give its own representation to the Audit Committee and the Board’.

• The Chairman Audit Committee is not satisfied with Management’s response and on it not providing information (as listed above) including the external auditor representation (listed as point (a) above) for review when queried and has directed me to refer the matter to the regulators for their advice on the actions taken by the CFO and Management in violation of ICAP, SBP, SECP and other regulations /Code of Conduct’, relating to the conflict of interest and related self-review/independence threat (as stated the financial statements for the year ended 31 December 2011 have still not been approved thus the review work would fall under non-assurance service provided to a financial statement audit client during the period of the audit engagement).

• Chairman Audit Committee has also stated ‘appropriate regulators may also take necessary action against CFO’.

• As management has not provided the external auditor representation on the said matter, please confirm if Internal Audit (on behalf of the Audit Committee) is empowered to write to the external auditor and query it on the said matter including mitigating factors put in place to minimize threats to an acceptable level etc?

• Also, if your response confirms that Internal Audit/Audit Committee is empowered to write to the external auditor and based on the reply received if the Chairman Audit Committee is not satisfied with the external auditor representation on the assignment and conflict of interest mitigation etc., then what would the next steps be in regards to referring back to the ICAP?

Opinion:

The Code of Ethics for Chartered Accountants institutes the fundamental principles of professional ethics and provides a conceptual framework for applying those principles. One of the basic elements of the framework is ‘Independence’. It is important to note that independence of mind as well as in appearance is necessary for the practicing chartered accountants to enable them to express a conclusion, without bias, conflict of interest or undue influence.

Practicing chartered accountants are expected to provide a variety of non-assurance services that are consistent with their skills and expertise. While rendering other non-assurance services to an audit client, practicing chartered accountants are required to apply the conceptual framework to identify threats to comply with the fundamental principles and assess their significance and implication.

The responsibility of evaluation of such threats rests on the practicing chartered accountants and they should consider qualitative as well as quantitative factors while doing so. The obligation on the part of a practicing chartered accountant becomes more critical in a situation where the applicable guidelines or regulations do not clearly prohibit any specific service.

With regard to your query whether Internal Audit (on behalf of the Audit Committee) is empowered to write to the external auditor, the Committee would like you to refer section 290.157, 290.159, 290.161 and 290.162 of Part B of ‘Code of Ethics for Chartered Accountants’ for guidance.

The Committee is of the view that it is the prerogative of Audit Committee to recommend the appointment of auditor to the BOD for conducting non-assurance services. Likewise, the Audit Committee may recommend termination if they foresee conflict of interest and threat of self-review and independence arising by the acceptance of non-assurance services by the external auditor. In such cases, the Audit Committee has a right to recommend to the BOD appointment of a person having requisite qualification and experience for performing non-assurance services.

To evaluate the various threats arising out of the acceptance of non-assurance services by the external auditor, the Audit Committee may communicate directly with the external auditor and request information about the safeguards that may have been applied by them, in reducing the threats to an acceptable level.

With regard to your second query, the Committee is of the opinion that if the Chairman Audit Committee is not satisfied with the external auditor’s representation then he should first discuss this within the Audit Committee and then take to the Board (if Audit Committee agrees) before approaching ICAP. If Board agrees with the recommendation of the Audit Committee to approach ICAP then a formal complaint may be referred to ICAP.

(June 27, 2012)

13. Requirement to obtain NOC from the retiring Cost Auditor

Enquiry:

Cost auditor is appointed by the board of directors of the company and thereafter approval from SECP is obtained. Later on cost auditors resign for any reason and board of directors appoint new cost auditor and obtain the approval of SECP. Does new cost auditor require to obtain NOC from the retiring auditors before holding the office? As per understanding the NOC mentioned in the law is required for the financial audit because cost audits can also be carried on by the CA, CMAs.

Opinion:

We wish to draw your attention to the following relevant paragraphs of the ICAP Code of Ethics for Chartered Accountants:

Definition of Existing Accountant

A Chartered Accountant in practice currently holding an audit appointment or carrying out accounting, taxation, consulting or similar professional services for a client.

