(a) The issue of auditors providing non-assurance services to audit clients has been topical for many years, and there are many arguments for and against their outright prohibition. IESBA conducted a review of the International Code of Ethics for Professional Accountants (the Code) and made a number of changes to the guidance, tightening the services which can be provided, with a particular focus on public interest entities.
The amendments mean that the Code no longer permits the provision of normally prohibited non-assurance services in emergency situations to public interest clients, such as certain bookkeeping and taxation services. The provisions in the Code relating to management responsibility were strengthened to ensure better understanding of what constitutes a management responsibility. It continues to be emphasised in the Code that auditors must not assume management responsibility when providing non-assurance services to audit clients.
The Code, while not providing an exhaustive list, sets out a number of examples of activities which may result in management responsibility. A number of new activities have been explicitly added, including being involved in the strategic direction of the company, hiring of personnel and reporting to those charged with governance on behalf of management, and thus effectively making these activities prohibited in line with the Code.
There are varying views on whether it is appropriate for auditors to provide non-assurance services to their clients. For example, governance regulations in some jurisdictions can be relatively lenient. For example, the UK Corporate Governance Code requires the audit committee to review and monitor the external auditor’s independence and objectivity. This includes the audit committee evaluating and approving the provision of non-audit services by the audit firm. This assessment would include consideration of whether the audit firm was complying with the relevant ethical guidance. In contrast, the US Sarbanes-Oxley Act takes a stricter approach and prohibits audit firms from providing other services to audit clients.
Those arguing in favour of outright prohibition suggest that this would be a simple way to eliminate the threats to objectivity, which the provision of non-assurance services to audit clients creates. The IESBA quote states that several threats to objectivity are created when performing such services. A self-review threat arises when the auditor, in performing additional services for the client, performs work which impacts on the financial statements, meaning that the auditor is reviewing their own figures, or matters over which they have provided guidance or advice. An example could be where the audit firm performs a valuation service on a matter which is material to the financial statements.
Depending on the nature of the additional service, an advocacy threat may arise, where the audit firm is perceived to be supporting the interests of their client. This could happen, for example, if the audit firm advises their client in relation to a legal dispute or tax tribunal.
In particular, non-audit services can be very lucrative, leading potentially to a self-interest threat. The greater the volume and financial significance of the non-assurance services provided, the greater the risk that the auditor will have relationship and economic reasons not to challenge management’s views and positions with the necessary degree of professional scepticism.
It has also been argued that outright prohibition would benefit the market and competition within the audit market, allowing smaller audit firms to provide the services which larger firms would no longer be able to offer to their audit clients or conversely allow smaller firms to ascertain a larger proportion of the external audit market.
However, there are also many arguments which support auditors providing these additional services. By having the same firm provide the audit and the non-assurance service, the client benefits in two ways. The audit firm will already possess a good knowledge and understanding of the client and its operating environment, resulting in deeper insight and a better quality service being provided. This will then lead to cost benefits, as the non-assurance service will be provided in a more efficient way.
Audit firms would also argue that participation in services such as due diligence reviews and forensic investigations allows the audit firm to understand their clients’ business and risks better and to obtain insights into management’s objectives and capabilities which are useful in an audit context. This may reduce audit risk.
Many non-assurance services can be safely provided as long as steps are taken to assess potential threats to objectivity, and to adequately address those risks, for example, by the use of separate teams to provide audit and non-assurance services. However, in the case of public interest entities, such as listed companies, the IESBA has taken the view that no safeguards are available to reduce the risks to an acceptable level in the case of some non-assurance services and it continues to emphasise that the auditor shall not become involved in activities which result in them assuming any form of management responsibility.

(b) (i) Before accepting the engagement to review Waters Co’s prospective financial information, there are several matters to be considered. A significant matter is whether it is ethically acceptable to perform the review. The review would constitute a non-assurance service provided to an audited entity, and IESBA’s International Code of Ethics for Professional Accountants states that this may create self-interest, self-review and advocacy threats to independence. In this case, the advocacy threat may be deemed particularly significant as Hunt & Co could be perceived as promoting the client’s position to the bank. The review engagement should only be provided if safeguards can be used to reduce the threat to an acceptable level, which may include:
– Having a professional accountant who was not involved with the non-assurance service review the non-assurance work performed or otherwise advise as necessary.
– Discussing ethical issues with those charged with governance of the client.
– Using separate teams to work on the audit and on the review engagement.
