Drafting Conventions

1. Drafting Conventions IESBA CAG March 2009 Ken Dakdduk, TF Chair

2. Project Status • Exposure draft issued July 2008 • CAG discussion Sept and Nov 2008 • IESBA discussion Dec 2008 and Feb 2009 • Approval targeted April 2009

3. Activities since November CAG • Considered: • Exception clause • Inadvertent violations • Documentation • Effective date • Use of “shall” • Response letter comments

4. Exception clause • IESBA considered exception clause under three categories: • Catastrophic events • Natural disasters • Terrorist acts • Mergers and acquisitions • Audit client acquires another entity or is acquired by another entity • All other situations

5. Category 1 – Catastrophic events • Code not written for such situations • Regulators/member bodies responded in the past • e.g., audit firms allowed to assist clients to re-create data lost because of terrorist act • IESBA believes regulators and member bodies would respond if similar situation were to occur

6. Category 2 – Mergers and acquisitions • Audit client may merge with, acquire, or be acquired by an entity that is not a client • Transactions are outside control of firm • May happen quickly • Firm needs to identify and address interests and relationships creating independence issues • IESBA believes Code should address such situations

7. Category 3 – All other situations • Examples to date were not compelling • Concern over a general exception clause • Would weaken the Code • Could be abused • IESBA did not support providing a specific exemption for such situations

8. Consulting with a member body or regulator for Category 1 and 3 situations • Board believes consultation with a member body or regulator would be appropriate • Agreed to include a sentence in Code to that effect • Helpful to the accountant and the member body/regulator to know that board would approve of consultation • Particularly important when • The Code is not the regulator’s Code • The regulator or member body does not respond

9. Consultation clause • When a professional accountant encounters circumstances that are so unusual that the application of a specific requirement of the Code would result in a disproportionate outcome or an outcome that may not be in the public interest, the professional accountant is recommended to consult with a member body or the relevant regulator.

10. Mergers and acquisitions • Task Force consulted with independence specialists to understand: • Types of interests and relationships that create independence issues in an M&A situation • Time typically available to address issues • Process of identifying new related entities • Safeguards that can be put in place

11. Related entities • Code requires firm and network firms to be independent of the “audit client” • When audit client is a listed entity • Need to be independent of all related entities • When audit client is not a listed entity • Need to be independent of related entities the client controls

12. Interests and relationships • Issues can be created by any of the interests or relationships covered by the Code • Many can be safeguarded/terminated without significant difficulty • Financial interests in a liquid market • Some pose challenges • No one can immediately take over; potentially lengthy period to find another provider, negotiate, and transfer arrangement • Payroll services or software support services • A contingent fee arrangement that needs to be renegotiated

13. Time to address independence issue • Sufficient time is needed to: • Identify relevant related entities and interests and relationships • Apply safeguards or terminate interests or relationships • What is sufficient depends on the situation • Size and number of related entities • Types of interests and relationships • Difficulty in terminating • Whether more time is needed to find another service provider or participant for a business relationship

14. Time to address independence issues • Considered in context of a business environment more typical than recent times • Large acquisitions • Generally have advance notice, but extent varies • Typically involve listed entities • Other acquisitions • Can have less notice • Sometimes find out after the fact • Lack of contact throughout the year

15. Process of attaining independence 1. Identify entities that will become related entities • Can be lengthy process for client and firm • Can require several weeks for large companies • Particularly for some financial services companies • Need to determine whether entities meet the definition of a related entity • Control – upstream, downstream, and common (listed entities); downstream (nonlisted entities) • Materiality of client to upstream controlling entities (listed entities) • Significant influence and materiality

16. Process of attaining independence 2. Identify interests and relationships: • Firm and network firm interests and relationships • Information about non-assurance services to non-assurance clients generally not maintained at the network level • Can be a lengthy process for the client and firm 3. Terminate interests and relationships that are not permitted under the Code 4. Apply safeguards, where necessary, for other interests or relationships

