Commission Recommendation of 16 May 2002 — Statutory Auditors' Independence in the EU: A Set of Fundamental Principles (Text with EEA relevance) (notified under document number C(2002) 1873)
Date: 2002-05-16
Institutions: European Commission
Subjects: duties of civil servants, financial control, income in addition to normal pay, job description, management accounting, protective clause, provision of services, publication of accounts, remuneration of work

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II

(Acts whose publication is not obligatory)

COMMISSION

COMMISSION RECOMMENDATION

of 16 May 2002

Statutory Auditors' Independence in the EU: A Set of Fundamental Principles

(notified under document number C(2002) 1873)

(Text with EEA relevance)

(2002/590/EC)

THE COMMISSION OF THE EUROPEAN COMMUNITIES,

(4)

Having regard to the Treaty establishing the European
Community, and in particular Article 211, second indent
thereof,

Whereas:

(1)

(2)

(3)

The independence of statutory auditors is fundamental
to the public confidence in the reliability of statutory
auditors' reports. It adds credibility to published financial
information and value to investors, creditors, employees
and other stakeholders in EU companies. This is particu-
larly the case in companies which are public interest
entities (e.g., listed companies, credit institutions, insur-
ance companies, UCITS and investment firms).

Independence is also the profession's main means of
demonstrating to the public and regulators that statutory
auditors and audit firms are performing their task at a
level that meets established ethical principles, in partic-
ular those of integrity and objectivity.

(5)

Council Directive 84/253/EEC (1) on ‘the approval of
persons responsible for carrying out the statutory audits
of accounting documents’ establishes
the minimum
qualifications required of persons who are allowed to
carry out statutory audits.

(1) OJ L 126, 12.5.1984, p. 20.

Articles 24 and 25 of this Directive require EU Member
States to prescribe that statutory auditors do not carry
out statutory audits, either in their own right or on
if they are not independent.
behalf of an audit firm,
Article 26 of the Directive requires Member States to
ensure that statutory auditors are liable to appropriate
sanctions when they do not carry out a statutory audit
in an independent manner. Furthermore, Article 27 of
the Directive requires Member States to ensure, at a
minimum, that the members and shareholders of an
audit firm do not intervene in the conduct of statutory
audits in any way which jeopardises the independence of
the natural persons performing the statutory audit on
behalf of that audit firm. This requirement also applies
to those members of the administration, management
and supervisory body of the audit firm who are not
personally approved as statutory auditors.

Member States' national rules on statutory auditors'
independence currently differ in several respects such as:
the scope of persons to whom independence rules
should apply, both within an audit firm and outside the
firm; the kind of financial, business or other relation-
ships that a statutory auditor, an audit firm or an indi-
vidual within the firm may have with an audit client; the
type of non-audit services that can and cannot be
provided to an audit client; and the safeguards which
need to be put in place. This situation makes it difficult
to provide investors and other stakeholders in EU
companies with a uniformly high level of assurance that
statutory auditors perform their audit work indepen-
dently throughout the EU.

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(6)

(7)

(8)

(9)

At present there is no internationally accepted ethics
standard for statutory auditors' independence that could
be used as a benchmark for national independence rules
throughout the EU.

statutory auditors'

The issue of
independence was
addressed by the Commission's 1996 Green Paper (1) on
‘The Role, Position and Liability of the Statutory Auditor
in the EU’ that received the support of the Council, the
Economic and Social Committee and the European
the Commission's 1998
Parliament. As a result of
Communication ‘The Statutory Audit in the European
the EU Committee on
Union,
Auditing was created. This Committee established statu-
tory auditors'
independence as one of their priorities.
Finally, the Commission's Communication ‘EU Financial
Reporting Strategy: the way forward’ (3) underlines the
importance of a statutory audit carried out to uniformly
high levels across the EU, including a common approach
to professional ethics standards.

the way forward’ (2)

The scope of this initiative on statutory auditors' inde-
pendence applies to the EU statutory audit profession as
a whole. It aims at setting a benchmark for Member
States' requirements on statutory auditors' independence
throughout the EU.

Agreement was reached in the Committee on Auditing
that each Member State should provide statutory audi-
tors, regulators and the interested public with a common
understanding of the independence requirement by the
application of fundamental principles. This will bring
about consistency in interpreting and addressing facts
and circumstances which threaten a statutory auditor's
independence throughout the EU. The existence of such
principles should also help to provide a level playing
field for the provision of statutory audit services within
the single market. The principles should be compre-
hensive, rigorous, robust, enforceable and reasonable.
They should be consistently interpreted and applied by
professional bodies, supervisors and regulators, as well
as by statutory auditors, their clients and other interested
parties.

(10) Agreement was also reached in the Committee on
Auditing to build on this initiative in order to develop
common independence standards. This will contribute to
the creation of a single EU capital market as outlined by

the Financial Services Action Plan (4) and endorsed by
the Stockholm European Council (5). However, whilst
work to achieve harmonisation continues, the setting of
national independence rules that are complementary to
EU fundamental principles is to be left to the discretion
of Member States. Such rules would apply in particular
to statutory audits of companies operating in regulated
industries. Member States may also decide to require the
application of
the same independence standards to
unlisted companies as applicable to listed companies.

(11) A principles-based approach to statutory auditors' inde-
pendence is preferable to one based on detailed rules
because it creates a robust structure within which statu-
tory auditors have to justify their actions.
It also
provides the audit profession and its regulators with the
flexibility to react promptly and effectively to new devel-
opments in business and in the audit environment. At
the same time, it avoids the highly legalistic and rigid
approach to what is and is not permitted which can
rules-based regime. A principles-based
arise
approach can cater for the almost infinite variations in
individual circumstances that arise in practice and in the
different legal environments throughout the EU. Conse-
quently, a principles-based approach will better serve the
needs of European capital markets, as well as those of
SMEs.

in a

(12)

The benefits of safeguarding the statutory auditors' inde-
pendence include efficiencies and other positive effects
that, ultimately, contribute to the overall efficiency of
the capital markets. On the other hand, maintaining
statutory auditor independence creates a variety of addi-
tional costs that have to be borne by various parties.
These include the costs that are related to developing,
maintaining, and enforcing safeguards to independence.
When seeking to impose a certain safeguard on statutory
auditors, Member States and regulators need to take into
account the anticipated costs and benefits in particular
circumstances. For example, a particular safeguard may
bring substantial public benefits at a modest cost when
applied to the audits of public interest entities. But if
applied to the audit of a small company with relatively
little public interest, the same safeguard may result in
costs that are disproportionate to the associated benefits
to the users of this company's financial statements.

(1) OJ C 321, 28.10.1996, p. 1.
(2) OJ C 143, 8.5.1998, p. 12.
(3) COM (2000) 359, 13.6.2000.

(4) COM (1999) 232, 11.5.1999.
(5) Presidency Conclusions, Stockholm European Council, 23 and 24

March 2001.

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(13)

Establishing fundamental principles is not in itself suffi-
cient to ensure public confidence that the EU statutory
auditor applies proper standards of integrity and inde-
pendence. Appropriate systems of quality assurance are
necessary in order to check that the principles are prop-
erly applied by EU statutory auditors. In this regard the
Commission Recommendation on ‘Quality Assurance
for the Statutory Auditor in the EU’ (1) provides for
external quality reviews of statutory auditors, including a
review of compliance with independence standards.
Such quality assurance systems are subject to public
oversight.

independence could arise and provides guidance on the
measures a statutory auditor should take to mitigate
such threats in relation to a particular statutory audit. It
is to be noted that Section B is not intended to provide
an exhaustive list of all the circumstances where threats
to auditor independence might arise, but that statutory
auditors should be alert to any such threat and take
whatever action is necessary in accordance with the
principles and guidance in this Recommendation. The
basic principles in Section A and the essential safeguards
that are provided in Section B for specific circumstances
are supported by an annex, which provides related
explanations and guidance. Important terms are defined
in the Appendix,

(14)

This Recommendation is an important step towards
assuring audit quality. Further steps may be necessary.
The Commission intends to come forward with a
broader strategy on auditing which will address issues
such as the use of International Standards on Auditing
(ISAs), the establishment of a public oversight on the
audit profession and the role of audit committees.

(15)

This Recommendation emphasises the responsibility of
the audit profession to uphold auditor independence. If
this Recommendation does not bring about the desired
harmonisation, the Commission will review the situation
three years after the adoption of this Recommendation
taking into account
international developments. This
review will specifically address the question to what
this Recommendation has had an impact on
extent
auditor
independence where auditors have provided
non-audit services to audit clients.

(16)

There is general agreement in the EU Committee on
Auditing and in the Contact Committee on the
Accounting Directives on the fundamental principles of
this Recommendation.

(17)

This Recommendation provides a framework within
which all of the general
issues of statutory auditors'
independence are considered. Its Section A sets out the
overarching independence requirements for statutory
auditors and discusses the scope of persons to whom
independence rules should apply. Section B then reviews
a range of specific circumstances in which threats to

(1) C (2000) 3304, 15.11.2000.

HEREBY RECOMMENDS:

That rules, standards and/or regulation on statutory auditors'
independence in the Member States of the European Union
should implement the following set of fundamental principles:

A. FRAMEWORK

When carrying out a Statutory Audit (*), a Statutory Auditor (2)
must be independent from his Audit Client (*), both in mind
and in appearance. A statutory auditor should not carry out a
Statutory Audit if there are any financial, business, employment
or other relationships between the statutory auditor and his
client (including certain non-audit services provided to the
audit client) that a reasonable and informed third party would
conclude compromise the statutory auditor's independence.

1. Objectivity, integrity and independence

1. Objectivity and professional integrity should be the over-
riding principles underlying a statutory auditor's audit
opinion on financial statements. The main way in which the
Statutory Auditor can demonstrate to the public that a
Statutory Audit is performed in accordance with these prin-
ciples is by acting, and being seen to act, independently.

2. Objectivity (as a state of mind) cannot be subjected to
external verification, and integrity cannot be evaluated in
advance.

3. Principles and rules on statutory auditors'

independence
should allow a reasonable and informed third party to
evaluate the procedures and actions taken by a Statutory
Auditor to avoid or resolve facts and circumstances that
pose threats or risks to his objectivity.

(*) Defined in the glossary.
(2) Defined in the glossary. The term ‘statutory auditor’ refers to all
firm or
natural or legal persons, or other types of company,
partnership who,
in accordance with the provisions of the 8th
Company Law Directive (84/253/EEC), are approved by the
authorities of the Member States to carry out Statutory Audits.

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2. Responsibility and scope

3. A Statutory Auditor's independence risk assessment should

have due regard to both:

1. It is the responsibility of the Statutory Auditor to ensure
that the requirement for statutory auditors' independence is
complied with.

(a) the services provided to the Audit Client in recent years
and the relationships that existed with that Audit Client
before the appointment as Statutory Auditor; and

2. The independence requirement applies to:

(a) the Statutory Auditor himself; and

(b) the services provided to, and the relationships that exist
with, the Audit Client during the course of the Statutory
Audit.

(b) those who are in a position to influence the outcome of

the Statutory Audit.

4. Systems of safeguards

3. Those in a position to influence the outcome of the Statu-

tory Audit are:

(a) all persons who are directly involved in the Statutory

Audit (the Engagement Team (*)),

including

(i) the Audit Partners (*), audit managers and audit staff

(the Audit Team (*));

(ii) professional

disciplines
personnel
involved in the audit engagement
lawyers,
actuaries, taxation specialists, IT-specialists, treasury
management specialists);

from other

(e.g.,

(iii) those who provide quality control or direct oversight

of the audit engagement;

(b) all persons, who form part of the Chain of Command (*)
for the Statutory Audit within the Audit Firm (*) or
within a Network (*) of which the firm is a member;

(c) all persons within the Audit Firm or its Network who,
due to any other circumstances, may be in a position to
exert influence on the Statutory Audit.

3. Independence threats and risk

1. Different

types of safeguards — including prohibitions,
restrictions, other policies and procedures, and disclosures
— have to be established in order to mitigate or eliminate
threats to statutory auditors'

independence (see A. 3).

2. The existence and the effectiveness of various safeguards

affect the level of independence risk.

4.1. Audited entities' safeguards

4.1.1. G o v e r n a n c e

s t r u c t u r e ' s
d e n c e r i s k a s s e s s m e n t

i m p a c t o n i n d e p e n -

The Statutory Auditor should consider whether the governance
structure of the audited entity provides safeguards to mitigate
threats to his independence and how these safeguards are
operated. Such safeguards include:

1. the appointment of the Statutory Auditor by persons other

than the audited entity's management; and

2. oversight and communications within the audited entity
regarding the Statutory Audit and other services provided to
it by the Audit Firm or its Network.

1. Statutory auditors' independence can be affected by different
including self-interest, self-review, advo-

types of threats,
cacy, familiarity or trust, and intimidation.

2. The level of risk that a Statutory Auditor's independence
might be compromised will be determined by reference to
the significance of these threats, either individually or in
combination, and their impact on the Statutory Auditor's
independence. This determination will need to consider the
specific circumstances that relate to the Statutory Audit
concerned.

(*) Defined in the glossary.

