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Early in 2020 a colleague, Shruti Maharaj, and I wrote an article called “Auditors marking their own IFRS homework”, which was also published in Accountancy SA.
That discussion considered the dilemma faced by an auditor when approached for assistance with IFRS matters. On the one hand, we are always eager to assist wherever we can to improve financial reporting but, on the other hand, the auditor is always aware that they cannot advise the client and then later be the arbiter of the correctness of that advice.
That dilemma is called the self-review threat, which is one of five threats identified by the IESBA Code of Conduct as conditions that may impair an auditor’s (or any accountant’s) ability to act, or appear to act, independently or objectively, as the case may be.
I am going to look here at another threat - the so-called “advocacy” threat. In training new entrants to the profession, I have always found this the most difficult threat to explain and I have discovered that it is always easier to explain with an example rather than the definition.
Imagine any transaction where the recording or measurement involves some subjective judgement – there are so many examples of estimates in financial reporting in modern business that it should not be hard to find any number of examples. Let us focus, say, on the decision whether a repair should be recognised as an asset or an expense and let us assume that the client has decided that the appropriate treatment would be to treat the item as an expense because it was simply for the maintenance of an existing asset and it adds no additional functionality, etc.
The client then submits their tax return on that basis, and when they receive a query from the tax authority about that particular treatment, they ask for your assistance in motivating their case.
Provided you believe you have the appropriate skills and experience nothing stops you from accepting the engagement. So far. You research the Income Tax Act, practice notes, case law, etc. and you obtain a thorough understanding of the client’s case and circumstances. Based on all of this, your considered conclusion is that the client was correct in their chosen treatment and you draft the necessary opinion for the client to present. If necessary, you can even review the client’s case and assist them in presenting it to the authorities.
Of course, there is a difference between accounting and tax. From an accounting perspective it was appropriate to expense, but from a tax perspective it might have been capital in nature. The client can still claim capital allowances going forward and therefore this remains merely a temporary difference.
Still no problem.
However, if you were now also the auditor of those financial statements, I submit that it would be almost impossible for you to be impartial in considering whether the expenses were recognised correctly in accordance with IFRS (or any other financial reporting framework) and if property, plant and equipment were complete. Sure, you have applied tax rules and laws that may be completely different from the IFRS requirements, but will you be able to divorce yourself completely from your previous conclusion that an asset should not be recognised and consider the accounting treatment absolutely objectively?
Many readers would agree with me that it would be difficult, if not impossible, for an auditor to be independent in this case or at least be seen to be independent.
But remember that the principle of objectivity is a principle that applies to all work performed by professional accountants. Consequently, even if you are the compiler of the annual financial statements, or you completed the tax return for that same client, it would be very difficult for you to be objective once you have already advocated the client’s case.
And that is exactly what the advocacy threat is. The IESBA Code defines it as the threat that a professional accountant will promote a client's or employing organisation's position to the point that the accountant's objectivity is compromised, and it is a very real threat.
Many of these cases are easily dealt with by implementing safeguards, for example the tax consultant should not be a member of the audit team. But in some cases, the threat is so significant that it is irreconcilable with other work performed by accountants. For example, a firm or any individual in an audit firm can never support (advocate) a case for an audit client in litigation where the amounts are material to the financial statements on which the firm will be expressing an opinion.
Auditors and accountants should be aware of the advocacy threat and recognise that, whenever they need to defend or promote a certain position their objectivity and independence will be impaired. It is very difficult, I would even say impossible, for a human being to be completely objective again once they have openly supported a certain position. It is difficult to impartially admit that your initial diagnosis was incorrect.
Henk Heymans
National Quality Leader, RSM South Africa
