The accounting and legal community is calling on the Auditing and Assurance Standards Board and the Canadian Bar Association to provide more guidance over the role of in-house legal counsel in an exposure draft designed to assist auditors, law firms and management to communicate effectively with each other over audit inquiries.
The exposure draft, two years in the making, updates the existing Joint Policy Statement (JPS) to reflect developments in accounting and auditing standards as well as in the legal environment since the original statement was issued in 1978. The JPS covers situations when auditors request management to prepare an inquiry letter to send to an entity’s law firm to confirm the fairness of management’s evaluation of the entity’s claims. It is intended to protect solicitor-client confidentiality and privilege while ensuring that auditors have access to sufficient appropriate information to fulfil their professional responsibility in conducting the audit of the entity’s financial statements.
“What this JPS is trying to do is balance those apparently conflicting objectives,” explained Eric Turner, principal in the auditing and assurance standards department at CPA Canada. “We are looking for as much evidence as we can get and make sure that the financial statements are appropriately disclosed in accordance with accounting principles — what the contingencies are. On the other hand, the lawyer’s objectives are to provide good service to their client in defending any claims that they might have.”
The proposed draft introduces significant changes. Perhaps most notably, it expands the scope of the JPS to include in-house legal counsel acting in a legal capacity performing a role commonly assumed by external legal counsel. The exposure draft also updated guidance with respect to the timing of issuance of the inquiry and issuance letters, and it adopted a neutral accounting framework approach. That means it can be used regardless of the applicable financial reporting framework applied by management to evaluate the entity’s claims and possible claims.
“We spent a fair amount of time debating whether or not the policy should be getting into responses under specific accounting frameworks, whether it is the International Financial Reporting Standards (IFRS) or the Canadian Generally Accepted Accounting Principles (GAAP),” said William Scott, a corporate lawyer with Stikeman Elliott and Chair of the CBA JPS Review Committee. “Ultimately we decided that the policy should be framework neutral, and that the procedures to be followed and the responses lawyers are required to provide shouldn’t distinguish between the different accounting frameworks. It’s a kind of one size fits all Joint Policy Statement.”
The exposure draft, issued in November 2014, was the subject of a dozen written comments from members of both professions. The AASB, which establishes standards for assurance and related services engagements, and the CBA are now reviewing the comments. The AASB expects to approve the final JPS this October, and the CBA by next February. The revised JPS is expected to be in effect as of December 2016. “The comments were fairly light we thought,” remarked Scott. “We did take a number of suggestions aboard, and others we felt were adequately addressed in the exposure draft.”
Above all, accounting and law firms would like to see the JPS Review Committee clarify and elaborate the appropriate circumstances in which an auditor may communicate with in-house legal counsel. Some are concerned about the objectivity of in-house legal counsel, even when they are working in a legal capacity. Depending on the in-house legal counsel’s chain of reporting, there may be potential for bias or conflict that would impact the response letter, points out Jean-François Trépanier, senior manager, professional standards at Raymond Chabot Grant Thornton in Montreal. In-house legal counsel may for instance report to management, the board of directors or even the audit committee, which could raise questions about their objectivity. The same would hold true if they were involved in assisting in developing an estimate.
Auditors use professional judgment and exercise professional skepticism to determine the quantity and quality of audit evidence. When auditors use audit evidence provided by someone who works as part of management, they have to assess the reliability of that evidence. In the course of their investigation, auditors may rely on experts, including lawyers. When an auditor’s expert is also a management’s expert, Trépanier recommends that steps be taken to deal with the “threat of objectivity.” Written representation from the in-house legal counsel may be an appropriate way to gain assurance that the in-house legal counsel responded with an objective state of mind, said Trépanier.
“We’re not saying that it’s a complete no-go because the client after all could call an external legal counsel who would be the taking the same steps,” said Trépanier. “We would like to see the JPS be more explicit so that an auditor has a better grasp of the situation. It would also help the auditor determine the objectivity of an in-house legal counsel.”
It’s also important for auditors to have “sufficient knowledge” about the in-house legal counsel’s legal expertise and competence in the area of law for which a claim or possible claim is identified or in situations when the analysis hinges on complex or evolving law such as bankruptcy or employment law, noted in her comments Julie Corden, the national assurance leader at Deloitte LLP. “If the results of additional enquiries performed by the auditor results in a determination that in-house legal counsel may not have the competence and expertise to appropriately respond to audit inquiries regarding claims and possible claims, then it may be appropriate to provide guidance on the procedures that should be performed by the auditor to respond to this circumstance,” said Corden.
These are issues that the JPS review committee is examining. “Some of the respondents were questioning what would work would the auditor need to do to make him or herself comfortable that they can use the evidence in their audit,” said Svetlana Berger, principal, auditing and assurance standards, CPA Canada. “That’s an issue we are discussing with the AASB to ensure how to direct our auditors in this regard.”
That will not happen with an issue raised by Quebec CPAs. Trépanier as well as the technical working group – Assurance of the Quebec CPA Order believe that notaries should have been involved in the JPS review process. A notary, they point out, is a trained lawyer who is licensed to practice law, with the exception of pleading in court. That they were not considered in the process will “create an undesirable legal vacuum” since the Quebec Charter of Human Rights and Freedoms and Quebec courts have given notary-client privilege the “same status as that conferred on lawyers,” noted the Quebec CPA technical working group. Trépanier said that it would be appropriate to include notaries in the JPS because communications regarding claims and possible claims must also be sent to notaries if management used notaries for legal advice.
“In Quebec, lawyers and notaries are two separate professions, and we felt it wasn’t appropriate for us to be generating a policy that would apply to notaries in this context,” said Scott. “The likelihood of a notary receiving an audit inquiry from an auditing firm would be quite rare. That said, they are perfectly welcome to follow the same procedures, and may well decide to do that.”