4.1.2. I n v o l v e m e n t o f

t h e G o v e r n a n c e B o d y

1. Where a Public Interest Entity has a Governance Body (see
A. 4.1.1), the Statutory Auditor should at least annually:

(a) disclose to the Governance Body,

in writing:

(i) the total amount of fees that he, the Audit Firm and
its Network members have charged to the Audit
Client and its Affiliates for the provision of services
during the reporting period. This
total amount
should be broken down into four broad categories of
services: Statutory audit services; further assurance
services (*); tax advisory services; and other non-audit

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services. The category of other non-audit services
should be further broken down into subcategories so
far as items in them differ substantially from one
another. This break-down into subcategories should
at least provide information on fees for the provision
internal audit,
of financial
valuation,
litigation and recruitment services. For
each (sub-)category of service, the amounts charged
and contracted for, as well as existing proposals or
bids for future services contracts should be separately
analysed;

information technology,

(ii) details of all relationships between himself, the Audit
Firm and its Network member firms, and the Audit
that he believes may
Client and its Affiliates (*)
reasonably be thought to bear on his independence
and objectivity; and

(iii) the related safeguards that are in place;

(b) confirm in writing that, in his professional judgement,
the Statutory Auditor
independent within the
is
meaning of regulatory and professional requirements
and the objectivity of
the Statutory Auditor is not
compromised, or otherwise declare that he has concerns
that his independence and objectivity may be compro-
mised; and

(c) seek to discuss these matters with the Governance Body

of the Audit Client.

2. Where Audit Clients other than Public Interest Entities have
a Governance Body, the Statutory Auditor should consider
whether similar measures are appropriate.

4.2. Quality assurance

Quality assurance systems which meet the minimum require-
ments of the Commission Recommendation on ‘Quality Assur-
ance for the Statutory Audit in the EU’ (1) are required mecha-
nisms contributing to safeguard statutory auditors' compliance
with the independence requirement at a Member State level.

4.3.

The Statutory Auditor's overall safeguards

a non-auditor owner could not gain control over the Audit
Firm (3).

4.3.2. T h e

A u d i t

F i r m ' s

i n t e r n a l

s a f e g u a r d i n g

s y s t e m

1. A Statutory Auditor should set up and maintain a safe-
guarding system that is an integral part of his firm-wide
management and internal control structure.

2. The functioning of such a system should be documented so
that it can be subject to quality assurance systems (see A.
4.2).

3. Generally, the safeguarding system of an Audit Firm would

include:

(a) written independence policies which address current
independence standards, threats to independence, and
the safeguards related thereto;

(b) active and timely communication of the policies, and
any changes to them, to each Partner, manager and
employee,
training and education
thereon;

including regular

(c) appropriate procedures

to be applied by Partners,
managers and employees in order to meet independence
standards, both on a regular basis and in response to
particular circumstances;

(d) designation of top-level audit professionals (Partners)
responsible for updating the policies, timely communi-
cation of those updates, and overseeing the adequate
functioning of the safeguarding system;

4.3.1. O w n e r s h i p o f a n d c o n t r o l o v e r A u d i t F i r m s

If the Statutory Auditor is an Audit Firm, at least the majority
of the firm's voting rights (50 % plus one vote) must be held by
persons who are authorised to perform Statutory Audits within
the European Union (statutory auditors (2)). The Statutory
Auditor's legal statutes should contain provisions to ensure that

(*) Defined in the glossary.
(1) C (2000) 3304, 15.11.2000.
(2) For the purpose of this section in particular, the term ‘statutory
auditors’ refers to all natural or legal persons, or other types of
company, firm or partnership who, in accordance with the provi-
sions of
the 8th Company Law Directive (84/253/EEC), are
approved by the authorities of the Member States to carry out
Statutory Audits.

(e) documentation for each Audit Client that summarises
the conclusions that have been drawn from the assess-
ment of threats to the Statutory Auditor's independence
and the related evaluation of the independence risk. This
should include the reasoning for these conclusions. If
significant threats are noted, the documentation should
include a summary of the steps that were, or are to be,
taken to avoid or negate the independence risk, or at
least reduce it to an appropriate level; and

(3) This paragraph does not apply to an Audit Firm for which the
relevant Member State,
in accordance with Article 2.1 (ii) 2nd
phrase of the 8th Directive, does not require a majority of voting
rights to be held by statutory auditors, and of which all
the
shares are registered and can be transferred only with the agree-
ment of the firm and/or with the approval of the national autho-
rity competent for the approval of statutory auditors.

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(f) internal monitoring of compliance with safeguarding

policies.

other person being in a position to influence the outcome
of the Statutory Audit (any person within the scope of A.
2).

5. Public disclosure of fees

1. Where a Statutory Auditor or, if the Statutory Auditor is a
natural person, a firm of which he is a member or Partner
has received fees from an Audit Client for (audit and non-
audit) services provided during the client's reporting period,
all these fees should be publicly and appropriately disclosed.

The Statutory Auditor has to assess the significance of any
such threat, identify whether any safeguards would mitigate
the independence risk it presents, and take any action neces-
sary. This may include refusal of, or resignation from, the
audit engagement or exclusion of the relevant person from
the Audit Team. Where applicable, and especially with
regard to Public Interest Entity clients, the Statutory Auditor
should seek to involve the Governance Body in this process.

2. Financial interest in the Audit Client or its Affiliates will be
incompatible with the Statutory Auditor's independence, if:

2. Member States or their regulatory bodies should require this
disclosure to the extent that an Audit Client's audited finan-
cial statements have to be published in accordance with
their national

law.

(a) the Statutory Auditor, the Audit Firm, or any member of
the Engagement Team or the Chain of Command, or
any Partner of the firm or its Network who is working
in an ‘Office’ (*) which participates in a significant
proportion of an audit engagement, holds

3. The total fee income should be broken down by four cate-
gories: statutory audit services; further assurance services;
tax advisory services; and other non-audit services. The fees
for other non-audit services should be further broken down
into subcategories so far as items in them differ substantially
from one another. This break-down into subcategories
should at least provide information on fees for the provision
internal audit, valua-
of financial
tion, litigation and recruitment services. In respect of each
(sub-)category item, the figure relating to the corresponding
(sub-)category item for
the preceding reporting period
should be shown as well. Furthermore, a percentage break-
down for the (sub-)categories should be provided.

information technology,

4. Where a Statutory Audit of consolidated financial state-
ments is concerned,
the fees received by the Statutory
Auditor and his Network members for the services they
provided to the Audit Client and its consolidated entities
should be disclosed accordingly.

B. SPECIFIC CIRCUMSTANCES

1. Financial interests

1. An actual or impending, direct or indirect financial interest
in the Audit Client or its Affiliates, including any derivative
directly related thereto, may threaten the Statutory Auditor's
independence, if it is held by the Statutory Auditor or any

(i) any direct financial interest in the Audit Client; or

(ii) any indirect financial

interest in the Audit Client

which is significant to either party; or

(iii) any (direct or indirect) financial interest in the client's
Affiliates which is significant to either party;

(b) any other person within the scope of A. 2, holds any
(direct or indirect) financial interest in the Audit Client
or its Affiliates which is significant to either party.

Accordingly, the persons concerned should not hold any
such financial interests. Where such an interest is acquired
as a result of an external event (e.g. inheritance, gift, merger
of firms or companies) it must be disposed of as soon as
practicable, but no later than one month after the person
has knowledge of, and the right to dispose of, the financial
interest. In the meantime, additional safeguards are needed
to preserve the Statutory auditor's independence. These
could include a secondary review of the relevant person's
audit work or exclusion of the relevant person from any
substantive decision making concerning the Statutory Audit
of the client.

3. The Statutory Auditor's independence may also be threat-
ened by an apparently insignificant financial interest in an
Audit Client or its Affiliates. The level of threat will be
higher, and likely to be unacceptable,
is
neither acquired or held on standard commercial terms nor
negotiated on an arm's length basis. It is the responsibility
of the Statutory Auditor to assess the level of risk that such
an interest presents and to ensure that any necessary miti-
gating action is taken.

the interest

if

(*) Defined in the glossary.

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2. Business relationships

1. Business relationships between the Statutory Auditor, the
Audit Firm or any other person being in a position to
influence the outcome of the Statutory Audit (any person
within the scope of A. 2) on the one hand, and the Audit
Client, its Affiliates, or its management on the other hand,
may cause self-interest, advocacy or intimidation threats to
the Statutory Auditor's independence.

2. Business relationships, or commitments to establish such
relationships, should be prohibited unless the relationship is
in the normal course of business and insignificant in terms
of the threat it poses to the independence of the Statutory
Auditor.

Where applicable, and especially with regard to Public
Interest Entity clients, the Statutory Auditor should seek to
discuss with the Governance Body of the Audit Client any
cases where doubt arises whether or not a business relation-
ship is in the normal course of business and insignificant in
relation to his independence.

3. Paragraphs 1 and 2 above do not apply to the provision of
statutory audit services. However, neither the Audit Firm
nor any of its Network member firms should provide statu-
tory audit services to:

(a) any owner of the Audit Firm; or

(b) an Affiliate of such an owner where the owner may be
in a position to influence any decision-making of the
Audit Firm which affects its statutory audit function; or

(c) an entity where any individual who has a supervisory or
managerial role in that entity may be in a position to
influence any decision-making of the Audit Firm which
affects its statutory audit function (1).

3. Employment with the Audit Client

1. Dual employment of any individual who is in a position to
influence the outcome of the Statutory Audit both in the
Audit Firm (a person within the scope of A. 2) and in the
Audit Client or its Affiliates should be prohibited. Loan staff
assignments (2) to an Audit Client or any of its Affiliates are
also regarded as dual employment relationships. Where an

(1) Paragraph 3 lit. (a) and (b) do not apply to an Audit Firm for
which the relevant Member State, in accordance with Article 2.1
(ii) 2nd phrase of the 8th Directive, does not require a majority
of voting rights to be held by statutory auditors, and of which
all the shares are registered and can be transferred only with the
agreement of the firm and/or with the approval of the national
authority competent
statutory auditors;
provided that an Audit Client of such an Audit Firm is not in a
position to influence any decision making of
the firm which
affects its statutory audit function.

the approval of

for

(2) An individual who is engaged under a loan staff agreement,
works under the direct supervision of the client and does not
originate any accounting transaction or prepare original data that
is not subject to review and approval by the client.

Audit Firm's employee has worked with an Audit Client
under a loan staff assignment and is to be assigned to the
audit Engagement Team of that client's Statutory Audit, this
individual should not be given audit responsibility for any
function or activity that he was required to perform or
supervise during the former loan staff assignment (see also
B. 5 below).

2. Where a member of the Engagement Team is to leave the
Audit Firm and join an Audit Client, policies and procedures
of the Audit Firm (see A 4.3) should provide:

(a) a requirement that members of any Engagement Team
immediately notify the Audit Firm of any situation
involving their potential employment with the Audit
Client;

(b) the immediate removal of any such Engagement Team

member from the audit engagement; and

(c) an immediate review of the audit work performed by
the resigning or former Engagement Team member in
the current and/or (where appropriate) the most recent
audit. This review should be performed by a more senior
audit professional. If the individual joining the client is
an Audit Partner or the Engagement Partner, the review
should be performed by an Audit Partner who was not
involved in the audit engagement. (Where, due to its
size, the Audit Firm does not have a Partner who was
not involved in the audit engagement, it may seek either
a review by another statutory auditor or advice from its
professional regulatory body.)

3. Where a former Engagement Team member or an individual
within the Chain of Command has joined an Audit Client,
policies and procedures of the Audit Firm should ensure
that there remain no significant connections between itself
and the individual. This includes:

(a) regardless of whether the individual was previously
that all capital
involved in the audit engagement,
interests must be fully
balances and similar financial
settled (including retirement benefits) unless these are
made in accordance with pre-determined arrangements
that cannot be influenced by any remaining connections
between the individual and the Audit Firm;

(b) that the individual does not participate or appear to
in the Audit Firm's business or

participate further
professional activities.

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4. A Key Audit Partner leaving the audit firm to join the audit
client
for a Key Management Position (*), would be
perceived to cause an unacceptably high level of indepen-
dence risk. Therefore, a period of at least two years should
have elapsed before a Key Audit Partner can take up a Key
Management Position.

(d) has a business relationship with the Audit Client (see B.
2) unless it is in the normal course of business and
insignificant in terms of the threat it poses to the inde-
pendence of the Statutory Auditor.

2. Within an Audit Firm or Network an individual should not
be assigned to the Engagement Team if one of his close
family members meets any of the criteria under (1)(a) to (d)
above, nor should an Audit Partner who is working in an
‘Office’ where any of the other Partners in it has a close
family member who meets these criteria.

Appropriate safeguards should ensure that a member of the
Chain of Command does not participate in any decisions
that directly relate to the audit engagement if one of his
close family members meets any of the criteria under (1)(a)
to (d) above, or if he is working in an ‘Office’ where any of
the Partners in it has a close family member who meets
these criteria.

3. The Statutory Auditor should consider whether he or any
other individual
in the Engagement Team or Chain of
Command, or any person working in an ‘Office’ which
includes himself or such an individual, has any other close
personal relationships where similar safeguards would be
needed.

4. Assessment of

the facts of a relevant

individual's close
personal relationship should be based upon the knowledge
of the Statutory Auditor and the individual concerned. The
individual should be responsible for disclosing to the Statu-
tory Auditor any fact and circumstance which might require
safeguards to mitigate an unacceptable level of indepen-
dence risk.

4. Managerial or supervisory role in Audit Client

1. An individual who is in a position to influence the outcome
of the Statutory Audit (a person within the scope of A. 2)
should not be a member of any management body (e.g.
board of directors) or
audit
committee or supervisory board) of an Audit Client. Also,
he should not be a member of such a body in an entity
which holds directly or indirectly more than 20 % of the
voting rights in the client, or in which the client holds
directly or indirectly more than 20 % of the voting rights.

supervisory body (e.g.