17. IESBA Position • Provide guidance to deal with client M&A • Reinforce requirement to comply with Code • Guide firms and clients when additional time after effective date is needed to terminate an I/R • 12 respondents to the ED recommended Code include such guidance • Particularly in light of proposed new drafting conventions • Not in public interest for firms to resign as auditor in every case

18. Addressing interests and relationships • Firms shall identify and evaluate previous and current interests and relationships with the related entity • Take necessary steps to terminate by effective date any current interests and relationships that are not permitted by the Code

19. If interest/relationship cannot reasonably be terminated • Evaluate significance of the threat • More significant the threat, more likely firm cannot continue as auditor • Significance depends on: • Nature & significance of relationship • Type of non-assurance service or business relationship • Nature & significance of related entity relationship • Parent, subsidiary, or sister entity • Length of time until interest or relationship can reasonably be terminated • The evaluation is discussed with those charged with governance

20. “Cannot reasonably be terminated” • Firm and client should make all reasonable efforts to terminate the interest or relationship • Cannot delay termination merely because it is inconvenient • Factors considered by Task Force: • Disruption of service would be harmful to those who rely on the service • As might be the case in payroll and related tax services or software support services • Related entity needs time after the effective date to identify alternative service providers and contract with new provider • Firm needs time to transition to new service provider

21. Period of time • If interest or relationship cannot reasonably be terminated by effective date • Terminate as soon as possible within next 6 months • In no event may interest or relationship continue for more than 6 months after effective date • Limited period of time and transitional measures provides appropriate balance between: • Need for firm to comply as soon as possible to protect public interest; and • Avoiding needless costs, including market disruption, because of forced, unplanned change of auditors

22. Other requirements • No individual with the interest or relationship may be member of engagement team for the audit or the QC reviewer • Includes any individual providing the non-assurance service • Transitional measures to be considered and applied as necessary.

23. If firm will be replaced as auditor shortly after the merger or acquisition • Not necessary to terminate the interest or relationship if all of the following conditions are met: • Client requests firm to remain as auditor; • Firm will remain as auditor only for a short period of time and only until the next audit report is issued; • No individuals with such interest or relationship are members of the engagement team or the QC reviewer for the audit; • Includes any individual providing the non-assurance service; • Transitional measures are applied as necessary; • The matter is discussed with those charged with governance

24. Transitional measures • Review of audit or non-assurance work by a professional accountant • Review equivalent to an EQCR performed by a professional accountant not a member of the firm signing the opinion • Evaluation of results of non-assurance service by another firm or another firm re-performs non-assurance service to extent necessary to take responsibility for service

25. Discussion with those charged with governance • Reasons why any interest or relationship will not be terminated by the effective date • Transitional measures, if any, to be applied

26. Overall consideration • Even if all the foregoing requirements can be met • Firm shall determine whether threats created by previous and current interests and relationships would remain so significant that independence would be compromised • If so, firm shall resign as auditor

27. Documentation • Any interests or relationships that will not be terminated by the effective date • The reasons why the interest or relationship will not be terminated • Transitional measures, if any, to be applied • Results of discussion with those charged with governance

28. Other matters • Interest or relationship must be terminated as soon as reasonably possible within next 6 months • If not terminated, firm would not be independent • New information about an interest or relationship may surface after the end of the 6-month period • Should be addressed in the same way as other inadvertent violations

29. Inadvertent violations • Under ¶290.34, if an inadvertent violation occurs, it will generally not be deemed to compromise independence if: • Firm has appropriate quality control policies and procedures in place to maintain independence; • Once discovered violation is corrected promptly; and • Any necessary safeguards are applied to eliminate the threat or reduce it to an acceptable level

30. Inadvertent violations (cont’d) • This paragraph was not changed as part of the drafting conventions project • One respondent (IOSCO) commented on it • Recommended introducing a materiality test • Such a revision would be beyond the scope of this project • However, materiality is likely be part of the assessment to determine appropriate safeguards to apply

31. Inadvertent violations (cont’d) • Respondent also recommended that “inadvertent” be defined • IESBA view: • Definition is not needed; meaning is consistent with general usage (e.g., “unintentional,” “in error,” “by mistake”) • Any changes to the inadvertent violation clause would go beyond clarity

32. Inadvertent violations (cont’d) • ISQC1 requires firms to establish policies and procedures to provide reasonable assurance that independence is maintained • Paragraph will be clarified by explicit reference to ISQC • i.e., “. . .appropriate QC policies and procedures . . . equivalent to those required by International Standards on Quality Control to maintain independence . . .”

