Auditing and Assurance Standards and Guidance

1.33	In assessing the significance of the self-review threat in relation to an investment circular reporting engagement, the reporting accountant considers the extent to which the other service will:

involve a significant degree of subjective judgment; and

have a material effect on the preparation and presentation of the financial information that is the subject of the investment circular reporting engagement.

1.34

Where a significant degree of subjective judgment relating to the financial information is involved in an other service engagement, the reporting accountant may be inhibited from questioning that judgment in the course of the investment circular reporting engagement. Whether a significant degree of subjective judgment is involved will depend upon whether the other service involves the application of well-established principles and procedures, and whether reliable information is available. If such circumstances do not exist because the other service is based on concepts, methodologies or assumptions that require judgment and are not established by the engagement client or by authoritative guidance, the reporting accountant's objectivity and the appearance of its independence may be adversely affected. Where the provision of the other service during the relevant period also has a material effect on the financial information that is the subject of the investment circular reporting engagement, it is unlikely that any safeguard can eliminate or reduce to an acceptable level the self-review threat.

1.35

A management threat arises when the firm undertakes work that involves making judgments and taking decisions, which are the responsibility of the management of the party responsible for issuing the investment circular containing the financial information or the party on whose financial information the firm is reporting (the engagement client) in relation to:

the transaction (for example, where it has been working closely with a company in developing a divestment strategy); or

the financial information that is the subject of the investment circular reporting engagement (for example, deciding on the assumptions to be used in a profit forecast).

A threat to objectivity and independence arises because, by making judgments and taking decisions that are properly the responsibility of management, the firm erodes the distinction between the engagement client and the reporting accountant. The firm may become closely aligned with the views and interests of management and this may, in turn, impair or call into question the reporting accountant's ability to apply a proper degree of professional scepticism in performing the investment circular reporting engagement. The reporting accountant's objectivity and independence therefore may be impaired, or may be perceived to be, impaired.

1.36	Factors to be considered in determining whether an other service does or does not give rise to a management threat include whether:

the other service results in recommendations by the firm justified by objective and transparent analyses or the engagement client being given the opportunity to decide between reasonable alternatives;

the reporting accountant is satisfied that a member of management (or senior employee) has been designated by the engagement client to receive the results of the other service and make any judgments and decisions that are needed; and

that member of management has the capability to make independent management judgments and decisions on the basis of the information provided ('informed management').

1.37

Where there is 'informed management', the reporting accountant assesses whether there are safeguards that can be introduced that would be effective to avoid a management threat or to reduce it to a level at which it can be disregarded. Such safeguards would include the investment circular reporting engagement being provided by partners and staff who have no involvement in those other services. In the absence of 'informed management', it is unlikely that any safeguards can eliminate the management threat or reduce it to an acceptable level.

1.38

An advocacy threat arises when the firm undertakes work that involves acting as an advocate for an engagement client and supporting a position taken by management in an adversarial context (for example, by undertaking an active responsibility for the marketing of an entity's shares). In order to act in an advocacy role, the firm has to adopt a position closely aligned to that of management. This creates both actual and perceived threats to the reporting accountant's objectivity and independence. For example, where the firm, acting as advocate, has supported a particular contention of management, it may be difficult for the reporting accountant to take an impartial view of this in the context of its review of the financial information.

1.39

Where the provision of an other service would require the reporting accountant to act as an advocate for the engagement client in relation to matters that are material to the financial information that is the subject of the investment circular reporting engagement, it is unlikely that any safeguards can eliminate or reduce to an acceptable level the advocacy threat that would exist.

1.40	A familiarity threat arises when reporting accountants are predisposed to accept or are insufficiently questioning of the engagement client's point of view (for example, where they develop close personal relationships with client personnel through long association with the engagement client).

1.41	An intimidation threat arises when the conduct of reporting accountants is influenced by fear or threats (for example, where they encounter an aggressive and dominating party).

1.42

These categories may not be entirely distinct: certain circumstances may give rise to more than one type of threat. For example, where a firm wishes to retain the fee income from a large client, but encounters an aggressive and dominating individual, there may be a self-interest threat as well as an intimidation threat.

1.43

When identifying threats to objectivity and independence, reporting accountants consider circumstances and relationships with a number of different parties. The engagement client may constitute one or more parties, dependent on the circumstances of the transaction which is the subject of the investment circular⁵. Where the party responsible for issuing the investment circular is different from the party whose financial information is included in the investment circular, the reporting accountant makes an assessment of independence with respect to both these parties, applying the alternative procedures set out in paragraph 1.44 as necessary.

1.44	Where either:

an investment circular reporting engagement is undertaken to provide a report on the financial information relating to an audit client but the reporting accountant's report is to be published in an investment circular issued by another entity that is not an audit client; or

the reporting accountant's report is to be published in an investment circular issued by an audit client but the reporting accountant's report is on financial information relating to another entity that is not an audit client,

it may not be practicable in the time available to identify all relationships and other service engagements recently undertaken by the firm for the non-audit client and its significant affiliates. In such instances the reporting accountant undertakes those enquiries⁶ that are practical in the time available into the relationships and other service engagements that the firm has with the non-audit client and, having regard to its obligations to maintain confidentiality, addresses any identified threats. Having done so, the reporting accountant discloses to those charged with governance of the issuing engagement client that a consideration of all known threats has been undertaken and, where appropriate, safeguards applied, but this does not constitute a full evaluation of all relationships and other services provided to the non-audit client.