2. When a former member of the Engagement Team takes a
managerial or supervisory role in an Audit Client, B. 3(3)
and (4) will apply.

5. Establishing employment with Audit Firm

Where a director or manager of the Audit Client has joined the
Audit Firm, this person should not become a member of the
Engagement Team at any time in the two year period after
leaving the Audit Client. If the person is a member of the Chain
in any substantive
of Command, he should not
decisions concerning an audit engagement with this client or
with one of its Affiliates at any time in the two year period
after leaving the Audit Client. This requirement also applies to
a former employee of the Audit Client unless the responsibili-
ties he held and the tasks he performed at the Audit Client
were insignificant in relation to the statutory audit function.

take part

7. Non-audit services

6. Family and other personal relationships

1. An individual who is a Statutory Auditor should not accept
an audit engagement if one of his close family members:

7.1. General

(a) holds a senior management position with the Audit

Client;

(b) is in a position to exert direct influence on the prepara-
tion of the Audit Client's accounting records or financial
statements;

(c) has a financial

interest in the Audit Client (see B. 1)

unless it is insignificant; or

(*) Defined in the glossary.

1. Where a Statutory Auditor, an Audit Firm or one of its
Network member firms provides services other than statu-
tory audit work (non-audit services) to an Audit Client or to
one of its Affiliates, the overall safeguarding system (A 4.3)
of the Statutory Auditor has to ensure that:

(a) the individuals employed by either the Audit Firm or its
Network member firm neither take any decision nor
take part in any decision-making on behalf of the Audit
Client or one of its Affiliates, or its management while
providing a non-audit service; and

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(b) where an independence risk remains due to specific
threats which may result from the nature of a non-audit
service, this risk is reduced to an acceptable level.

3. However, where Statutory Audits of Public Interest Entity
clients are concerned, the provision of any such assistance
other than that which is within the statutory audit mandate
would be perceived to cause an unacceptably high level of
independence risk, and should therefore be prohibited.

2. Even if not involved in the decision-making of the Audit
Client or any of its Affiliates, the Statutory Auditor should
consider, amongst others, which of the following safeguards
in particular may mitigate a remaining independence threat:

(a) arrangements

self-review by
to reduce the risk of
compartmentalising responsibilities and knowledge in
specific non-audit engagements;

(b) routine notification of any audit and non-audit engage-
ment to those in the Audit Firm or Network who are
responsible for safeguarding independence,
including
oversight of ongoing activities;

(c) secondary reviews of the Statutory Audit by an Audit
Partner who is not involved in the provision of any
services to the Audit Client or to one of its Affiliates; or

(d) external review by another statutory auditor or advice

by the professional regulatory body.

3. Where applicable, and especially with regard to Public
Interest Entity clients, the Statutory Auditor should seek to
discuss the provision of non-audit services to an Audit
Client or to one of its Affiliates with the client's Governance
Body (see A. 4.1.2).

7.2.

Examples — analysis of specific situations

7.2.1. P r e p a r i n g a c c o u n t i n g r e c o r d s

a n d f i n a n c i a l

s t a t e m e n t s

1. A self-review threat exists whenever a Statutory Auditor, an
Audit Firm, an entity within a Network of
firms or a
Partner, manager or employee thereof participates in the
preparation of
the Audit Client's accounting records or
financial statements. The significance of the threat depends
upon the spectrum of these persons'
involvement in the
preparation process and upon the level of public interest.

7.2.2. D e s i g n

a n d

i m p l e m e n t a t i o n

o f

f i n a n c i a l

i n f o r m a t i o n t e c h n o l o g y s y s t e m s

1. The provision of services by the Statutory Auditor, the
Audit Firm or an entity within its Network to an Audit
Client that involve the design and implementation of finan-
cial information technology systems (FITS) used to generate
information forming part of the Audit Client's financial
statements may give rise to a self-review threat.

2. The significance of the self-review threat is considered too
high to permit a Statutory Auditor, an Audit Firm or one of
its group member firms to provide such FITS services
unless:

(a) the Audit Client's management acknowledges in writing
that they take responsibility for the overall system of
internal control;

(b) the Statutory Auditor has satisfied himself

the
Audit Client's management is not relying on the FITS
work as the primary basis for determining the adequacy
of its internal controls and financial reporting systems;

that

(c) in the case of an FITS design project,

the service
provided involves design to specifications set by the
Audit Client's management; and

(d) the FITS services do not constitute a ‘turn key’ project
(i.e., a project that consists of software design, hardware
configuration and the implementation of both), unless
the Audit Client or its management explicitly confirms
in the written acknowledgement required under (a) that
they take responsibility for

(i) the design, implementation and evaluation process,

including any decision thereon; and

(ii) the operation of the system, including the data used

or generated by the system.

2. The significance of the self-review threat is always consid-
ered too high to allow a participation in the preparation
process unless the assistance provided is solely of a tech-
nical or mechanical nature or the advice given is only of an
informative nature.

These provisions shall not limit the services a Statutory
Auditor, an Audit Firm or a member of
its Network
performs in connection with the assessment, design, and
implementation of
internal accounting controls and risk
management controls, provided these persons do not act as
an employee or perform management functions.

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a

3. In cases not prohibited under (2) the Statutory Auditor
should consider whether additional safeguards are needed to
mitigate
In particular
remaining self-review threat.
whether services that involve the design and implementa-
tion of
information technology systems should
only be provided by an expert team with different personnel
(including engagement partner) and different reporting lines
to those of the audit Engagement Team.

financial

7.2.3. V a l u a t i o n s e r v i c e s

1. A self-review threat exists whenever a Statutory Auditor, an
Audit Firm, an entity within a Network or a Partner,
manager or employee thereof provides the Audit Client with
valuation services that result in the preparation of a valua-
tion that is to be incorporated into the client's financial
statements.

2. The significance of the self-review threat is considered too
high to allow the provision of valuation services which lead
to the valuation of amounts that are material in relation to
the financial statements and where the valuation involves a
significant degree of
in the item
concerned.

subjectivity inherent

3. In cases not prohibited under (2) the Statutory Auditor
should consider whether additional safeguards are needed to
mitigate a remaining self-review threat. In particular, where
a valuation service should only be provided by an expert
(including engagement
team with different personnel
partner) and different reporting lines to those of the audit
Engagement Team.

7.2.4. P a r t i c i p a t i o n i n t h e A u d i t C l i e n t ' s

i n t e r n a l

a u d i t

relation to the authorisation, execution and recording
of accounting transactions);

(ii) determining the scope, risk and frequency of the
internal audit procedures to be performed; and

(iii) considering and acting on the findings and recom-
mendations provided by internal audit or during the
course of a Statutory Audit.

If the Statutory Auditor is not satisfied that this is the
case, neither he, nor the Audit Firm nor any entity
within its Network should participate in the Audit
Client's internal audit.

(b) not accept the outcomes of internal auditing processes
for statutory audit purposes without adequate review.
This will include a subsequent reassessment of the rele-
vant statutory audit work by an Audit Partner who is
involved neither in the Statutory Audit nor in the
internal audit engagement.

7.2.5. A c t i n g f o r t h e A u d i t C l i e n t i n t h e r e s o l u t i o n

o f

l i t i g a t i o n

1. An advocacy threat exists whenever a Statutory Auditor, an
Audit Firm, an entity within a Network or a Partner,
manager or employee thereof acts for the Audit Client in
the resolution of a dispute or litigation. A self-review threat
may also arise where such a service includes the estimation
of the Audit Client's chances in the resolution of litigation,
and thereby affects the amounts to be reflected in the
financial statements.

1. Self-review threats may arise in certain circumstances where
a Statutory Auditor, an Audit Firm or an entity within a
Network provides internal audit services to an Audit Client.

2. To mitigate self-review threats when involved in an Audit
Client's internal audit task, the Statutory Auditor should:

2. The significance of both the advocacy and the self-review
threat is considered too high to allow a Statutory Auditor,
an Audit Firm, an entity within a Network or a partner,
manager or employee thereof to act for an Audit Client in
the resolution of
litigation which involves matters that
would reasonably be expected to have a material impact on
the client's financial statements and a significant degree of
subjectivity inherent to the case concerned.

(a) satisfy himself that the Audit Client's management or
Governance Body is at all times responsible for

(i) the overall system of internal control (i.e., the estab-
lishment and maintenance of
controls,
including the day to day controls and processes in

internal

3. In cases not prohibited under (2) the Statutory Auditor
should consider whether additional safeguards are needed to
mitigate a remaining advocacy threat. This could include
using personnel (including engagement Partner) who are not
connected with the audit Engagement Team and who have
different reporting lines.

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7.2.6. R e c r u i t i n g s e n i o r m a n a g e m e n t

1. Where a Statutory Auditor, an Audit Firm, an entity within
a Network or a Partner, manager or employee thereof is
involved in the recruitment of senior or key staff for the
Audit Client, different kinds of threats to independence may
arise. These can include self-interest, trust or intimidation
threats.

2. Before accepting any engagement to assist in the recruit-
ment of senior or key staff, the Statutory Auditor should
assess the current and future threats to his independence
which may arise. He should then consider appropriate safe-
guards to mitigate such threats.

3. When recruiting staff to key financial and administrative
posts, the significance of the threats to the Statutory Audi-
tor's independence is very high. As such,
the Statutory
Auditor should carefully consider whether there might be
circumstances where even the provision of a list of potential
candidates for such posts may cause an unacceptable level
of
independence risk. Where Statutory Audits of Public
Interest Entities are concerned the independence risk would
be perceived to be too high to allow the provision of such a
short-list.

4. In any case, the decision as to who should be engaged

should always be taken by the Audit Client.

8. Audit and non-audit fees

8.1.

Contingent fees

1. Fee arrangements for audit engagements in which the
amount of the remuneration is contingent upon the results
of
the service provided raise self-interest and advocacy
threats which are considered to bear an unacceptable level
of independence risk. It is therefore required that:

(a) such an arrangement is never concluded without first
assessing the independence risk it might create and
ensuring that appropriate safeguards are available to
reduce this risk to an acceptable level; and

(b) unless the Statutory Auditor is satisfied that there are
appropriate safeguards in place to overcome the inde-
pendence threats, either the non-audit engagement must
be refused or the Statutory Auditor must resign from
the Statutory Audit to allow the acceptance of the non-
audit work.

8.2.

Relationship between total fees and total revenue

1. The rendering of any (audit and non-audit) services by a
Statutory Auditor, an Audit Firm or a Network to one Audit
Client or its Affiliates should not be allowed to create a
financial dependency on that Audit Client or client group,
either in fact or in appearance.

2. A financial dependency is considered to exist when the total
(audit and non-audit) fees that an Audit Firm, or a Network
receives or will receive from one Audit Client and its Affili-
ates make up an unduly high percentage of
the total
revenues in each year over a five-year period.

3. The Statutory Auditor should also consider whether there
are certain fee relationships with one Audit Client and its
Affiliates which may appear to create a financial depend-
ency in respect of a person who is in a position to influence
the outcome of the Statutory Audit (any person within the
scope of A. 2).

4. In any case, the Statutory Auditor, the Audit Firm or the
Network should be able to demonstrate that no financial
dependency exists in relation to a particular Audit Client or
its Affiliates.

(a) audit engagements should never be accepted on a

contingent fee basis; and

8.3. Overdue fees

(b) in order to avoid any appearance of contingency, the
basis for the calculation of the audit fees must be agreed
each year in advance. This should include scope for
variation so as to take account of unexpected factors in
the work.

2. Threats to independence may also arise from contingent fee
arrangements for non-audit services which the Statutory
Auditor, the Audit Firm or an entity within its Network
provides to an Audit Client or to one of its Affiliates. The
Statutory Auditor's
safeguarding system (see A. 4.3.2)
should therefore ensure that:

Where fees for audit or other work become significantly
overdue and the sum outstanding, or that sum together with
fees for current assignments could be regarded as a significant
loan (see also B. 2), the self-interest threat to independence is
considered to be so significant that a Statutory Auditor should
not accept reappointment or, where appropriate and practic-
able, should resign from the current audit engagement. The
situation should be reviewed by a Partner not involved in the
provision of any services to the client. Where such a review
cannot be performed, the situation should be subjected to an
external review by another statutory auditor. Alternatively,
advice should be sought from a professional regulatory body.

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8.4.

Pricing

A Statutory Auditor must be able to demonstrate that the fee
for an audit engagement is adequate to cover the assignment of
appropriate time and qualified staff to the task and compliance
with all auditing standards, guidelines and quality control
procedures. He should also be able to demonstrate that the
resources allocated are at least those which would be allocated
to other work of a similar nature.

9. Litigation

1. Both a self-interest and an advocacy threat may arise where
litigation takes place, or appears likely to take place,
between the Statutory Auditor, the Audit Firm or any other
person being in a position to influence the outcome of the
Statutory Audit (any person within the scope of A. 2) and
an Audit Client or its Affiliates. All of the audit and non-
audit services provided to the client have to be considered
in order to assess these threats.

2. Where the Statutory Auditor sees that such a threat my
arise, he should discuss the case with the Audit Client's
Governance Body or, where such a body does not exist,
with his professional regulatory body. The threats to the
Statutory Auditor's independence are likely to become
significant where there is a serious likelihood of litigation
which is material to any of the parties involved, or of
litigation which calls into question a prior Statutory Audit,
or where material
litigation is in progress. The Statutory
Auditor should cease to act as soon as such circumstances
become evident, subject to the requirements of national law.

