As professional accountants, we are all bound by ICAEW’s Code of Ethics. Auditors must also comply with the Financial Reporting Council’s (FRC’s) Ethical Standard (ES), with its focus on the fundamental ethical principles of integrity, objectivity and independence. After all, an audit or assurance opinion will not be worth much if the auditor has not upheld these principles.

The FRC issued a revised ES on 15 January 2024. This article will focus on requirements that will affect firms that do not audit listed, public interest entities (PIEs), or Other Entities of Public Interest (OEPIs). It will also consider the FRC guidance on the Objective, Reasonable and Informed Third Party test (ORITP test), which was issued by the FRC at the same time as the revised ES.

This revised ES takes effect from 15 December 2024, and engagements related to periods commencing before this date can be completed under the existing 2019 rules. In practice, this mostly means that audits for 2025 year-ends will be the ones entirely under the new standard. Be careful though – firms will need to be ready to comply from 15 December 2024, as most of the requirements in the revised ES relate to the entire period being audited.

The revised 2024 version of the standard does three main things:

• simplifies the standard and adds clarity to areas that were causing auditors and assurance providers issues;
• incorporates updates made to the International Code of Ethics for professional accountants from the International Ethics Standards Board for Accountants (IESBA); and
• adds a targeted restriction on fees from entities related by a single controlling party.

Together with the 2024 ES the FRC issued guidance for auditors on the application of the ORITP test, upon which many of the requirements in the ES are predicated. This guidance is not prescriptive, but it does examine ways in which firms can ensure they take account of the ORITP (see more below). 

There are some key aspects of the 2024 ES around fees, tax services and breach reporting for smaller firms to be aware of. 

Fees

There have long been limits on the regularly recurring fees received from a client and its subsidiaries, for firms that audit unlisted non-PIE entities. While the limits of 10% and 15% remain the same, the new standard requires that you consider the fees received from a collection of entities with the same beneficial owner or controlling party (which is not a corporate), as well as those companies in a group. This makes perfect sense, as you are trying to guard against the risk of intimidation and self-interest threats.

For example, if you are planning to issue a modified audit opinion, but you are afraid that you will lose the client (self-interest threat) or the client specifically tells you they will sack you as auditors if you issue such an opinion (intimidation), you don’t want to be in the position of the client making up a high proportion of your fees. If the company involved is one of several companies all controlled by the same person, the fact that they are not all subsidiaries is irrelevant. In this and similar scenarios, a controlling party could decide to replace you as auditor for all the companies that they control. 

Even under the existing ES, auditors are required to consider threats to their integrity, objectivity and independence, and fee dependence would be one of these. Auditors are also required to meet the ethical outcomes required by the overarching principles of the ES and so arguably, a firm should consider whether fees from clients controlled by a single party should be combined. Now, it is crystal clear that these should be considered.

It will be vital for firms to check whether any clients fall into this category as even before the new ES fully takes effect, it is questionable as to whether sufficient safeguards can be put in place where total fees from clients controlled by the same person exceed the limits. Ultimately the firm may need to resign from one or more engagements if the changes mean that limits are exceeded. 

Offering tax services

Original proposals to the consultation on the new ES included extending the prohibition on providing tax services to certain entities to include providing such services to the controlling shareholders of an entity relevant to an engagement. Following feedback though, the requirement included is that firms need to identify threats to independence from the provision of tax services to controlling shareholders of an entity relevant to an engagement, including familiarity threats, and any relevant safeguards that can be applied. As firms already need to consider the threats to independence from providing other services and put in place relevant safeguards, the point of this revision is largely to remind firms that providing services to individuals who control a client, creates similar risks to providing services to the client. 

Breach reporting

Firms have been required to report breaches in the ES or related policies and procedures for many years and this requirement is maintained. As before, firms supervised by a Recognised Supervisory Body (RSB) such as ICAEW, will report those breaches to this RSB, rather than to the FRC. The requirements in the 2024 ES additionally set out that the engagement partner and ethics partner (where needed) must consider the ORITP perspective in making judgements on what extra steps are needed when a breach is identified. As breach reporting requires firms to have a system to capture such breaches, an additional requirement states that systems must be designed with this objective.

Guidance on ORITP test

While not part of the ES, the FRC’s ORITP Guidance document was issued at the same time and is useful as it highlights not just that auditors should consider the perspective of an ORITP in an abstract sense, but that they should look to consider how they formed those views.

To inform the guidance, the FRC did some research, using its collaborative Audit & Assurance Sandbox, to ask firms how they operationalised the ORITP test, with a view to identifying good practices and innovative ideas around how the test is implemented. 

A variety of possibilities are offered in the guidance. Some involve seeking views on the firms’ ORITP judgements and guidance from an independent panel or non-executive directors from the firm’s boards, which may be impractical for some firms. But smaller firms might want to consider how they check that judgements required to take into account the ORITP test are made, and whether auditors truly have considered such views. 

In conclusion

Ethical standards are something that need constant thought to avoid inadvertent breaches, which often have severe consequences. Between now and December 2024, audit firms would do well to remind staff and partners of both the existing ES requirements and the changes and take steps to ensure that all of the firm’s relevant policies and procedures are reviewed and, if necessary, updated. Even if your firm uses a third party to supply you with appropriate policies, you need to ensure that you can implement these appropriately.

Julia Penny, Director, JS Penny Ltd and ICAEW president 2022-23.