The request by the finance director to assist him in presenting the final version of the strategic plan to the board also needs to be considered. The request to be involved in confirming that the plan is consistent with competitors suggests that if the board is not satisfied the company may not move forward with the plan or apply for the bank funding. If the engagement partner is involved, this would likely result in the firm taking on a management responsibility as they are essentially supporting the strategic direction suggested by management. Further, by attending the presentation the partner could be seen to be communicating with the board on behalf of management. Both of these activities are now referenced as management activities in the Code and therefore the firm should advise the finance director that Hunt & Co may be able to perform the review for the purposes of the bank but the firm will not be able to take part in the presentation.
As well as ethical matters, ISAE 3400 The Examination of Prospective Information requires that certain matters are considered before a review engagement is accepted. Hunt & Co must also consider the specific terms of the engagement. For example, the firm will need to clarify whether the bank has requested a review report to be issued, and what exact information will be included in the application to the bank. It is likely that more than just a forecast statement of profit or loss is required, for example, a forecast statement of cash flows and accompanying narrative, including key assumptions is likely to be required for a lending decision to be made.
ISAE 3400 also requires that consideration should be given to the intended use of the information, and whether it is for general or limited distribution. It seems in this case the review engagement and its report will be used solely in connection with raising bank finance, but this should be confirmed before accepting the engagement.
The period covered by the prospective financial information and the key assumptions should also be considered. ISAE 3400 states that the auditor should not accept an engagement when the assumptions used are clearly unrealistic or when the auditor believes that the prospective financial information will be inappropriate for its intended use. For example, the assumption that the necessary capital expenditure can take place by September 20X5 may be overly optimistic.
The firm should also consider whether there are staff available with appropriate skills and experience to perform the review engagement, and the deadline by which the work needs to be completed. If the work on the cinemas is scheduled to be completed by September 20X5, presumably the cash will have to be provided very soon, meaning a tight deadline for the review engagement to be performed.
(ii) Examination procedures should include the following:
– Agreement that the accounting policies used in preparing the forecast statement of profit or loss are consistent with those used in historical financial information and comply with IFRS Standards.
– The forecast should be cast to confirm accuracy.
– The time frame of the work to be carried out needs to be discussed with management, with enquiry being made to ascertain how the work can be carried out in such a short period of time, for example, will all cinemas be closed for the period of refurbishment? This will help to confirm the accuracy of the revenue and expenses recognised.
– Review of market research documents and review of prices charged by competitors showing new technology films to support the assumption regarding increase in price and consumer appetite for the films.
– Analytical review followed by discussion with management on the trend in revenue, which is forecast to increase by 22·9% and 7% in the years to 31 May 20X6 and 20X7 respectively.
– Consider the capacity of the cinemas and the number of screenings which can take place to assess the reasonableness of projected revenue.
– Analytical review of the composition of operating expenses to ensure that all expenses are included at a reasonable amount. In 20X5, operating expenses are 80·7% of revenue, but this is forecast to reduce to 73·4% in 20X6 and to 69·8% in 20X7, indicating understatement of forecast expenses.
– Review the list of operating expenses to ensure that any loss to be recognised on the disposal of old equipment has been included, or that profit on disposal has been netted off.
– Quotations received from potential suppliers of the new technology should be reviewed to verify the amount of the capital expenditure and therefore that depreciation included in the forecast statement of profit or loss appears reasonable.
– Recalculation of depreciation expense and confirmation that depreciation on the new technology has been included and correctly calculated and agrees to the forecast statement of financial position.
– Recalculation of finance cost to ensure that interest payable on the new bank loan has been included, with confirmation of the rate of interest to bank documentation.
– Review of capital expenditure budgets, cash flow forecasts and any other information to accompany the forecast statement of profit or loss for consistency, and confirmation that the amount planned to be spent on the cinemas can be met with the amount of finance applied for as well Waters Co’s own cash balance.
(iii) Report on prospective financial information
ISAE 3400 contains requirements on the content of a report on prospective financial information, stating that it should contain, in addition to a title, addresses and being appropriately signed and dated:
– Identification of the prospective financial information;
– A reference to the ISAE or relevant national standards or practices applicable to the examination of prospective financial information;
– A statement that management is responsible for the prospective financial information including the assumptions on which it is based;
– When applicable, a reference to the purpose and/or restricted distribution of the prospective financial information;
– An opinion as to whether the prospective financial information is properly prepared on the basis of the assumptions and is presented in accordance with the relevant financial reporting framework;
​​​​​​​– Appropriate caveats concerning the achievability of the results indicated by the prospective financial information.
In terms of the assurance level, the report will include a statement of negative assurance as to whether the assumptions provide a reasonable basis for the prospective financial information. This is a lower level of assurance than that given in an audit of historical financial information. The assurance provided is limited due to the future orientation of the information subject to review, and because the nature of the investigative procedures performed are less detailed and substantive in nature.