10. Senior personnel acting for a long period of time

1. Trust or familiarity threats may arise where certain members
of the Engagement Team work regularly and for a long
period of time on an Audit Client engagement, particularly
where Public Interest Entity Audit Clients are concerned.

2. To mitigate these threats, where the audit of a Public
is

the Statutory Auditor

Interest Entity is concerned,
required:

(a) as a minimum to replace the Key Audit Partners (*) of
the Engagement Team (including the Engagement
Partner) within 7 years of appointment to the Engage-
ment Team. The replaced Key Audit Partners should not
be allowed to return to the Audit Client engagement
until at least a two years period has elapsed since the
date of their replacement; and

(b) to consider the independence risk which may arise in
relation to the prolonged involvement of other Engage-
ment Team members, and to adopt appropriate safe-
guards to reduce it to an acceptable level.

3. Where Audit Clients other than Public Interest Entities are
concerned, it is preferable that the procedures set out at (2)
above should also apply. However, where the Audit Firm is
unable to provide for rotation of Key Audit Partners, the
Statutory Auditor should determine what other safeguards
should be adopted to reduce the independence risk to an
acceptable level.

This Recommendation is addressed to the Member States.

Done at Brussels, 16 May 2002.

For the Commission

Frederik BOLKESTEIN

Member of the Commission

(*) Defined in the glossary.

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The following comments provide additional guidance for the interpretation of the fundamental set of principles set out in
the Recommendation.

ANNEX

A. FRAMEWORK

The basic test for the effectiveness of the approach adopted by a statutory auditor to mitigate threats and risks to his
independence in respect of a particular audit engagement is whether a reasonable and informed third party, knowing all
the relevant facts and circumstances about a particular audit engagement, will conclude that the statutory auditor is
exercising objective and impartial

issues brought to his attention.

judgement on all

The statutory auditor should have a clear understanding of what is meant by objectivity, which is a state of mind, and
independence as a matter of both fact and appearance. Accordingly, when addressing the issue of whether he can conduct
an objective and independent audit, he should consider a wide range of factors and issues. These should include: the range
of persons, besides himself, who may influence the result of the audit in question; whether there are any existing or
potential threats or risks which a reasonable and informed third party might regard as compromising his independence;
and what system of safeguards would eliminate or mitigate any such threat or risk and demonstrate his independence. In
some cases, the only safeguard certain to demonstrate his independence will be to decline certain relationships with the
audit client.

1. OBJECTIVITY, INTEGRITY AND INDEPENDENCE

Public understanding of the ethical requirements that apply to statutory auditors is a prerequisite for the public confidence
in the public interest role of statutory audits, the reliability of audited financial statements, and the ability of the audit
profession to play its proper part in the audit process. This also includes an understanding of the ways in which
It is therefore important that there should be a common
compliance with such requirements can be monitored.
understanding of what is meant by the ‘statutory auditor's independence requirement’ (1), how it relates to the ethical
requirements of ‘objectivity’ and ‘integrity’ (2), and how, and to what extent, compliance with these requirements can be
objectively assessed.

The ultimate goal of the Statutory Audit is to express an objective audit opinion. The main means by which the Statutory
Auditor demonstrates that he can express such an opinion is by demonstrating that he performs the audit process in an
objective manner. To achieve this he must act with fairness, intellectual honesty, integrity (which implies fair dealing and
truthfulness) and without any conflict of interest which might compromise his independence.

Neither objectivity nor integrity can easily be tested or subjected to external verification. As such, the Member States and
the audit profession have developed rules and guidance that both uphold the pre-eminence of these principles and clarify
the ethical responsibilities of statutory auditors.

The requirement that a Statutory Auditor should be independent addresses both:

— independence of mind, i.e. the state of mind which has regard to all considerations relevant to the task in hand, but no

others; and

— independence in appearance, i.e. the avoidance of facts and circumstances which are so significant that a reasonable

and informed third party would question the Statutory Auditor's ability to act objectively.

The concept of statutory auditor independence requires a test which looks first at the relevant circumstances in which the
Statutory Auditor finds himself, especially at any relationship or interest which has any relevance to his task.

Independence is not an absolute standard which Statutory Auditors must attain, free from all economic, financial and
other relationships that could appear to entail dependence of any kind. Such a state is manifestly impossible as everyone
has some dependency or relationship with another person.

(1) See Article 24 of the 8th Company Law Directive which requires Member States to prescribe that statutory auditors have to be

independent in accordance with the law of the Member State which requires the Statutory Audit.

(2) See also Article 23 of the 8th Company Law Directive which requires Member States to prescribe that statutory auditors shall

carry out Statutory Audits with professional

integrity.

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Nevertheless, it is possible objectively to test a Statutory Auditor's compliance with the concept of independence through
a monitoring process: This would look first at the relevant circumstances in which the Statutory Auditor finds himself,
and especially at any relationship or interest that he may have with respect to his task. Secondly, it would look at whether
such an interest or relationship would cause a reasonable and informed third party, knowing all these circumstances, to
conclude that the Statutory Auditor is independent, i.e. is capable of exercising objective and impartial judgement on all
issues encompassed within the statutory audit engagement. In this sense, independence could be seen as a proxy for
integrity and objectivity and be verified by a reasonable and informed third party.

2. RESPONSIBILITY AND SCOPE

R e s p o n s i b i l i t y

It is the responsibility of statutory auditors, whether natural or legal persons, generally to comply with national law and
national professional rules in respect of Statutory Audits. This includes rules on independence.

In the case of a particular Statutory Audit, it is the appointed Statutory Auditor who is responsible for ensuring that the
requirement for statutory auditors' independence is complied with. This requirement applies not only to himself and to
the organisational entity forming the Audit Firm (assuming it is not the same legal person as the Statutory Auditor), but
also to any other person who is in a position to influence the outcome of the Statutory Audit.

A Statutory Auditor, or — if the Statutory Auditor is an individual — the Audit Firm that carries out the audit work,
should have adequate systems to take all reasonable steps to ensure that individuals within the firm comply with its
independence policies and procedures (see also A. 4.3). These systems could encompass, among others, such matters as
internal organisation, employment contracts and sanctions.

If a Statutory Auditor is a member of a Network, he should take all reasonable measures to ensure that, in as far as they
are in a position to exert influence on the Statutory Audit, the entities within this Network, their owners, shareholders,
partners, managers and employees all comply with the independence rules that apply in the jurisdiction where the audit
opinion is to be issued. This could, for example, be achieved by:

— contractual agreements which allow the Statutory Auditor to impose independence rules on his Network member
firms, their Partners (*), managers and employees with regard to his particular Audit Clients, including inter-firm
quality review procedures, and external quality assurance access;

— providing his Network member firms with regular information on Audit Clients, and requiring these firms to provide
regular information on their own business and financial relationships with such clients. This two-way flow of
information is necessary to identify all relationships that his network member firms may have with an Audit Client
and its Affiliates that might be affected by the Statutory Auditor's independence policies;

— obligatory intra-firm consultation procedures in any case where there are doubts as to whether the Statutory Auditor's
independence could be compromised by his Audit Client's relationship with one of the Network member firms.

These instruments may also be appropriate to safeguard independence in situations where subcontractors or agents of the
Statutory Auditor or the Audit Firm are involved in the audit, other than its Network member firms.

For any particular audit engagement where the Statutory Auditor is an Audit Firm, the responsibility for determining the
scope of persons to whom the independence requirement applies, and what instruments and rules it may be appropriate
to apply to them, generally lies with the audit Engagement Partner (*). This individual will need to exercise adequate
professional judgement in order to fulfil this task since it is his responsibility to assess whether or not the independence
requirement is complied with. He should also be informed of any audit and non-audit relationship which the Statutory
Auditor, the Audit Firm or the Network has with the client (see also ‘Audit Firm's Independence Policies’ under A. 4.3.2).

(*) Defined in the glossary.

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D e t e r m i n a t i o n o f

t h e s c o p e

A Statutory Auditor must recognise that threats to his independence may arise not only from his own relationships with
the Audit Client but also from other direct or indirect relationships with other individuals and firms within his practice
and in the audit environment. The Statutory Auditor has to assess actual and potential threats arising from client
relationships with the natural and legal persons within the Engagement Team, within the Audit Firm and any Network of
which it is a member. He also has to consider relationships with other persons, such as sub-contractors or agents for the
Audit Firm or the Audit Client, including those engaged on non-audit matters, with relationships to another. In summary,
he has to identify any person who is in a position to influence the outcome of the Statutory Audit.

When considering the range of persons to whom independence requirements should apply, the Statutory Auditor must be
sensitive to a variety of factors. These can include the size and legal and organisational structure of the Audit Client, the
size, structure and internal organisation of the Audit Firm and of any of the Networks of which it is a member. The
Statutory Auditor should also consider the volume and nature of services provided to the Audit Client by the Audit Firm
or any of its Network member firms.

For example, for a small Audit Firm of four or five Partners which is the Statutory Auditor to a company with three
branches all

in the same Member State, the independence rules would usually apply to:

— the Engagement Partner, the Audit Team, and any Partner in their Chain of Command;

— any Partner with responsibility for non-audit services to the same client; and

— any other person within the firm who is, or might be seen to be, in a position to influence the outcome of the

Statutory Audit.

However, when the Statutory Auditor of a medium-sized multinational company is one firm in a Network, the scope of
the rules might extend to:

— the Engagement Partner and Audit Team in the Statutory Auditor;

— any Partner and Audit Team member in the same firm or in another firm in the Network who participates in the audit
of the client's overseas entities, including any in centralised services or specialist discipline units which contribute to
such work;

— any Partner in the same firm or in another firm in the Network who participates in the provision non-audit services to

the client;

— any Partner in the Chain of Command (either in the jurisdiction where the audit opinion is to be delivered or in an

overseas country where audit or non-audit work is done for the Audit Client); and

— any other person within the firm or another firm in the Network who is in a position to influence the outcome of the

Statutory Audit.

In either case, the independence requirements apply equally to everyone falling within their scope; the difference lies in
the number of people the Statutory Auditor may need to consider for inclusion within it.

P e r s o n s o t h e r

t h a n m e m b e r s o f

t h e E n g a g e m e n t T e a m o r

t h e C h a i n o f C o m m a n d

The Statutory Auditor should give further consideration to other persons who, even if they are not part of the
Engagement Team or the Chain of Command, might influence the outcome of the Statutory Audit. These might include:

— owners or shareholders of the Audit Firm with potential influence by virtue of the significance of their voting rights.
Where, for example, there are only a few owners or shareholders of an Audit Firm, every owner or shareholder might
be considered as being in a position to influence the outcome of the Statutory Audit;

— individuals who have supervisory or direct management responsibility for the audit function at successive levels in any

location where members of the Audit Team are employed;

— other audit and non-audit Partners with potential influence by virtue of their working relationship with a member of
the Audit Team. Depending on factors such as the size and the internal organisation of an office, practice unit, Audit
Firm, or even Network, all Partners of such an entity might be considered as being in a position to influence the
outcome of the Statutory Audit.

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The Statutory Auditor must also consider whether, there might be persons outside the Audit Firm or its Network who,
due to their relationship with persons within the firm or group, have or appear to have an ability to influence the
outcome of the Statutory Audit. Examples might include:

— family members or other close personal contacts of members of the Engagement Team or Chain of Command who
hold significant financial interests in the Audit Client or who hold a key position with the client or an entity with
significant interests in it (see B. 6); or

— individuals or entities with financially significant commercial relationships with either the Statutory Auditor and his

firm or the Audit Client. These could include major suppliers, customers or contractors.

The Statutory Auditor will need to identify those individuals in the Audit Firm or the Network whose involvement in the
audit engagement might be affected by such an external influence, either in fact or in appearance, taking into account the
fact that he would not be able to impose his independence rules on persons outside the Audit Firm or its Network.

3. INDEPENDENCE THREATS AND RISK

In order to avoid or resolve facts and circumstances that might compromise a Statutory Auditor's independence, it is
essential firstly to identify the threats to independence which arise in specific circumstances. Secondly, one must evaluate
their significance so as to determine the level of risk that a Statutory Auditor's independence may be compromised.

The more clearly a Statutory Auditor is able to identify the nature of the threats, the more clearly he can judge the level of
risk to his independence that they create. Based on their general nature the following types of threats to independence
have been recognised:

— Self-interest threat: the Statutory Auditor's independence may be threatened by a financial or other self-interest conflict
(e.g., direct or indirect financial interest in the client, over-dependence on the client's audit or non-audit fees, the desire
to collect outstanding fees, fear of losing the client);

— Self-review threat: relates to the difficulty of maintaining objectivity in conducting self-review procedures (e.g., when
taking decisions, or taking part in decisions, that should be taken wholly by the Audit Client's management; or when
any product or judgement of a previous audit or non-audit assignment performed by the Statutory Auditor or his firm
needs to be challenged or re-evaluated to reach a conclusion on the current audit);

— Advocacy threat: the Statutory Auditor's independence may be threatened if the Statutory Auditor becomes an advocate
for, or against, his client's position in any adversarial proceedings or situations (e.g. dealing in or promoting shares or
securities in the client; acting as an advocate on behalf of the client in litigation; when the client litigates against the
auditor);

— Familiarity or trust threat: a risk that the Statutory Auditor may be over-influenced by the client's personality and
qualities, and consequently become too sympathetic to the client's interest through, for example, too long and too
close relationships with client personnel, which may result in excessive trust in the client and insufficient objective
testing of his representations.

