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Drafting ConventionsDrafting Conventions

Ken DakddukKen DakddukTask Force ChairTask Force Chair

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OverviewOverview

• Implications of IAASB Clarity projectImplications of IAASB Clarity project

• ““Clearly insignificant”Clearly insignificant”

• ““Consider”Consider”

• ““Examples” or “illustrates”Examples” or “illustrates”

• ““Creates a threat” or “may create a threat”Creates a threat” or “may create a threat”

• Threat definitionsThreat definitions

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IAASB Clarity ConventionsIAASB Clarity Conventions

• State objective to be achieved in relation to each State objective to be achieved in relation to each ISAISA

• Requirements designed to achieve stated objective Requirements designed to achieve stated objective will be identified by use of the word “shall”will be identified by use of the word “shall”

• No use of present tenseNo use of present tense

• Each ISA to contain application material Each ISA to contain application material

– Provides further explanation and guidance supporting Provides further explanation and guidance supporting proper application of the standardsproper application of the standards

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IAASB Clarity ConventionsIAASB Clarity Conventions

• Code based on a conceptual frameworkCode based on a conceptual framework– Objective: comply with fundamental principlesObjective: comply with fundamental principles

• Separately stating objectives and converting Separately stating objectives and converting text into application guidance text into application guidance – Could lengthen the Code; might weaken itCould lengthen the Code; might weaken it– Conclusion:Conclusion:

• Would not work well in the CodeWould not work well in the Code• Whether other approaches would work requires a Whether other approaches would work requires a

longer-term effortlonger-term effort

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RequirementsRequirements

• Accountant should not do something Accountant should not do something – ¶¶110.2 “accountant should not be associated with . . . 110.2 “accountant should not be associated with . . .

information . . . that [is] . . . false or misleading”information . . . that [is] . . . false or misleading”

• Accountant should consider something Accountant should consider something – ¶¶140.8 “accountants should consider the following 140.8 “accountants should consider the following

points”points”

• Accountant is required to do something Accountant is required to do something – ¶¶290.3 “it is . . . required by this Code . . . that 290.3 “it is . . . required by this Code . . . that

members . . . be independent”members . . . be independent”

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RequirementsRequirements

• Accountant is obliged to do somethingAccountant is obliged to do something– ¶100.6 “accountant has an obligation to ¶100.6 “accountant has an obligation to

evaluate any threats”evaluate any threats”

• Accountant can do something if necessary Accountant can do something if necessary steps are taken steps are taken – ¶¶290.132 “the following safeguards are 290.132 “the following safeguards are

necessary”necessary”

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Not a RequirementNot a Requirement

• Statement of expectationStatement of expectation– ¶300.5 “accountant . . . is expected . . . to . . ¶300.5 “accountant . . . is expected . . . to . .

encourage an ethics-based culture”encourage an ethics-based culture”

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PrinciplePrinciple

• ShallShall – to be used to denote: – to be used to denote:– a requirement to comply with specific guidance a requirement to comply with specific guidance

(e.g., a fundamental principle)(e.g., a fundamental principle)• no room for judgment; cannot “opt out”no room for judgment; cannot “opt out”

– a clear prohibition a clear prohibition • ¶110.2 “accountant should not be associated with”¶110.2 “accountant should not be associated with”

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Effect of ApproachEffect of Approach

• Will result in “shall” being used more often Will result in “shall” being used more often throughout the entire Codethroughout the entire Code

• Respondents to December 2006 ED Respondents to December 2006 ED perceive Code is moving closer to “rules-perceive Code is moving closer to “rules-based”based”– Use of “shall” could exacerbate this perceptionUse of “shall” could exacerbate this perception– Rules can be based on principles Rules can be based on principles – Current wording retained if requirement is clear Current wording retained if requirement is clear

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Clearly InsignificantClearly Insignificant

• The Code (The Code (¶100.2) ¶100.2) requires:requires:– Identification of threats to compliance with the Identification of threats to compliance with the

fundamental principles;fundamental principles;– Evaluation of the significance of the threats; Evaluation of the significance of the threats;

andand– If threats are not If threats are not clearly insignificant, clearly insignificant,

application of safeguards to eliminate them or application of safeguards to eliminate them or reduce them to an reduce them to an acceptable level.acceptable level.