1.45	The firm should establish policies and procedures to require persons in a position directly to influence the conduct and outcome of the investment circular reporting engagement to be constantly alert to circumstances and relationships with:

(a)

the engagement client, and

(b)

other parties who are connected with the investment circular, that might reasonably be considered threats to their objectivity or the perceived loss of their independence, and, where such circumstances or relationships are identified, to report them to the engagement partner or to the ethics partner, as appropriate.

1.46

Such policies and procedures require that threats to the reporting accountant's objectivity and independence are communicated to the appropriate person, having regard to the nature of the threats and the part of the firm and the identity of any person involved. The consideration of all threats and the action taken is documented. If the engagement partner is personally involved, or if he or she is unsure about the action to be taken, the matter is resolved through consultation with the ethics partner.

1.47

In addition to considering independence in the context of the engagement client, the reporting accountant also considers relationships with other parties who are connected with the investment circular. These parties will include the sponsor or nominated advisor, other parties from whom, in accordance with the engagement letter, the reporting accountant takes instructions and other entities directly involved in the transaction which is the subject of the investment circular.⁷ The reporting accountant considers the circumstances involved and uses judgment to assess whether it is probable that a reasonable and informed third party would conclude that the reporting accountant's objectivity either is impaired or is likely to be impaired as a result of relationships held with any of these parties.

1.48

In the case of established financial institutions or advisers, the reporting accountant may have extensive relationships with these parties, including for the provision of other services or the purchase of goods and services in the ordinary course of business. These relationships will not generally give rise to a significant threat to the reporting accountant's objectivity.

1.49

Relationships with other parties who are connected with the investment circular which are outside the ordinary course of business or which are material to any party are more likely to give rise to a significant threat to the reporting accountant's objectivity. Consideration of the threats to the reporting accountant's objectivity in relation to other entities will primarily be concerned with matters that could give rise to self-interest and intimidation threats, for example:

where there is financial dependence on the relationship with the other party arising from fees (including any contingent element) for investment circular reporting engagements undertaken by the firm as a result of connections with the other parties;

joint ventures or similar relationships with the other party or with a senior member of their management;

significant purchases of goods or services which are not in the ordinary course of business or are not on an arm's length basis;

personal relationships between engagement team members and individuals in senior positions within the other party; or

large direct financial interests in, or loans made by, the other party.

1.50	The firm should establish policies and procedures to require the engagement partner to identify and assess the significance of threats to the reporting accountant's objectivity, including any perceived loss of independence:

(a)

when considering whether to accept an investment circular reporting engagement and planning the work to be undertaken;

(b)

when signing the report;

(c)

when considering whether the firm can accept or retain an engagement to provide other services to an engagement client during the relevant period; and

(d)

when potential threats are reported to him or her.

1.51

An initial assessment of the threats to objectivity and independence is required when the engagement partner is considering whether to accept an investment circular reporting engagement and planning the engagement. At the end of the engagement, when reporting on the work undertaken but before issuing the report, the engagement partner draws an overall conclusion as to whether any threats to objectivity and independence have been properly addressed in accordance with the APB Ethical Standard for Reporting Accountants. If, at any time, the reporting accountant is invited to accept an engagement to provide other services to an engagement client for which the firm is undertaking an investment circular reporting engagement, the engagement partner considers the impact this new engagement may have on the reporting accountant's objectivity and independence.

1.52

When identifying and assessing threats to their objectivity and independence, reporting accountants take into account their current relationships with the engagement client (including other service engagements) and those that existed prior to the current engagement in the relevant period. The relevant period covers the period during which the engagement is undertaken and any additional period before the engagement period but subsequent to the balance sheet date of the most recent audited financial statements⁸. This is because those prior relationships may be perceived as likely to influence the reporting accountant in the performance of the investment circular reporting engagement or as otherwise impairing the reporting accountant's objectivity and independence.

1.53	A firm's procedures will include reference to records of past and current engagements whenever a new investment circular reporting engagement is proposed.

1.54	Where the engagement client or a third party calls into question the objectivity and independence of the firm in relation to a particular client, the ethics partner carries out such investigations as may be appropriate.

⁵ For example, where a report on a target company's financial statements is prepared by that company's auditors for inclusion in the acquiring company's investment circular.

⁶ For example, these enquiries are likely to include reviewing the list of engagements recorded in the firm's accounting systems and an enquiry of individuals within the firm who are responsible for maintaining such systems as to whether any confidentially coded engagements could be relevant.

⁷ Where such entities are part of a complex group or corporate structure, the reporting accountant considers issues relating to the wider group and not just the entity directly involved in the transaction.

⁸ In the case of newly incorporated clients (not part of an established group of companies), where there has been no financial statement audit, this period is from the date of incorporation.