— Intimidation threat: covers the possibility that the auditor may be deterred from acting objectively by threats or by fear

of, for example, an influential or overbearing client.

The significance of a particular threat depends on a variety of (quantifiable and non-quantifiable) factors such as its force,
the status of the person(s) involved, the nature of the matter causing the threat, and the overall audit environment. When
evaluating the significance of a threat the Statutory Auditor also has to consider that different kinds of threats may arise in
one set of circumstances. With regard to one certain set of circumstances a threat can be considered significant if,
considering all of its quantitative and qualitative aspects, both alone and in combination with others, it increases the level
of independence risk to an unacceptably high level.

4. SYSTEMS OF SAFEGUARDS

Where threats to statutory auditors independence exist, the Statutory Auditor should always consider and document
whether safeguards are appropriately applied to negate or reduce the significance of threats to acceptable levels. The
safeguards to be recognised relate to different responsibilities in the audit environment, including the governance structure
of the Audit Client (see A. 4.1), the entire system of self-regulation, public regulation and oversight of the audit profession
including disciplinary sanctions (see A. 4.2), and the Statutory Auditor's system of internal quality control (see A. 4.3).

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L e v e l o f

i n d e p e n d e n c e r i s k

The level of independence risk can be expressed as a point on a continuum that ranges from ‘no independence risk’ to
‘maximum independence risk.’ Although it cannot be measured precisely, the level of independence risk for any specific
activity, relationship, or other circumstance that may pose a threat to a Statutory Auditor's independence can be described
as being within, or at one of the endpoints, on the independence risk continuum.

The Statutory Auditor and any other person involved in a decision concerning the independence of the Statutory Auditor
in relation to his client (e.g., regulatory bodies, other statutory auditors who are consulted for advice) need to evaluate the
acceptability of the level of independence risk that arises from specific activities, relationships, and other circumstances.
That evaluation requires these independence decision makers to judge whether existing safeguards eliminate or adequately
mitigate threats to independence posed by those activities, relationships, or other circumstances. If they do not, a further
decision has to be made on which additional safeguard (including prohibition) or combination of safeguards would reduce
independence risk, and the corresponding likelihood of compromised objectivity, to an acceptably low level.

4.1. Audited entities' safeguards

4.1.1. Governance structure's impact on independence risk assessment

When analysing governance responsibilities in the Audit Client which may help to safeguard its Statutory Auditor's
independence, it is appropriate to differentiate between the governance structure of a Public Interest Entity client (*) and
that of an Audit Client with relatively little public interest. This differentiation is relevant both to the corporate
governance task, which is to particularly protect actual and potential investors, and to the appearance of the Statutory
Auditor's independence.

A u d i t C l i e n t s o f p u b l i c i n t e r e s t

With regard to the appearance of independence in relation to a Public Interest Entity (*) client, the Statutory Auditor has
to consider the whole variety of possible perceptions of the national, regional or even international public. In this respect
corporate governance plays an important role in safeguarding statutory auditors'

independence.

Statutory auditors are formally appointed by a majority vote of the shareholders at the Annual General Meeting.
Shareholders often appoint the Statutory Auditors recommended to them by management. This is particularly the case if
no additional approval
is required by any Governance Body (*) of the Audit Client other than management (e.g.
supervisory board, non-executive directors, audit committee) or by any regulatory body (e.g. regulatory authority of a
certain industry) (1). This does not necessarily protect the interests of minority shareholders or potential investors, nor
does it contribute to the safeguarding of statutory auditors'

independence.

Accordingly, governance structures within an entity being audited should ensure that the appointment of the Statutory
Auditor is made in the interests of its shareholders, and that during the engagement the Statutory Auditor performs his
work in the same interests. If, for example, a supervisory board or an audit committee is to be effective in accomplishing
its task of over-seeing the financial reporting process, it must rely in part on the work, guidance and judgment of the
Statutory Auditor. Integral to this reliance is the requirement that the Statutory Auditor performs his service indepen-
dently.

In order to determine the significance of a threat to independence and to evaluate the level of the independence risk (see
A. 3 and A. 4), the Statutory Auditor should carefully consider whether the audited entity's governance structure provides
an appropriate infrastructure to generally safeguard its statutory auditors independence. The analysis of such an
infrastructure may include issues such as:

— the involvement of a Governance Body in the Statutory Auditor's appointment (e.g., formal approval of management's

recommendation only or. active participation in negotiations with the potential Statutory Auditor);

— the duration of the Statutory Auditor's appointment (one audit vs.

long-term contract);

— the involvement of a Governance Body in commissioning non-audit services from the Statutory Auditor, the Audit
Firm or from any entity within the Network of which it is a member (e.g., no involvement or active participation
when negotiating significant engagements);

— the existence of oversight and communications regarding the Statutory Audit and other services provided to the
audited entity by the Statutory Auditor, the Audit Firm or its Network, and the frequency of such communications
with the Statutory Auditor.

(*) Defined in the glossary.
(1) In some jurisdictions the national law provides for certain types of companies, such as cooperatives or associations, to have their
financial statements audited by a particular Statutory Auditor who is assigned by virtue of the law governing these companies,
and not appointed by any management body or Governance Body. Statutory Auditors of this kind of entities may consider this
circumstance as a general safeguard contributing to mitigate a certain kind of self-interest threats to independence.

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O t h e r A u d i t C l i e n t s

When auditing clients other than Public Interest Entities,
the Statutory Auditor should still analyse whether the
governance infrastructure of the Audit Client provides general safeguards to his independence. Where the client has no
Governance Body, the Statutory Auditor should analyse whether the Audit Client's management policies provide
safeguards to his independence and whether there are specific threats which could be addressed by appropriate policies
within the entity. Such policies might include internal procedures for objective choice in commissioning non-audit
services. The Statutory Auditor should also consider the quality and quantity of staff in the Audit Client. This may be
particularly relevant when assessing the risk of taking managerial decisions on behalf of the client. For example, where the
client has an insufficient number of staff, the Statutory Auditor may find himself taking such decisions without meaning
to.

4.1.2. Involvement of the Governance Body

As stated under A. 4.1.1, to some extent it is the responsibility of the Audit Client to safeguard the independence of its
Statutory Auditor. Discussions between the Statutory Auditor and the Governance Body of the client are the main means
to establish a link between the Statutory Auditor's own safeguards and those of the Audit Client. To protect himself and
to allow the quality assurance regime (see A. 4.2) to verify his compliance with this requirement, whenever deemed
necessary, but at least annually the Statutory Auditor should initiate the process by writing to the Audit Client to invite
him to discuss these issues.

D i s c l o s u r e o f

f e e s

The disclosure to the Governance Body of fee relationships between the Statutory Auditor, the Audit Firm and its
Network members and the Audit Client and its Affiliates will help the Governance Body to evaluate the impact of these
relationships on the Statutory Auditor's independence. If necessary, the Governance Body may require additional measures
to safeguard the independence of the Statutory Auditor. In this regard, the disclosure should be made on a regular basis,
but at least annually, before the audit engagement is accepted or renewed. In addition, the disclosure should be more
detailed and wider than required for publication purposes (see A. 5). In particular, it should extend to the amounts
charged and contracted for, to the value of outstanding service contracts or arrangements, to current proposals or bids for
future service engagements, and to compensation received or expected from contingent fee arrangements on non-audit
services (see B. 8.1), each broken down by type of service.

4.2. Quality assurance

To ensure that Statutory Auditors comply with professional standards, including the independence requirement, a control
or enforcement system is needed. Safeguards and procedures to be considered include the effectiveness of the overall
control environment. This starts with a professional approach towards matters of quality and ethics and takes account of
the levels of assurance provided by a regularly monitored and evidenced control system. One way to enforce indepen-
dence requirements is the Member State system for quality assurance on Statutory Audits. The Commission Recommenda-
tion on ‘Quality Assurance for the Statutory Audit in the EU’ recommends that statutory auditors' compliance with ethical
principles and rules, including independence rules, should be subjected to quality review procedures. As the recommended
systems of quality assurance include public oversight, they are also able to address the public perception of independence
issues.

4.3.

The Statutory Auditor's overall safeguards

4.3.1. Ownership of and control over Audit Firms

N e e d t o s a f e g u a r d c o n t r o l o v e r

t h e A u d i t F i r m

For an Audit Firm to be authorised to carry out Statutory Audits, Article 2.1 b) ii) of the 8th Company Law Directive
requires the majority of the Audit Firm's voting rights to be held by statutory auditors. These persons must be approved
by a competent authority of any of the EU Member States, i.e., natural persons or firms who satisfy at least the minimum
conditions of that Directive.

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Without any further restrictions, this would allow Audit Firms to raise capital on capital markets by either private or
public offerings. Some Member States regard such funding as raising serious concerns about statutory auditor indepen-
dence. As a result, they have imposed more restrictive rules on the ownership of Audit Firms (e.g. allowing a maximum of
25 % ownership by individuals who are not statutory auditors, or restricting minority ownership to members of certain
regulated professions only).

There is a concern as to whether holding majority voting rights is sufficient to ensure that statutory auditors control the
firm. For example, if one non-auditor held 49 % of the voting rights and the other 51 % were divided amongst a number
of statutory auditors, the non-auditor owner could have effective control of the Audit Firm. In this respect, careful
attention should be paid to the resulting threats to statutory auditors independence. Consideration should also be given to
the safeguards needed to avoid such situations. These might include, for example, limiting the voting rights of a single
non-auditor owner to 5 % or 10 % of the whole. Where only a few statutory auditors hold the majority of the voting
rights in an Audit Firm, it may be appropriate to allow certain individuals to hold a higher proportion than this. In
particular, this may be appropriate if these individuals are members of a regulated profession (e.g., lawyers, notaries), or
other persons (e.g., management or other professional consultants) whose professional activities rest with the Audit Firm
or with one of its Network members.

The risks that relationships between the Statutory Auditor, the Audit Firm and a non-auditor owner of the Audit Firm and
an Audit Client might compromise the Statutory Auditor's independence should be addressed by reference to A. 2, which
sets out the scope of persons to which the independence requirement applies, and B. 1 and B. 2, which consider the
financial and/or business links which may exist between them.

4.3.2. The Audit Firm's internal safeguarding system

As far as the Statutory Auditor is concerned, he has to comply with independence standards, regardless of whether those
are imposed by law or regulators, or by professional bodies as part of a self-regulatory regime, or adopted voluntarily by
the Audit Firm as part of its own policies. In order to ensure his compliance the Statutory Auditor needs to set up a
system of related safeguards, or — if the Statutory Auditor and the Audit Firm are not identical legal persons — at least
require the Audit Firm to do so.

A u d i t F i r m ' s i n d e p e n d e n c e p o l i c i e s

An Audit Firm should develop independence policies covering activities that are acceptable and not acceptable when
performed for Audit Clients or their Affiliates.

Regardless of the way in which detailed independence standards are developed, the objective is to enforce appropriate
implementation and maintenance of Statutory Auditors' safeguards and to encourage their continuous improvement.
Accordingly, an Audit Firm's independence policies should be flexible enough to allow for their regularly update. Such an
update could arise due to changing circumstances and facts or when independence standards themselves change due to a
change in public expectations.

The design and documentation of the Audit Firm's independence policies should reflect the immediate practice environ-
ment (e.g., size and organisational structure of the Audit Firm). It should also reflect the audit environment (e.g., client and
business portfolio of the Audit Firm and others outside the Audit Firm who are involved in Audit Firm's assignments).

An Audit Firm must have appropriate policies and procedures in place to ensure that the relevant Engagement Partner is
notified of any other relationship which exists between the firm and its Network member firms, and the Audit Client and
its Affiliates. This includes the requirement that the Engagement Partner has to be consulted prior to acceptance of any
assignment from the Audit Client or its Affiliates. It is then the responsibility of the Engagement Partner to assess whether
any such relationship may reasonably be thought to affect the independence of the Statutory Auditor. For practical
reasons, particularly with regard to group audit situations, this assessment may be partially delegated to other Audit
Partners. For example, an Audit Partner of the Audit Team in a particular country should be notified of, and should assess
the impact of, all (existing and potential) relationships in that country. However, the Engagement Partner should always be
involved in the independence risk assessment of any significant relationship. In cases where the Audit Client has a
Governance Body (see A. 4.1), it will be appropriate to involve that body in the process of assessing the independence
risk.

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Where persons other than the Audit Firm, its Partners, managers and employees are involved with the Audit Client or in
the audit assignment (e.g.; subcontracted specialists, Network member firms), the Audit Firm's independence policies
should also address requirements and consultation processes needed to prevent these persons from causing an unaccept-
able level of independence risk for the Statutory Auditor.

In order to ensure that its Partners, managers and employees comply with its independence policies, the Audit Firm will
need to communicate its policies appropriately, and to train these individuals on a regular basis. This should also include
informing them about sanctions for independence policy violations.

P r o c e d u r e s t o b e a p p l i e d

In accordance with the independence policies adopted by an Audit Firm and depending on its size, the procedures to be
applied by Partners, managers and employees may vary. For a small Audit Firm it might be appropriate to consider its
independence only on a case by case basis, and then to decide on certain procedures to mitigate the independence risk.
However, for a large Audit Firm it might be necessary to establish routine procedures in order to detect even hypothetical
threats to the Statutory Auditor's independence. For example, to detect a self-interest threat resulting from financial or
business relationships, it might be necessary for such an Audit Firm to maintain a regularly updated database (e.g.,
restricted entity list). Such a database could provide all Partners, managers and employees with information on all Audit
Clients that may give rise to a self-interest threat if they fulfil certain criteria. This database should be available to anyone
within the Audit Firm who may be in a position to influence the outcome of any Statutory Audit. The operation of this
safeguarding system will require these individuals to regularly provide the Audit Firm with certain personal and client
information.