210.10 A chartered accountant in practice who is asked to replace another chartered accountant in practice, or who is considering tendering for an engagement currently held by another chartered accountant in practice, should determine whether there are any reasons, professional or other, for not accepting the engagement, such as circumstances that threaten compliance with the fundamental principles. For example, there may be a threat to professional competence and due care if a chartered accountant in practice accepts the engagement before knowing all the pertinent facts.

210.11 The significance of the threats should be evaluated. Depending on the nature of the engagement, this may require direct communication with the existing accountant to establish the facts and circumstances behind the proposed change so that the chartered accountant in practice can decide whether it would be appropriate to accept the engagement. For example, the apparent reasons for the change in appointment may not fully reflect the facts and may indicate disagreements with the existing accountant that may influence the decision as to whether to accept the appointment.

Please also refer clause 7 of Part 1 of 1st Schedule of Chartered Accountants Ordinance 1961 which mentions that:

“A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he:

(7) Accepts a position as auditor previously held by another members of the Institute without first communicating him in writing.”

Conclusion:

From the above, we can conclude that it appears to be necessary for a chartered accountant in practice to communicate with the existing accountant carrying out an audit appointment including cost audit.

(January 2010)

14. Appointment of one auditor in place of two Retiring Auditors

Enquiry:

A brief description of the situation is that our company has appointed one external auditor in place of two joint auditors in the Annual General Meeting. The objective of which was to reduce audit costs. Both the retiring auditors were working at a fee of say Rs. 100,000/= each. My question now is that whether the incoming auditor can accept the engagement at a fee less than Rs. 200,000/=. The company’s management is of the view that the incoming auditor is not appointed at a fee lower than the audit remuneration of the single predecessor auditor i.e. Rs. 100,000/=. Whereas the incoming auditor is of the view that this may provoke the provisions of under cutting.

Opinion:

The Committee has examined your inquiry and would like to comment and opine as follows:

Audit fee is a composite figure and it is presumed to have been fixed keeping in view the scope and quantum of work of a particular audit engagement. In the case cited by you, the Committee is given to understand that the audit fee for the year is Rs.200,000/= that it is being shared by two auditors.

The Committee further observed that the term ‘undercutting’ itself has not been precisely defined in International Standards of Auditing or Code of Ethics prescribed by the Institute of Chartered Accountants of Pakistan. Literal meaning of the verb ‘undercut’ means “to sell or work at lower price than”. To Stretch the term, Undercutting may also mean to gain out of an event, transaction or appointment at the cost of another. Accordingly, if the incoming auditor takes up an audit appointment at lower fees to the detriment of the existing auditor whether directly or indirectly, it would amount to undercutting. To put it plainly, the Committee observed that charging a smaller fee in itself is not a conclusive proof of undercutting since there may be good reasons for it to prove otherwise. Undercutting is, therefore, always a question of fact dependent on the circumstances of each case. For example in the case of a philanthropic organization, the incoming auditor may decide not to charge any fee, despite the fact that the outgoing auditor used to charge the fee for the same assignment.

In the case cited by you the reason conveyed to us for lowering the fee does not appear to be in line with section 240.1 of the Revised (May 2008) Code of Ethics for Chartered Accountants which is reproduced below for your ready reference.

Section 240

Fees and Other Types of Remuneration

240.1 When entering into negotiations regarding professional services, a chartered accountant in practice may quote whatever fee deemed to be appropriate commensurate with the nature and service to be rendered. However, in such cases, chartered accountants in practice should be careful not to quote fee lower than that charged by the chartered accountants in practice previously carrying out the audit unless scope and quantum of work materially differs from the scope and quantum of work carried out by the previous auditor, as it could then be regarded as undercutting.”

In view of the above the committee concurs with the view of the incoming auditor that lowering the fee in this case would amount to under cutting.

May we remind you that our opinion is based on the particular information supplied to us and in the nature of guidance only. As stated earlier It is solely, the responsibility of the incoming auditor to display in each case that his appointment did not amount to undercutting.

(June 5, 2009)