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Clearly InsignificantClearly Insignificant

• Clearly insignificantClearly insignificant is lower than is lower than acceptable levelacceptable level– Clearly insignificant means trivial and inconsequentialClearly insignificant means trivial and inconsequential– No definition of “acceptable level” in the CodeNo definition of “acceptable level” in the Code

• Agree it is slightly higher than clearly insignificantAgree it is slightly higher than clearly insignificant

• When threat is already at an acceptable level When threat is already at an acceptable level (before safeguards applied), no safeguards (before safeguards applied), no safeguards requiredrequired

• Documentation for independence purposes Documentation for independence purposes required only when safeguards are needed to required only when safeguards are needed to reduce threats to an acceptable levelreduce threats to an acceptable level

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Task Force Proposal – Eliminate Use of Task Force Proposal – Eliminate Use of “Clearly Insignificant”“Clearly Insignificant”

• Professional accountants shall apply this Professional accountants shall apply this conceptual framework to:conceptual framework to:– identify threats to compliance with the identify threats to compliance with the

fundamental principles, fundamental principles, – evaluate the significance of the threats, andevaluate the significance of the threats, and– apply safeguards, when necessary, to eliminate apply safeguards, when necessary, to eliminate

threats or reduce them to an acceptable levelthreats or reduce them to an acceptable level

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Task Force Proposal – Define “Acceptable Task Force Proposal – Define “Acceptable Level”Level”

A level at which a reasonable and informed A level at which a reasonable and informed third party would be likely to conclude, third party would be likely to conclude, weighing all the specific facts and weighing all the specific facts and circumstances, that compliance with the circumstances, that compliance with the fundamental principles is not compromised.fundamental principles is not compromised.

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Clearly Insignificant – Other InteractionsClearly Insignificant – Other Interactions

• Delete “clearly insignificant” throughout Delete “clearly insignificant” throughout CodeCode

• Gifts and hospitality – refer to “trivial and Gifts and hospitality – refer to “trivial and inconsequential”inconsequential”

• Close business relationships – may use Close business relationships – may use “insignificant”“insignificant”

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Task Force Proposal – Documentation Task Force Proposal – Documentation Conforming Change (290.29)Conforming Change (290.29)

• Documentation is not by itself a determinant of Documentation is not by itself a determinant of whether a firm is independent whether a firm is independent

• International auditing standards require documentation International auditing standards require documentation of: of:

– conclusions regarding compliance with independence conclusions regarding compliance with independence requirements, and requirements, and

– any relevant discussions that support those conclusionsany relevant discussions that support those conclusions• When threats require the application of safeguards, When threats require the application of safeguards,

that documentation shall that documentation shall alsoalso describe describe– the nature of those threats the nature of those threats – the safeguards applied to eliminate them or reduce them to the safeguards applied to eliminate them or reduce them to

an acceptable levelan acceptable level

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Consider v. evaluate v. determineConsider v. evaluate v. determine

• ““Consider” used frequently in the CodeConsider” used frequently in the Code– Could be interpreted as less robust than Could be interpreted as less robust than

intendedintended

• Task Force proposal:Task Force proposal:– Consider = thinking about several mattersConsider = thinking about several matters– Evaluate = assessing and weighingEvaluate = assessing and weighing– Determine = concluding and making a decisionDetermine = concluding and making a decision

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Consider v. evaluate v. determineConsider v. evaluate v. determine

