Auditors, when carrying out audit engagements, are required to comply with the independence requirements set out in the Hong Kong Institute of CPAs’ Code of Ethics for Professional Accountants (code). Auditors of public interest entities (PIE) must comply with more stringent independence requirements.
In May, the Institute responded to the International Ethics Standards Board for Accountants (IESBA) Exposure Draft (ED) Proposed Revisions to the Definitions of Listed Entity and Public Interest Entity in the Code. The submission is available on the Institute’s website.
The ED proposed revisions to the code that broadens the definition of a PIE and also:
- Introduce an overarching objective for additional requirements to enhance confidence in the audit of financial statements of PIEs.
- Provide guidance on factors to consider when determining the level of public interest in an entity.
- Broaden the definition of PIE to additional categories of entities.
- Replace the term “listed entity” with the term “publicly traded entity” and redefine that PIE category.
- Introduce new requirements for firms to determine if additional entities should be treated as PIEs for independence purposes and to publicly disclose if an audit client was treated as a PIE.
- Recognize and encourage local regulators to refine PIE categories in regard to national conditions.
These points, and the views of the Institute, are considered in this article.
The IESBA’s overarching objective is to refine the definition in the international code so that when determining which entities should be categorized as PIEs in the local code, local bodies assess the public interest in the financial condition of an entity (i.e. how its financial success or failure may impact the public) and not the public interest in other aspects of that entity such as the quality of the products or services it provides, the manner in which it delivers those products or services, or the nature of the data the entity holds.
Overall, the Institute supports the overarching objective. However, the definition of “financial condition” is unclear and distinguishing the “financial condition” and other aspects of the entity in practice may be challenging due to interlinkages. The Institute also highlighted that the auditor, in general, has no responsibility for the “financial condition” of the entity other than providing an audit opinion on the financial statements based on its audit work.
The IESBA’s proposed broad approach uses a longer and more broadly defined list of categories than the extant code, which only has a narrow list of entities to which local bodies can add. The broad approach comprises three key elements:
- The development of a longer and broader list of high level categories of entities as PIEs in the IESBA code;
- Refinement of the IESBA definition by relevant local bodies by tightening definitions, setting size criterion and adding new types of entities or exempting particular entities; and
- Determination by firms if any additional entities should be treated as PIEs.
It would be difficult, if not impossible, to develop a single global definition of PIEs that can be consistently applied by all jurisdictions without modification and further refinement at a local level.
The Institute received mixed views on the proposed broad approach. Some stakeholders have expressed concerns that the approach will drive increased differences between jurisdictions. They are of the view that the extant provisions in the code allow jurisdictions to add to the list of PIEs where necessary under local laws and regulations. There are concerns that the approach will spill over to other sections of the code and have unintended consequences.
The IESBA proposed a new term “publicly traded entity” to replace “listed entity” in the code. This is intended to scope in more entities, as it is not confined to shares, stock or debt traded only in formal exchanges but also encompasses those over-the-counter trading platforms. The new term also aims to remove the confusion created by the term “recognized stock exchange” in the extant definition.
The IESBA also expanded the PIE categories other than “publicly traded entity” to include banks, insurance companies, entities providing post-employment benefits, collective investment vehicle and an entity specified as such by law or regulation to meet the objective set out.
The Institute supports the proposal for the new term “publicly traded entity” as it would expand the scope of an entity and reduce confusion.
Stakeholders expressed views that converged definitions of “PIE” and “publicly traded entity” should be developed by international standard setters. Though this may be difficult in practice, converged definitions would be helpful to minimize the expectation gap on financial reporting and auditing among stakeholders.
The Institute supports the expanded categories and sought further clarification on the term “law and regulation.”
Role of local bodies
Another component of the broad approach is the local refinement of the IESBA’s final revisions by the relevant bodies such as regulators or oversight bodies, national standard setters and professional accounting bodies through tightening definitions, setting size criteria and adding new types of entities or exempting particular entities.
The Institute recommends clarifying the proposed requirement to state clearly the role of local bodies to refine the PIE list for the purpose of requiring additional independence requirements on auditors. Additional guidance from IESBA to support local bodies before and during the implementation stage would be helpful.
Role of firms
The proposed third component of the broad approach is that firms are now required to determine whether to treat additional entities or certain categories of entities, as PIEs, rather than encouraged to as in the extant code.
The Institute expresses the significant concern and disagreement from local stakeholders on the proposal. Stakeholders from the small and medium practice community highlighted Hong Kong’s requirement of a statutory audit for most of the entities and corporations. The proposed revision may impose a significant amount of cost and undue pressure on these practitioners to assess whether each client is a PIE at the client acceptance and engagement continuance exercise.
Stakeholders also commented that the “reasonable and informed third party” approach would often be taken as hindsight. Regulators may question a firm as to why an entity in a certain industry has not been treated as a PIE where peers have treated entities in the same industry as a PIE before market practice or norms are established. The Institute recommends that the IESBA re-consider the proposal.
Transparency requirement for firms
The IESBA recognized that one side effect of its proposals may be increased uncertainty by the public as to whether an entity has been treated as a PIE by a firm given the local variations that might arise and the new requirement on firms to determine additional PIEs. To address this issue, the IESBA proposed a new general requirement for a firm to disclose whether an entity has been treated as a PIE without at this stage stating how that disclosure should be made.
The Institute expresses concerns about the proposal and is of the view that the benefits of having this disclosure is less than its potential cost and may lead to unintended consequences. Having such a statement without providing additional context to users may create confusion and add to the expectation gap between stakeholders and auditors.
This article was contributed by Selene Ho CPA, Deputy Director, and Norman Chan FCPA (practising), Associate Director, of the Institute’s Standard Setting Department. Visit the department’s “What’s new” webpage for our latest publications, and follow us on LinkedIn for upcoming activities.