Depending on its size and structure, it might also be appropriate for an Audit Firm or Network to establish internal
procedures to ensure that there is appropriate consultation across the firm or Network about any client where the
significance of an independence threat is unclear. This consultation would involve experienced Partners who are not
involved in the Audit Client's affairs and who are not impacted by the independence threat in question.

D o c u m e n t a t i o n o f

i n d e p e n d e n c e a s s e s s m e n t

The main purpose of the Statutory Auditor's documentation of his independence assessment on a certain Audit Client is
to provide evidence that he performed his assessment properly. It is appropriate for such documentation to be included in
the audit files.

I n t e r n a l m o n i t o r i n g o f c o m p l i a n c e

The monitoring of compliance with the Audit Firm's independence policies should be an integral function of the Audit
Firm's quality review structure. Large Audit Firms may designate this task to quality control specialists, or even
independence specialists. This may not be appropriate for small and medium sized Audit Firms which generally only
assess their independence on a case by case basis. However, such firms should at least have their individuals' compliance
reviewed by a Partner who is not a member of the particular Engagement Team. In the case of sole practitioners and of
small partnerships where either all Partners are in the Engagement Team or the involvement of any other Partner outside
the Engagement Team would increase the level of independence risk (e.g., when this Partner provides significant non-audit
services to the Audit Client), the Statutory Auditor should either seek advice from his professional regulatory body or ask
for a review by another statutory auditor.

5. PUBLIC DISCLOSURE OF FEES

A Statutory Auditor should be able to demonstrate that his independence has not been compromised by providing
non-audit services to an Audit Client for which the remuneration he receives is disproportionate to the fees he was paid
for the Statutory Audit. This should also be in the interest of the relevant Audit Client (see also A. 4.1.2), since it will add
credibility to its published financial information. Public disclosure requirements imposed by Member States through
national law or their relevant regulatory bodies should enable a reasonable and informed third party to take a view on the
extent of any imbalance between statutory audit and other fees. To assist such assessment, the fees received for other than
statutory audit services should be broken down into three broad categories (further assurance, tax advisory and other
non-audit services) reflecting the different kinds of services which may have been provided. Regarding the category other
non-audit services, at least the minimum information about the provision of financial information technology, internal
audit, valuation, litigation and recruitment services should be given. It may also be appropriate to identify particular
engagements which make up a significant proportion of a particular (sub-)category.

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B. SPECIFIC CIRCUMSTANCES

1. FINANCIAL INTERESTS

The term ‘financial interest’ would usually comprise the whole variety of financial interests that the Statutory Auditor
himself, his Audit Firm or any other person within the scope of section A. 2 may have in an Audit Client or in any
Affiliate of the client. The term includes ‘direct’ and ‘indirect’ financial

interests such as

— direct or indirect shareholding in the Audit Client or its Affiliates,

— holding or dealing in securities of the Audit Client or its Affiliates,

— accepting pension rights or other benefits from the Audit Client or its Affiliates.

Commitments to hold financial interests (e.g. contractual agreements to acquire a financial interest) and derivatives which
are directly related to financial interests (e.g., stock options, futures, etc.) should be dealt with in the same way as would
an already existing financial

interest.

D i r e c t

f i n a n c i a l

i n t e r e s t s

When a person who is directly involved in the conduct of the statutory audit (the Statutory Auditor, the Audit Firm, an
individual in the Engagement Team or within the Chain of Command) holds a direct financial interest in the Audit Client,
such as shares, bonds, notes, options, or other securities, the significance of the self-interest threat is considered to be too
high to enable any safeguards to reduce the Statutory Auditor's independence risk to an acceptable level.

In such a case the Statutory Auditor either has to withdraw from the engagement or, if an individual of the Audit Firm
holds the direct financial

interest, has to exclude this individual from the engagement.

Where a direct financial interest in the Audit Client is held by a Partner of the Audit Firm or its Network who works in an
‘Office’ the perception of self-interest is considered as being too high to allow this situation to be maintained.

I n d i r e c t

f i n a n c i a l

i n t e r e s t s

The term ‘indirect financial interest’ refers to situations where, for example, a person within the scope of A. 2 has
investments in non-client entities that have an investment in the Audit Client, or in companies in which an Audit Client
also has invested.

A person within the scope of A. 2 should not hold such an indirect financial interest where the self-interest threat
resulting from this financial involvement is significant. This is particularly the case when an indirect shareholding in the
Audit Client allows or appears to allow that person to influence management decisions of the Audit Client (e.g., by
significant indirect voting rights), or when the direct shareholder due to any circumstance could or appears to be able to
influence the outcome of the Statutory Audit. In addition, an unacceptable level of independence risk can also arise in
situations where the Statutory Auditor or any other person within the scope of A. 2 serves as a voting trustee of a trust or
executor of an estate containing securities of an Audit Client. However, this will only be the case when there are no
appropriate safeguards to mitigate this risk such as supervision and control by beneficiaries, governmental authorities or
courts.

On the other hand, the potential self-interest threat to the Statutory auditor's independence may be regarded as
interests in the Audit Client
insignificant to the independence risk if, for example, when holding indirect financial

— the financial interest is directly held by an investment fund, pension fund, UCITS or an equivalent investment vehicle,

and

— the person holding the indirect interest is not directly involved in the audit of the fund manager, nor able to influence

the individual

investment decisions of the fund manager.

E x t e r n a l e v e n t s

If a financial interest is acquired as a result of an external event (e.g. inheritance, gift, merger of firms or companies) and a
further holding of that interest would create a significant threat to the Statutory Auditor's independence, it must be
disposed of as soon as practicable, but no later than one month after the person has knowledge of and the right to
dispose of the financial interest. Where the interest is in a listed company and has been acquired by way of inheritance,
for example, the shares should be sold within a month after having both the knowledge of the inheritance and the right to
sell the shares in accordance with applicable stock exchange regulations that govern the disposal or sale of shares by those
with insider knowledge.

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Until the financial interest is disposed of, additional safeguards are needed to preserve the Statutory Auditor's indepen-
dence. For example, where a Statutory Auditor becomes aware that a member of the Engagement Team has acquired
shares in a client as the result of inheritance, that individual should not continue to be a member of the Engagement
Team until the shares have been sold. He should also be excluded from any substantive decision making concerning the
Statutory Audit of the client until the shares have been sold.

I n a d v e r t e n t v i o l a t i o n s

There will be occasions where the Statutory Auditor becomes aware that an individual in his Audit Firm inadvertently
holds a financial interest in an Audit Client or in one of its Affiliates which, in general, would be regarded as a violation of
independence requirements. Such inadvertent violations will not compromise the Statutory Auditor's independence with
respect to an Audit Client, provided that the Statutory Auditor

— has established procedures that require all professional personnel to report promptly any breaches of the indepen-
dence rules resulting from the purchase, inheritance or other acquisition of a financial interest in an Audit Client by
such individuals (see also A. 4.3.2);

— promptly notifies the individual to dispose of the financial interest at the earliest opportunity after the inadvertent

violation is identified; and

— takes particular care when reviewing the relevant audit work of this individual.

Where it proves impossible to compel the individual to dispose of the financial interest, the individual should be removed
from the Engagement Team. Where an individual other than a member of the Engagement Team inadvertently holds a
financial interest that may compromise the Statutory Auditor's independence, this individual should be excluded from any
substantive decision making concerning the Statutory Audit of the client.

Whatever financial involvement exists, it is primarily the Statutory auditor's safeguarding system (see A. 4.3) which should
provide evidence that the threats to independence have been identified and investigated. Where appropriate, the evidence
should also refer to the involvement of the client's Governance Body in this process. In addition, wherever a decision has
been taken about whether or not the threats are significant, the reasons behind that decision should be recorded.

2. BUSINESS RELATIONSHIPS

B u s i n e s s r e l a t i o n s h i p s

Business relationships are relationships that involve a commercial or financial common interest between the Statutory
Auditor, the Audit Firm or any other person being in a position to influence the outcome of the Statutory Audit (any
person within the scope of A. 2) on the one hand and the Audit Client, an Affiliate of the client, or the management
thereof on the other. The following are examples of such relationships that would,
if significant to the auditor or
conducted outside the normal course of business, cause a self-interest, advocacy or intimidation threat:

— having a financial interest in a joint venture with the Audit Client, or with an owner, managing director or other

individual who performs senior management functions of that client;

— having a financial interest in a non-audit client that has an investor or investee relationship with the Audit Client;

— giving a loan to the Audit Client or guarantees for the Audit Client's risks;

— accepting a loan from an Audit Client or having borrowings guaranteed by the Audit Client;

— providing services to a managing director or another individual performing a senior management function of the
interest of such individual;

Audit Client in respect of the personal

— receiving services from the Audit Client or its Affiliates which concern underwriting, offering, marketing or selling of

securities issued by the audit firm or one of its group member firms.

Commitments to establish such relationships should be dealt with in the same way as an already established relationship.

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I n t h e n o r m a l c o u r s e o f b u s i n e s s

In the normal course of its business, a Statutory Auditor may not only provide audit or non-audit services to the Audit
Client or to its Affiliates, but may also purchase goods or services from these entities. Examples could include insurance
and bank services, commercial loan agreements, the purchase of office equipment, EDP software, or company cars. If
these transactions are performed at arm's length (as between third parties), they generally do not threaten the Statutory
Auditor's independence (e.g. purchase of goods which are offered under normal wholesale discount terms, and are
available to the whole of the client's other customers). However, the Statutory Auditor should carefully consider the risk
that even an arm's length transaction could reach a magnitude which threatens his independence by creating financial
dependencies, either in fact or at least in appearance.

Accepting any goods or services on favourable terms from an Audit Client is not considered to be within the normal
course of business, unless the value of any benefit is insignificant.

S i g n i f i c a n c e o f

i n d e p e n d e n c e r i s k

Whether a business relationship should be regarded as a significant threat to the Statutory Auditor's independence
depends on whether a reasonable and informed third party would assume that such a relationship could have an influence
on the outcome of the Statutory Audit. Objective criteria are therefore needed in order to evaluate the significance of a
relationship to the Statutory Auditor, as well as to the Audit Client. With regard to the financial statements and the audit
task, the relationship should not result in the Statutory Auditor, the Audit Firm or one of its Network members being able
to influence management decisions of the Audit Client. Conversely, the relationship should not enable the Audit Client, or
one of its Affiliates to influence the outcome of the Statutory Audit, either in fact or in appearance.

Whatever business relationship exists, it is primarily the Statutory auditor's safeguarding system (see A. 4.3) which should
provide evidence that the threats to independence have been identified and investigated. Where appropriate, the evidence
should also refer to the involvement of the client's Governance Body in this process. In addition, wherever a decision has
been taken about whether or not the threats are significant, the reasons behind that decision should be recorded.

P r o v i s i o n o f s t a t u t o r y a u d i t s e r v i c e s

The threat to independence is considered too high to permit a Statutory Auditor, an Audit Firm or any member of its
Network to provide statutory audit services to an owner of the Audit Firm. The provision of audit services to an Affiliate
of such an owner is also considered incompatible with the independence requirement when that owner is, or appears to
be, in a position to influence any decision-making of the Audit Firm that impacts on its statutory audit function. Such an
influence may arise, for example, due to the percentage of the voting rights that the owner holds in the Audit Firm. It
could also arise due to the nature of the position held by the owner or one of the owner's representatives in the Audit
Firm. A position of potential concern might include a director or senior manager of the owner being a member of the
Audit Firm's supervisory board. Furthermore, the Statutory Auditor should also consider whether the provision of audit
services to those clients could compromise his independence where the clients officers, directors or shareholders either
hold a significant amount of voting rights of the Audit Firm or, otherwise, are, or appear to be, in a position to influence
the firm's decision-making with regard to its statutory audit function.

3. EMPLOYMENT WITH THE AUDIT CLIENT

D u a l e m p l o y m e n t a n d l o a n s t a f f a g r e e m e n t s

The risk to the Statutory Auditor's independence is considered too high to permit a person within the scope of A. 2 who
is employed by the Audit Firm and/or its Network member firm to also be employed by the Audit Client and/or one of its
Affiliates. The Statutory Auditor's policies and procedures (see A. 4.3.2) should provide for adequate measures to identify
any instance of such dual employment.

The Statutory Auditor should also carefully consider those situations where an individual employed by the Audit Firm or
a Network member firm works under any loan staff agreement with the Audit Client or one of its Affiliates. A loan staff
agreement means an engagement where an employee of the Audit Firm or Network works under the direct supervision of
the client and does not originate any accounting transaction or prepare original data that is not subject to review and
approval by the client. Such an assignment may be acceptable, provided that the individual does not take a position where
he can influence the outcome of the Statutory Audit. If an individual is to be assigned to the Engagement Team having
completed such a loan staff engagement, he should not be given audit responsibility for any function or activity that he
was required to perform or supervise during the former loan staff assignment (see also B. 5 below).