• ¶100.17 - ¶100.17 - When initiating . . . a . . . conflict resolution When initiating . . . a . . . conflict resolution process, a professional accountant shall process, a professional accountant shall considerconsider the the following following

– ““Consider” is used consistent with our drafting convention; no Consider” is used consistent with our drafting convention; no changechange

• ¶290.11 – ¶290.11 – In considering In considering evaluatingevaluating the significance of any the significance of any particular matters particular matters

– Changed “considering” to “evaluating”Changed “considering” to “evaluating”• ¶290.157 - ¶290.157 - Before a firm accepts an engagement . . . Before a firm accepts an engagement . . .

consideration should be given to it shall consideration should be given to it shall determinedetermine whether providing such a service would create a threatwhether providing such a service would create a threat

– Changed “consideration should be given to” to “determine” Changed “consideration should be given to” to “determine”

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Examples/IllustrateExamples/Illustrate

• Use of “examples/illustrates” might convey Use of “examples/illustrates” might convey that guidance is not mandatorythat guidance is not mandatory– ¶200.1 – This Part of the Code ¶200.1 – This Part of the Code illustratesillustrates how how

the CF . . . is to be appliedthe CF . . . is to be applied• Changed “illustrates” to “demonstrates”Changed “illustrates” to “demonstrates”

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ThreatsThreats

• ““Creates” or “may create” a threatCreates” or “may create” a threat

• Code does not define “threats”; for example:Code does not define “threats”; for example:– ¶200.4 Examples of circumstances that ¶200.4 Examples of circumstances that may may

createcreate self-interest threats…include…undue self-interest threats…include…undue dependence on total fees from a clientdependence on total fees from a client

– ¶290.129 Threats to independence ¶290.129 Threats to independence may be may be createdcreated when a close family member…is a when a close family member…is a director…of the client…director…of the client…

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Description of Five Categories of ThreatsDescription of Five Categories of Threats

• Conceptual framework approach first set out Conceptual framework approach first set out in independence section of Code in independence section of Code

• Framework later expanded to cover entire Framework later expanded to cover entire CodeCode– Descriptions of threat categories (self review, Descriptions of threat categories (self review,

self interest, advocacy, intimidation, self interest, advocacy, intimidation, familiarity) were made more genericfamiliarity) were made more generic

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Task Force Proposal – ThreatsTask Force Proposal – Threats

• To clarify when a threat is created or may be created:– Include general definition of a “threat”– Ensure requirement to exercise professional

judgment is retained

• Recommend defining individual threats – Self review, self interest, advocacy,

intimidation, and familiarity

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Threats – Proposed DefinitionThreats – Proposed Definition

• Threats are created by relationships or other circumstances that could compromise a professional accountant’s ability to comply with the fundamental principles

– i.e., the circumstance provides an incentive for the accountant to not comply with the fundamental principles

• Fundamental principles = integrity, objectivity, professional competence & due care, confidentiality, and professional behavior

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Threats – Proposed DefinitionThreats – Proposed Definition

• Threats are created by relationships or other circumstances that could compromise a professional accountant’s ability to comply with the fundamental principles

• “Could compromise” means a threat requires evaluation of the relationship or circumstance to determine whether it would compromise compliance

– Explicit prohibition against the relationship or circumstance makes evaluation unnecessary

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Threats – Proposed DefinitionThreats – Proposed Definition

• Threats are created by relationships or other circumstances that could compromise a professional accountant’s ability to comply with the fundamental principles

• Many relationships and circumstances described in the Code would “create” a threat

– Will require changing “may create a threat” to “creates a threat” in many parts of the Code

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Threats – Proposed DefinitionThreats – Proposed Definition

• Threats are created by relationships or other circumstances that could compromise a professional accountant’s ability to comply with the fundamental principles

• Points for discussion– Whether to focus on

incentives not to comply; e.g., “relationships . . . that could provide an incentive for an accountant to not comply with the fundamental principles”

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Threats – Proposed DefinitionThreats – Proposed Definition

• Threats are created by relationships or other circumstances that could compromise a professional accountant’s ability to comply with the fundamental principles

• Points for discussion– Whether the definition

should cover perceptions; e.g., “. . . that could compromise, or could be perceived to compromise . . .”

