4.16 The Bill includes a general requirement of auditor independence which was recommended by the Ramsay report. The standard is defined by reference to circumstances (a ‘conflict of interest situation’) whereby a an auditor or professional member of the audit team is not capable of exercising objective and impartial judgment in relation to the conduct of the audit. The standard also includes an objective test whereby a reasonable person with full knowledge of all relevant facts and circumstances, would conclude that the auditor, or a professional member of the audit team, is not capable of exercising objective and impartial judgment in relation to the conduct of the audit of the audited body.
4.17 The Bill requires an auditor to give the directors of a company an annual declaration that the auditor has complied with the auditor independence requirements of the Corporations Act and of any applicable codes of professional conduct.
4.18 In formulating the general requirement of independence and the declaration of independence consideration was given to whether to maintain the status quo whereby a statement of best practice has been developed and implemented by industry with no legislative sanction attached in the event of non-compliance. This approach would not give rise to new or additional costs. However, it would omit a key element of the proposed package of auditor independence reforms which would be contrary to the recommendations of both the Ramsay report and the HIHRC. In addition current professional requirements apply to members of the professional bodies only and therefore are limited in their application across the profession.
4.19 Consideration was also given to introducing the general requirement of independence as a legal obligation. This would provide consistent coverage of the entire profession and thereby achieve a level playing field. It would also provide stronger sanctions to address instances of non-compliance.
4.20 The declaration of independence effectively builds on the general statement of principle and is a means of assuring investors, shareholders and the market more generally that the auditor is complying with the general requirement to be independent.
4.21 The legislative measures will apply a consistent and objective standard of conduct across the auditing profession and thereby promote the credibility and reliability of auditing reports and financial statements. The inclusion of an objective standard in the general auditor independence requirement is critical for enforcement purposes because objectivity, being a state of mind, is not, except in unusual circumstances, subject to direct proof. The difficulties associated with identifying a compromise of independence are also inherent in the nature of the audit process. Accordingly, the perception of auditor independence, as demonstrated by external facts and circumstances, under an objective standard, takes on great importance.
4.22 A legislative requirement in many cases will formalise and reinforce conduct which many auditors are, or should as a matter of best practice be complying with. In this respect the compliance costs that these proposals give rise to are expected to be minimal or at least comparable to costs currently incurred by auditors.
4.23 There are a number of short-term costs that will be incurred by auditors who do not, as a matter of best practice, act independently of their client or who do not follow the rules of the professional bodies. These costs will primarily be in the nature of administrative costs arising as a result of implementing measures that are necessary to comply with the requirements, such as the establishment of quality control systems to detect and prevent threats to auditor independence. It is expected that compliance with the general requirement and declaration of independence will not give rise to any significant compliance burden in the longer term.
4.24 There has been broad support for introducing a general requirement of independence as a legal obligation in the Corporations Act. This proposal has been the subject of consultation in the context of CLERP 9, the Ramsay report and the HIHRC.
4.25 Option 2 is considered to provide the most assurance to investors of the integrity of audited financial statements.
Restrictions on employment and financial relationships
4.26 The Bill contains a comprehensive range of restrictions on specific employment and financial relationships between an auditor and the audit client. These restrictions incorporate the recommendations of the Ramsay report which described these restrictions as ‘core circumstances which, if they exist, necessarily mean that the auditor is not independent’. These ‘core circumstances’ are drawn from key international rules and principles (SEC rules on audit independence, the independence rules of the International Federation of Accountants and the European Union Commission Recommendation on auditor independence).
4.27 Consideration was given to leaving the regulation of specific employment and financial restrictions to the professional accounting bodies Professional Statement F.1 on auditor independence. While this would not involve any additional regulatory compliance costs, this would be contrary to the Ramsay report recommendations that these restrictions should be contained in the Corporations Act as they are fundamental restrictions that are necessary to ensure auditor independence.
4.28 In formulating the specific restrictions on employment and financial relationships, consideration was also given to their inclusion in the Corporations Act as legal obligations. This approach would facilitate their enforcement and is consistent with the approach recommended by the Ramsay report. While this approach would involve some additional compliance costs, they should not be too onerous given that auditors should already be complying with similar, although less extensive requirements in Professional Statement F.1.
4.29 Generally, there is broad support for introducing specific restrictions on employment and financial relationships between auditors and their audit clients. There are concerns regarding the level of detail that is required to put the provisions into a legislative form and some stakeholders consider that it would be desirable to continue relying on the professional rules. These proposals have been the subject of consultation in the context of CLERP 9, the Ramsay report and the HIHRC.
4.30 Option 2 has been adopted as a means of strengthening the current restrictions in the professional rules by making the requirements legal obligations within the Corporations Act. The Bill therefore sets up a legislative framework for auditor independence and audit oversight which is currently only dealt with in a cursory way in the law. The requirements will improve both actual and the perception of independence and thereby lead to greater confidence in the credibility and reliability of audited financial statements.