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E n g a g e m e n t

t e a m m e m b e r

j o i n i n g t h e A u d i t C l i e n t

The overall safeguarding system of the Audit Firm (see A. 4.3) should include policies and procedures that can be adapted
to suit the specific circumstances. These will, for example, depend upon a number of factors such as:

— the position of the departing individual at the Audit Firm (e.g. Partner vs. senior or other professional),

— the circumstances which lead to the departure (e.g. retirement, termination, voluntary withdrawal),

— the position the departing individual is taking at the client (e.g., managerial position vs. position with insignificant

influence on the financial statements),

— the length of time that has passed since the individual

left the Audit Firm, and

— the length of time that has elapsed since the departing individual performed services related to the audit engagement.

S e c o n d P a r t n e r ' s r e v i e w

In cases, where the individual leaving the Audit Firm was an Engagement or Audit Partner, the required review by another
Audit Partner should also consider the risk that the former partner might have been influenced by the client during the
previous audit. In addition, the former partner may have established close relationships with other Audit Team members
which might threaten the independence of those staying on the Audit Team. Finally, the former partner could use his
knowledge of the current audit approach and testing strategy to circumvent the audit designs.

It might be appropriate for a small Audit Firm which is not able to perform a second Partner's review either to have a
similar review performed by another statutory auditor or, at least, to seek advice from its professional regulatory
authority.

4. MANAGERIAL OR SUPERVISORY ROLE IN AUDIT CLIENT

The acceptance of a managerial or supervisory role in an Audit Client is not the only potential concern with regard to
intimidation and self-review threats. Such threats can also arise when an individual within the scope of A.2 becomes a
member of a managerial or supervisory body of an entity that is not an Audit Client (non-client entity), but is either in a
position to influence the Audit Client or to be influenced by the Audit Client. In these cases, the level of independence
risk is unacceptably high. The acceptance of such positions should therefore be prohibited.

Where national
law requires members of the audit profession to undertake supervisory roles in certain companies,
safeguards must ensure that such professionals do not have any responsibility with regard to the Engagement Team.

B.4 (2) recognises that a former member of an Engagement Team who leaves the Audit Firm, whether to retire or to take
up a post with a non-client entity, might be invited to take a non-executive post on a management or supervisory body of
the Audit Client. In such cases, the Audit Firm will need to ensure that the requirements of B. 3(3) and (4) are met.

5. ESTABLISHING EMPLOYMENT WITH AUDIT FIRM

When a director or manager of an Audit Client joins the Audit Firm, the self-review threat is considered as too high to be
mitigated by any safeguard other than the prohibition of such a person from becoming a member of the Engagement
Team or from taking part in any substantive decisions concerning the client's audit for a two-year period. Where a former
employee of the Audit Client joins the Audit Firm, the significance of the self-review threat will relate to the responsibili-
ties and tasks this employee had at the Audit Client and those he is going to take at the Audit Firm. For example, if the
former employee prepared accounts or valued elements of the financial statements, the same safeguards would apply as
for a director or manager; on the other hand, when the former employee held, for example, a non-management position
in a branch of the Audit Client, the self-review threat may be mitigated if his activities as a member of the Engagement
Team do not relate to that branch.

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6. FAMILY AND OTHER PERSONAL RELATIONSHIPS

The Statutory Auditor must be able to assess the risk to his independence when he or any member of the audit
Engagement Team or the Chain of Command, or any Partner in an ‘Office’ which includes himself or such an individual,
has any close family member or any other close personal relationship with anyone who meets the criteria under 1(a) to
(d). His consideration of the facts should be based on his knowledge of the circumstances of all relevant individuals within
the Audit Firm or its Network. Policies and procedures should be in place that require such individuals to disclose to the
best of their knowledge, on which the Statutory Auditor would then rely, any fact or circumstance which need to be
taken into account. The Statutory Auditor should evaluate all such information, determine whether any of the criteria are
met and take any necessary mitigating action within a reasonable period of time. This might include refusal of the
engagement, or exclusion of an individual from the Engagement Team or the ‘Office’.

The Audit Firm's policies and procedures should make it clear that it is the responsibility of individuals in the Engagement
Team or Chain of Command or ‘Office’ to assess to the best of their knowledge who are, or might appear to be, their
close family members and close non-family contacts. They should disclose any relevant facts or circumstances in respect
of a particular Audit Client to the Audit Partner in charge of the engagement.

C l o s e f a m i l y m e m b e r s

The term ‘close family member’ normally refers to parents, siblings, spouses or cohabitants, children and other
dependants. Depending on the different cultural and social environments in which the audit takes place, the term may
extend to other family members who may have less immediate but not necessarily less close relationships with the
relevant individual. These could include former spouses or cohabitants and the spouses and children of family members.

C l o s e n o n - f a m i l y r e l a t i o n s h i p s

Close relationships other than family ones are hard to define, but could include a relationship with any person other than
a family member which entails frequent or regular social contact.

I n a d v e r t e n t v i o l a t i o n s

There will be occasions where the Statutory Auditor becomes aware that an individual in his Audit Firm inadvertently has
not reported to the firm a family or other personal relationship with an Audit Client which, in general, would be regarded
as a violation of independence requirements. Such inadvertent violations will not compromise the Statutory Auditor's
independence with respect to an Audit Client, provided that the Statutory Auditor

— has established procedures that require all professional personnel to report promptly any breaches of the indepen-
dence rules resulting from changes in their family or other personal relationships, the acceptance of an audit sensitive
position by their close family members or other close persons (i.e., those falling within the scope of (1)(a) and (1)(b)
above), or the purchase, inheritance or other acquisition of a significant financial interest in an Audit Client by such
family members or persons;

— promptly removes the individual from the Engagement Team, or if the individual is not a member of the Engagement
Team, excludes him from substantive decisions concerning the Statutory Audit of the relevant client. In the case of a
significant financial interest, he should notify the individual to ensure that the financial interest is disposed of at the
earliest opportunity after the inadvertent violation is identified; and

— takes particular care when reviewing the relevant audit work of this individual.

7. NON-AUDIT SERVICES

7.1. General

I n d e p e n d e n c e f r o m A u d i t C l i e n t ' s d e c i s i o n - m a k i n g

The self-review threat is always considered too high to allow the provision of any services other than statutory audit work
that involves the Statutory Auditor in any decision-making of either the Audit Client, any of its Affiliates, or the
management of such an entity. Therefore, if the Statutory Auditor or a member within his Network intends to provide
non-audit services to an Audit Client or to one of its Affiliates, the Statutory Auditor has to ensure that any individual
acting for or on behalf of the Audit Firm or its Network member does not take any decision for, nor take part in any
decision-making on behalf of, the Audit Client, any of its Affiliates or the management of such an entity.

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Any advice or assistance related to any service provided by the Statutory Auditor or the Audit Firm should give the Audit
Client, a client's Affiliate or the management of such an entity the opportunity to decide between reasonable alternatives.
This does not prevent the Statutory Auditor, Audit Firm or one of its Network members from making recommendations
to the Audit Client. However, such advice should be justified by objective and transparent analyses in the expectation that
the Audit Client will review the recommendations before reaching any decision. If the Audit Client is seeking advice
where, due to legal or regulatory provisions, only one solution is available, the Statutory Auditor should ensure that his
includes advice from external professionals).
documentation refers to these provisions (e.g. quotes the relevant law,

7.2.

Examples — analysis of specific situations

Business and financial markets are evolving continuously and information technologies are changing rapidly. These
developments have significant consequences for management and control. With this state of change, it is not possible to
draw up a comprehensive list of all those situations where the provision of non-audit services to an Audit Client would
create a significant threat to statutory auditors' independence. Neither is it possible to list the different safeguards which
may exist to mitigate such threats. The examples which follow describe specific situations that could compromise a
Statutory Auditor's independence. They also discuss the safeguards which may be appropriate to reduce the independence
risk to an acceptable level in each circumstance. In practice, the Statutory Auditor will need to assess the implications of
similar, but different circumstances, and to consider what safeguards would satisfactorily address the independence risk in
the judgement of an informed third party.

7.2.1. Preparing accounting records and financial statements

S p e c t r u m o f

i n v o l v e m e n t

i n t h e p r e p a r a t i o n p r o c e s s

There is a spectrum of involvement by the Statutory Auditor (including his Audit Firm, Network member firms, or any
employees thereof) in the preparation of accounting records and financial statements. At one end of the spectrum, the
Statutory Auditor may prepare prime accounting records, do the bookkeeping and prepare the financial statements, as
well as performing the Statutory Audit of these financial statements. In other cases, the Statutory Auditor helps his Audit
Client in the preparation of the financial statements on the basis of the trial balance, assisting his Audit Client in the
calculation of the closing entries (calculation of accruals, bad debts, depreciation, etc.). At the other end of the spectrum,
the Statutory Auditor does not participate in any part of the preparation process. Even in the latter case, the Statutory
Auditor who detects shortcomings in the Audit Client's proposed disclosures will normally suggest and draft the
amendments required. This is part of the Statutory Audit mandate and should not be considered as the provision of a
non-audit service. While management always has responsibility for the presentation of the financial statements, the end
result is that it is uncommon for a set of financial statements to appear where the Statutory Auditor has had no hand
whatsoever in the presentation or drafting.

N a t u r e o f a s s i s t a n c e a n d a d v i c e

The Audit Client and its management must be responsible for the financial statements and for maintaining accounting
records. The Statutory Auditor's safeguards must at least ensure that, when providing bookkeeping-related assistance, the
accounting entries and any underlying assumptions (e.g. for valuation purposes) are originated by the client. In addition,
the Statutory Auditor should not be involved in the decision-making of the Audit Client or its management in respect of
the entries or assumptions.

The Statutory Auditor's assistance should therefore be limited to carrying out technical or mechanical tasks and to
providing advisory information on alternative standards and methodologies which the Audit Client might wish to apply.

Examples of assistance which compromise independence include the following:

— determining or changing journal entries, or the classifications for accounts or transactions, or other accounting

records without obtaining the client's approval;

— authorising or approving transactions; or

— preparing source documents or originating data (including decisions on valuation assumptions), or making changes to

such documents or data.

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Examples of assistance which would not necessarily compromise independence could include:

— performing mechanical bookkeeping tasks, such as recording transactions for which the Audit Clients management
has determined the appropriate account classification; posting coded transactions to a client's general ledger; posting
client-approved entries to a client's trial balance; or providing certain data-processing services;

— informing the client about applicable accounting standards or valuation methodologies for the client to decide which

should be adopted.

L e v e l o f p u b l i c i n t e r e s t

The self-review threat that arises when a Statutory Auditor assists in the preparation of the accounting records or financial
statements of a Public Interest Entity is perceived to be so high that it cannot be mitigated by safeguards other than the
prohibition of any such assistance that goes beyond the statutory audit mandate (i.e., any assistance other than the
suggestion and drafting of amendments during the due course of the Statutory Audit, after having detected shortcomings
in the Audit Client's proposed disclosures).

In any case, where the Statutory Auditor is asked to participate in the preparation of an Audit Client's accounting records
or financial statements, he should carefully consider the public perception in relation to his task. This may depend on the
size and structure of the Audit Client as well as on the business environment in which this client operates at either a local,
regional or national level. Where the threat is perceived to reach a level that would cause the public to question his
independence, the Statutory Auditor should not accept the engagement.

E m e r g e n c y s i t u a t i o n s

In emergency cases, a Statutory Auditor may participate in the preparation process to an extent which would not be
acceptable under normal circumstances (see (2) and (3) above). This might arise when, due to external and unforeseeable
events, the Statutory Auditor is the only person with the resources and necessary knowledge of the Audit Client's systems
and procedures to assist the client in the timely preparation of its accounts and financial statements. A situation could be
considered an emergency where the Statutory Auditor's refusal to provide these services would result in a severe burden
for the Audit Client (e.g., withdrawal of credit lines), or would even threaten its going concern status.

In such an emergency situation, however, the Statutory Auditor should take no part in any final decisions and should seek
the client's approvals wherever possible. He should also consider additional safeguards that would allow him to minimise
the level of risk to his independence. Where appropriate, he should seek to discuss the situation with the Audit Client's
Governance Body and ensure that the services he provided and the reasons for this are summarised in the financial
statements.

S t a t u t o r y a u d i t s o n c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s o f P u b l i c I n t e r e s t E n t i t i e s

When the consolidated financial statements of a Public Interest Entity client are subject to a Statutory Audit, there might
be situations where it is impractical for a subsidiary of such an Audit Client to make arrangements in accordance with (3)
above. As a result, it is possible that its local auditor will have to participate in the preparation of financial statements that
are to be included in the Audit Client's consolidated financial statements. Under such circumstances, the self-review threat
from the perspective of the Statutory Auditor of the Public Interest Entity client, is generally not considered to be
significant, provided that the bookkeeping-related assistance is solely of a technical or mechanical nature or the advice is
only of an informative nature (see (2) above), that the financial statements of such subsidiaries are not material to the
Audit Client's consolidated financial statements (neither separately nor in total), and that the fees the Audit Firm and its
Network members receive for all such services collectively are insignificant in relation to the consolidated audit fee.

7.2.2. Design and implementation of financial

information technology systems

F i n a n c i a l

i n f o r m a t i o n

Statutory audit work includes the testing of those hardware and software systems that are used by the Audit Client to
generate the financial
information which is to be disclosed in its financial statements. Where a Statutory Auditor
(including his Audit Firm, Network member firms, or any employees thereof) is involved in the design and implementa-
tion of such a financial information technology system (FITS), a self-review threat may arise. In this respect, financial
information does not only include those figures which are directly disclosed in the financial statements, but also
comprises any other valuation or physical data to which the financial statements' disclosures relate. Such information is
generated by either integrated IT-systems or a variety of stand-alone systems (e.g., systems for bookkeeping, cost-
accounting, payroll, or cash management as well as those systems which may only provide physical numbers, such as
some warehousing and production control systems, etc.).