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Threats – Proposed DefinitionThreats – Proposed Definition

• Threats are created by relationships or other circumstances that could compromise a professional accountant’s ability to comply with the fundamental principles

• Points for discussion– Whether to describe the

action required after the definition of “threats” e.g., “Unless the relationship . . . is prohibited by this Code, a threat requires evaluation of the relationship . . . to determine whether it would compromise compliance . . . and, if so, application of safeguards . . .”

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Self-Interest ThreatSelf-Interest Threat

• The threat that a professional accountant will act in his or The threat that a professional accountant will act in his or her own best interest, or in the best interest of a member of her own best interest, or in the best interest of a member of his or her immediate or close family member because of a his or her immediate or close family member because of a potential benefit from a financial interest in or other potential benefit from a financial interest in or other relationship with a client of the employerrelationship with a client of the employer

• Points for discussionPoints for discussion– Whether “best interest” should be “interest”Whether “best interest” should be “interest”– Whether “a member of his or her immediate or close family Whether “a member of his or her immediate or close family

member” should be “his or her firm, employer, or other member” should be “his or her firm, employer, or other persons”persons”

– Whether “a potential benefit” is necessaryWhether “a potential benefit” is necessary

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Circumstances That Create Self-Interest Circumstances That Create Self-Interest Threats Threats ¶200.4 ¶200.4

• A member of the audit team having a direct financial A member of the audit team having a direct financial interest in an audit client interest in an audit client

• Undue dependence on total fees from a client Undue dependence on total fees from a client • Having a significantHaving a significant business relationship with a clientbusiness relationship with a client• Concern about the possibility of losing a client Concern about the possibility of losing a client • Potential employment with a clientPotential employment with a client• Contingent fees relating to an assurance engagementContingent fees relating to an assurance engagement• The discovery of a significant error in the performance of a The discovery of a significant error in the performance of a

re-evaluation of a professional services engagement re-evaluation of a professional services engagement

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Self-Review ThreatSelf-Review Threat

• The threat that a professional accountant will not The threat that a professional accountant will not appropriately re-evaluate the results of a previous appropriately re-evaluate the results of a previous service that he or she will rely upon in forming a service that he or she will rely upon in forming a judgment as part of providing a current service or judgment as part of providing a current service or because he or she, or others within his or her firm because he or she, or others within his or her firm or organization, performed the previous serviceor organization, performed the previous service

• Points for discussionPoints for discussion– Whether “a current service” should be “another Whether “a current service” should be “another

service”service”

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Circumstances That Create Self-Review Circumstances That Create Self-Review Threats Threats ¶200.5¶200.5

• Reporting on the operation of financial systems after being Reporting on the operation of financial systems after being involved with their design or implementation involved with their design or implementation

• Having prepared the original data used to generate records Having prepared the original data used to generate records that are the subject matter of the engagement.that are the subject matter of the engagement.

• A member of the assurance team being, or having recently A member of the assurance team being, or having recently been, a director or officer of that client been, a director or officer of that client

• A member of the assurance team being, or having recently A member of the assurance team being, or having recently been, employed by the client in a position to exert been, employed by the client in a position to exert significant influence over the subject matter of the significant influence over the subject matter of the engagement engagement

• Performing a service for a client that directly affects the Performing a service for a client that directly affects the subject matter of the assurance engagement.subject matter of the assurance engagement.