33. Documentation • In December, the IESBA discussed the requirement to document threats “at the margin” • IESBA was concerned the proposed language was too broad

34. Documentation • When safeguards are required to reduce a threat to an acceptable level, the documentation shall include the nature of the threat and the safeguards that reduce the threat to an acceptable level • When a threat is such that the professional accountant considered whether safeguards were necessary and concluded that they were not because the threat was already at an acceptable level, the documentation shall include the • Nature of the threat • Conclusion that safeguards were not necessary • Rationale for the conclusion

35. Effective date • Exposure draft proposed point in time effective date • Effective December 15, 2010, subject to transitional provisions, with earlier adoption encouraged • Effective date based on proposed June 2009 release

36. ED comments on effective date • Majority supported point in time effective date • Minority believe that effective date should be linked to the client’s fiscal period • One respondent preferred an earlier effective date • Wants IT1 & IT2 to be applied sooner • One respondent recommended that effective date of Jan 1, 2011 would be easier to implement

37. IESBA Position – effective date • Point in time appropriate for most of the Code • Simpler to move effective date to January 1, 2011, with non-assurance services to be completed by July 1, 2011

38. IESBA Position – effective date (cont’d) • Partner rotation • One respondent’s comments suggest it is not clear how the point in time effective date would apply • KAP (other than engagement partner/QC reviewer) would be required to rotate on December 15, 2011 • Can the KAP complete the 2011 audit in 2012? • Is 2010 the KAP’s last year-end audit? • IESBA position - tie to client’s fiscal year • Fiscal periods beginning on or after December 15, 2011

39. ED transitional provisions • Partner rotation – one extra year for those individuals that previously were not required to rotate (new key audit partners) • Public Interest Entities – one extra year for entities that are not public interest entities • Provision of non-assurance services – an extra six months to complete newly prohibited non-assurance services that were contracted for before the effective date

40. ED comments on transitional provisions • Majority supported transitional provisions • Minority views: • Transitional provision for partner rotation is not necessary • Transitional provision for non-assurance services is not necessary • Transitional provision for non-assurance services should allow 12 months to complete in exceptional circumstances • Should be a “fresh-start” for provisions when PIE fees >15% • Concern with transitional periods that produce different effective dates

41. IESBA Position – Transitional provisions • Fees exceed 15% • Without a “fresh-start” the change would be applied retroactively • Should be explicit that a “fresh-start” approach is to be taken • Should also be linked to the client’s fiscal year • Assuming a client had a Dec 31st year-end, a pre-or post issuance review would be required in relation to the 2012 audit if fees exceed 15% for 2011 and 2012

42. IESBA Position – Transitional provisions • ED proposed that early adoption be encouraged • Some respondents stated effective date was ambitious • Some member bodies and firms may need the full 18 months to effect an orderly implementation of the changes • Preferable to have the more neutral statement that early adoption is permitted

43. Principles/Rule and use of “shall” • In December, IESBA agreed Task Force should review usage of “shall” with view to determining that each usage is appropriate • Task Force reviewed Code and proposed limited changes to use “shall” only to denote a requirement • IESBA agreed with Task Force’s proposal

44. Re-exposure – Due process requirements • After approving revised content, IESBA required to assess whether there is substantive change that warrants re-exposure. For example: • Changes arising from matters not aired in the ED • Commentators have not had an opportunity to make views known • Changes arising from matters not previously deliberated by the IESBA

45. Re-exposure – IESBA preliminary discussion • Many Board members expressed the view that re-exposure is not warranted • Many respondents expressed view Code should address M&A • Board is doing so • M&A clause provides pragmatic guidance • Generally codifies best practice • In most cases firm’s will be able to terminate I/R by effective date • M&A clause is not likely to be used in every M&A case

46. Discussion