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Advocacy ThreatAdvocacy Threat

• The threat that a professional accountant The threat that a professional accountant who promotes a client’s or employer’s who promotes a client’s or employer’s position may do so to the point that his or position may do so to the point that his or her objectivity is compromised her objectivity is compromised

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Circumstances That Create Advocacy Threats Circumstances That Create Advocacy Threats ¶200.6¶200.6

• Promoting shares in a listed entity when that Promoting shares in a listed entity when that entity is a financial statement audit client entity is a financial statement audit client

• Acting as an advocate on behalf of an Acting as an advocate on behalf of an assurance client in litigation or disputes with assurance client in litigation or disputes with third parties third parties

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Familiarity ThreatFamiliarity Threat

• The threat that a professional accountant will become too The threat that a professional accountant will become too sympathetic to the interests of a client or employer or will sympathetic to the interests of a client or employer or will not appropriately evaluate the worked performed by the not appropriately evaluate the worked performed by the client or employer because the work client or employer because the work

– (i) involves issues that are familiar to the professional (i) involves issues that are familiar to the professional accountant, or accountant, or

– (ii) was performed by an individual familiar to the (ii) was performed by an individual familiar to the professional accountantprofessional accountant

• Points for discussionPoints for discussion– Whether (i) should read “involves matters that the professional Whether (i) should read “involves matters that the professional

accountant has been closely associated with”accountant has been closely associated with”– Whether (ii) should read “was performed by an individual with Whether (ii) should read “was performed by an individual with

whom the professional accountant has a close relationship”whom the professional accountant has a close relationship”

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Circumstances That Create Familiarity Circumstances That Create Familiarity Threats Threats ¶200.7¶200.7

• A member of the engagement team having a close or immediate A member of the engagement team having a close or immediate family relationship with a director or officer of the client family relationship with a director or officer of the client

• A member of the engagement team having a close or immediate A member of the engagement team having a close or immediate family relationship with an employee of the client who is in a family relationship with an employee of the client who is in a position to exert direct and significant influence over the subject position to exert direct and significant influence over the subject matter of the engagement matter of the engagement

• A director or officer of the client or an employee in a position A director or officer of the client or an employee in a position to exert direct and significant influence over the subject matter to exert direct and significant influence over the subject matter of the engagement was recently a partner of the firmof the engagement was recently a partner of the firm

• Accepting gifts or preferential treatment from a client, unless the Accepting gifts or preferential treatment from a client, unless the value is trivial or inconsequential value is trivial or inconsequential

• Long association of senior personnel with the assurance client Long association of senior personnel with the assurance client

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Intimidation ThreatIntimidation Threat

• The threat that a professional accountant will subordinate The threat that a professional accountant will subordinate his or her judgment to that of [an individual associated his or her judgment to that of [an individual associated with] a client or employer because of theirwith] a client or employer because of their

– (i) reputation, or (i) reputation, or – (ii) because of their attempts to exercise excessive influence (ii) because of their attempts to exercise excessive influence

over him or her over him or her

• Points for discussionPoints for discussion– Whether (i) should read “[the individual’s] reputation or expertise”Whether (i) should read “[the individual’s] reputation or expertise”– Whether (ii) should read “will be deterred from acting objectively Whether (ii) should read “will be deterred from acting objectively

because the [individual associated with the] client or employer is because the [individual associated with the] client or employer is aggressive or dominant or attempts to exercise excessive influence aggressive or dominant or attempts to exercise excessive influence over him or her”over him or her”

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Circumstances That Create Intimidation Circumstances That Create Intimidation Threats Threats ¶200.8¶200.8

• Being threatened with dismissal or replacement in Being threatened with dismissal or replacement in relation to a client engagementrelation to a client engagement

• Being threatened with litigation by the client Being threatened with litigation by the client • Being pressured to reduce inappropriately the Being pressured to reduce inappropriately the

extent of work performed in order to reduce feesextent of work performed in order to reduce fees• The client hires as part of its management team an The client hires as part of its management team an

expert on determining fair values of assets in the expert on determining fair values of assets in the client’s industryclient’s industry

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DiscussionDiscussion