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S p e c t r u m o f

i n v o l v e m e n t

There is a spectrum of involvement by the Statutory Auditor in the design and implementation of FIT-systems:

At one end of the spectrum, there are engagements where the Statutory Auditor takes on a management role or
responsibilities for the FIT-systems design and implementation project as a whole, or for the operation of the FIT-system
and the data it uses or generates. Such an engagement would clearly result in an unacceptable level of independence risk.

In other cases, the Statutory Auditor must carefully assess the independence risk which might arise from his involvement
in systems design and implementation for the Audit Client, particularly if there are public interest implications. In all cases
he should consider whether there are appropriate safeguards to reduce the independence risk to an acceptable level. For
example, the level of risk may be acceptable where the Statutory Auditor's role is to provide advice to a consortium
retained by the Audit Client to design and/or implement a project. Similarly, there is little risk in the case of a smaller
company client, where the Statutory Auditor is asked to tailor a standard, off-the-shelf accounting system to meet the
needs of that client's business. However, independence risk may be perceived to be unacceptably high in the case of a
design project for a large company or Public Interest Entity client.

At the other end of the spectrum, the Statutory Auditor might be engaged to provide his Audit Client with a review of
alternative systems. Based on this review the client himself decides which system to install. The provision of such a service
would generally not compromise the Statutory Auditor's independence, provided that cost and benefits of the systems
reviewed are properly documented and discussed with the Audit Client. However, his independence will be compromised
if the Statutory Auditor has a significant financial interest (see B.1) or a significant business relationship (see B.2) with any
of the systems suppliers.

7.2.3. Valuation services

V a l u a t i o n s e r v i c e s

A valuation comprises the making of assumptions with regard to future developments, the application of certain
methodologies and techniques, and the combination of both in order to compute a certain value, or a range of values, for
an asset, a liability or for a business as a whole. The underlying assumptions of such a valuation may relate to
interpretations of the present or expectations of the future, including both general developments and the consequences of
certain actions taken or planned by the Audit Client or anybody within its close business environment.

Engagements to review or to issue an opinion on the valuation work performed by others (e.g. engagements under
Articles 10 and 27 of the 2nd Company Law Directive (77/91/EEC), Articles 10 and 23 of the 3rd Company Law
Directive (78/855/EEC), or under Article 8 of the 6th Company Law Directive (82/891/EEC)), or to collect and verify data
to be used in a valuation performed by others (e.g., typical ‘due diligence’ work in connection with the sale or purchase of
a business), are not regarded as valuation services under this principle.

M a t e r i a l i t y a n d s u b j e c t i v i t y

Valuation services leading to the valuation of amounts which neither separately nor in the aggregate are material in
relation to the financial statements are not considered to create a significant threat to independence.

The underlying assumptions of a valuation and the methodologies to be applied are always the responsibility of the Audit
Client or its management. Therefore, as part of its decision-making process, the Audit Client or its management has
generally to determine the underlying assumptions of the valuation, and to decide on the methodology to be applied for
the computation of the value. This is of particular importance when the valuation to be performed requires a significant
degree of subjectivity, either in relation to the underlying assumptions or regarding the differences in applicable
methodologies.

However, with regard to certain routine valuations, the degree of subjectivity inherent in the item concerned may be
insignificant. This is the case when the underlying assumptions are determined by law (e.g., tax rates, depreciation rates
for tax purposes), other regulations (e.g., provision to use certain interest rates), or are widely accepted within the Audit
Client's business sector, and when the techniques and methodologies to be used are based on general accepted standards,
or even prescribed by laws and regulations. In such circumstances, the result of a valuation performed by an informed
third party, even if not identical, is unlikely to be materially different. The provision of such valuation services might
therefore not compromise a statutory auditor's independence, even if the value itself could be regarded as material to the
financial statements, provided that the Audit Client or its management has at least approved all significant matters of
judgement.

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A d d i t i o n a l s a f e g u a r d s

Some valuation services involve an insignificant degree of subjectivity. These could include those requiring the application
of standard techniques or methodologies or where the service is a review of the valuation methods used by a third party,
but where the resulting valuation is material in relation to the financial statements. In these cases, the Statutory Auditor
should consider whether there remains a self-review threat which should be mitigated by additional safeguards. It may be
appropriate to address such a threat by setting up a valuation service team separate from the Engagement Team, with
different reporting lines for both.

7.2.4. Participation in the Audit Client's internal audit

Internal Audit is an important element of an entity's internal control system. In companies, particularly small and medium
sized ones, which cannot afford an internal audit department or where such a department lacks certain facilities (e.g.
access to specialists in information technology or treasury management), participation by the Statutory Auditor in the
internal audit may strengthen management control capacities.

However, self-review threats can arise if, for example, there is not a clear separation between the management and control
of the internal audit and the internal audit activities themselves, or if the Statutory Auditor's evaluation of his Audit
Client's internal control system determines the kind and volume of his subsequent statutory audit procedures. To avoid
such threats, the Statutory Auditor, the Audit Firm or its Network member must be able to show that it is not involved in
management and control of the internal audit. Furthermore, in his capacity as the statutory auditor of the client's financial
statements the Statutory Auditor must be able to demonstrate that he has taken appropriate steps to have the results of
the internal audit work reviewed and has not placed undue reliance on these results in establishing the nature, timing and
extent of his statutory audit work. In order to ensure that the Audit Firm's statutory audit work meets required auditing
standards and that the Statutory Auditor's independence is not compromised, an appropriate review of these matters
should be performed by an Audit Partner who has not been involved in either the Statutory Audit or any of the internal
audit engagements which may impact the financial statements.

In companies where the internal audit department reports to a Governance Body rather than to management itself, the
internal audit function performs a role that is complementary to the statutory audit function. It can therefore be seen as a
separate element of the corporate governance framework. If the Statutory Auditor is asked to perform internal audit work
in these circumstances, he must still be able to demonstrate that he has adequately assessed any threats to his
independence, and has applied any necessary safeguards.

7.2.5. Acting for the Audit Client in the resolution of litigation

A d v o c a c y a n d s e l f - r e v i e w t h r e a t s

In certain circumstances the Statutory Auditor, the Audit Firm, an entity within a Network or a Partner, manager or
employee thereof will assist the Audit Client in the resolution of a dispute or litigation.

A Statutory Auditor who acts for the Audit Client in the resolution of a dispute or litigation is generally perceived to take
on an advocacy role which is incompatible with the responsibility of a Statutory Auditor to give an objective opinion on
the financial statements. This advocacy threat is accompanied by a self-review threat when the assistance in the resolution
of litigation also requires the Statutory Auditor to estimate chances of his Audit Client succeeding in the action if this
could affect amounts to be reflected in the financial statements. A Statutory Auditor who is involved in the resolution of
litigation has therefore to consider the significance of both the advocacy threat and the self-review threat.

The advocacy threat is increased when the Statutory Auditor, the Audit Firm or a Network member firm takes an active
role on behalf of the Audit Client to resolve disputes or litigation. It is less likely that this threat will become significant,
when the Statutory Auditor is only required to give evidence to a court or tribunal in a case in which the client is
involved.

Even when taking a relatively active role on behalf of the client, there can be other specific situations which are generally
not seen to compromise a Statutory Auditor's independence. Such situations could include, the representation of an Audit
Client before the court or the tax administration in a case of tax litigation. They could also include advising the client and
defending a particular accounting treatment in a situation where a Member State's authority, securities regulator or review
panel, or any other similar European or international body investigates the Audit Client's financial statements. However,
whatever the circumstances, the Statutory Auditor should analyse the specific situation and his particular involvement to
carefully assess whether or not there is a significant risk to his independence.

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M a t e r i a l i t y a n d s u b j e c t i v i t y

The provision of legal services to an Audit Client in connection with the resolution of a dispute or litigation does not
usually create a significant threat to independence when these services involve matters that are not expected by a
reasonable and informed third party to have any material

impact on the financial statements.

Acting as an advocate of the Audit Client is inherently subjective, but the degree of subjectivity varies depending upon the
nature of the legal proceedings. During the course of an audit, the Statutory Auditor usually has the choice either to
evaluate the outcome of a legal proceeding himself, or to rely on a confirmation provided by an external lawyer engaged
by the client. The degree of subjectivity in both cases is governed by factors such as the competence of the lawyer, his
compliance with ethical rules of the lawyers' profession, and the given evidence, rather than whether or not the lawyer is
an employee of the Audit Firm or of a third party law firm.

With respect to legal situations where the outcome of legal proceedings can be reasonably estimated on given evidence,
the estimation of amounts affected by litigation should not lead to material differences between services provided by the
Audit Firm or a third party law firm (e.g. litigation regarding employment contracts with staff, or certain tax proceedings).

On the other hand, there might be situations that involve significant inherent subjectivity. There may also be situations
where it is impossible to evaluate evidence in an objective manner due to the nature of the business relationship between
the Statutory Auditor and the Audit Client (e.g. personal involvement of former or present management, non-executive
directors, or shareholders). In such cases, the Statutory Auditor should ensure that he is not involved in the Audit Client's
actions in the resolution of litigation, except in minor cases where the matter concerned would not reasonably be
expected to have a material

impact on the financial statements.

A d d i t i o n a l s a f e g u a r d s

the Statutory Auditor should consider whether there remain threats to
In circumstances not covered under (2),
independence which have to be mitigated by additional safeguards. It might be appropriate to avoid the audit Engagement
Team being involved in the litigation process by setting up different engagement teams with different reporting lines for
the Statutory Audit and the legal services related to the litigation.

7.2.6. Recruiting senior management

A Statutory Auditor who is asked to assist an Audit Client to recruit senior or key staff should first assess the threats to
his independence which might arise from, for example, the role of the person to be recruited and the nature of the
assistance sought. The need for careful assessment is highest where the person recruited is likely to have a significant role
in the client's financial management processes and hence to have regular contact with the Statutory Auditor. However,
threats such as self-interest and familiarity may arise from other appointments too.

With regard to the nature of the assistance sought, an example of an acceptable service might include reviewing the
professional qualifications of a number of applicants and giving an objective opinion on their suitability for a post.
Another acceptable service might include the provision of a short-list of candidates for interview, provided that it has
been drawn up using criteria specified by the client, rather than on the Statutory Auditor's own judgement. In both cases,
care would be needed to ensure that any opinion given about the candidates did not pre-empt the Audit Client's decision.
If the Statutory Auditor concludes that he cannot give the assistance requested without directly or indirectly participating
in the Audit Client's decision as to who should be appointed, he should decline to provide it.

8. AUDIT AND NON-AUDIT FEES

8.1. Contingent fees

A u d i t

f e e a r r a n g e m e n t s

Statutory audit work performed in the public interest is inherently unsuitable for fee arrangements where the Statutory
Auditor's remuneration depends on either any performance figure of the Audit Client or the outcome of the audit itself.
Audit fees that are fixed by any court or governmental body do not constitute contingent fees.

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N o n - a u d i t

f e e a r r a n g e m e n t s

Self-interest, self-review and advocacy threats to a Statutory Auditor's independence also arise when the fee for a
non-audit engagement is dependent upon a contingent event. This applies to all contingent arrangements between the
Statutory Auditor, the Audit Firm or an entity within its Network, and the Audit Client or any of its Affiliates.
Dependency on a contingent event means, for example, that the fee depends in some way on the progress or outcome of
the project or the attainment of a particular performance figure by the Audit Client (or its Affiliate).

In assessing the extent to which contingent fee arrangements pose a threat to statutory auditor independence, and the
availability of suitable safeguards, the Statutory Auditor should consider amongst other factors: the relationship between
the activity for which the contingent fee is to be paid, and the conduct of any current or future audit; the range of
possible fee amounts; and the basis on which the fee is to be calculated.

In performing this assessment, the Statutory Auditor should consider, inter alia, whether the amount of the contingent fee
is directly determined by reference to an asset or transaction value (e.g., percentage of acquisition price) or a financial
condition (e.g., growth in market capitalisation) the measurement of which will be subsequently exposed to an audit
examination and whether this increases the self-interest threat to unacceptable levels. On the other hand, independence
threats will generally not arise in situations where there is no direct link between the basis of the contingent fee (e.g., the
starting salary of a new employee when a recruitment service is provided) and a significant aspect of the audit
engagement. Where a Governance Body exists, the Statutory Auditor should disclose contingent fee arrangements to that
body in accordance with the principles set out under Section A. 4.1.2.

8.2. Relationship between total fees and total revenue

Excessive dependence on audit and non-audit fees from one Audit Client or one client group clearly gives rise to a
self-interest threat to the Statutory Auditor's independence. The Statutory Auditor or the Audit Firm has not only to avoid
the existence of such a financial dependency, but also has to consider carefully whether the appearance of such a
dependency might create a significant threat to independence.

A p p e a r a n c e o f

f i n a n c i a l d e p e n d e n c y

The Statutory Auditor, the Audit Firm or a Network might be perceived to be financially dependent on a single Audit
Client or client group when the total audit and non-audit fee that it receives, or expects to receive, from that client or
client group exceeds a critical percentage of its total income. The public perception of this critical percentage will depend
upon different factors within the audit environment. For example, the level might be different depending on the size of
the firm, whether it is well established or newly created, whether it operates locally, nationally or internationally, and on
the general business situation in markets in which it is operating.

These circumstances have to be carefully considered by the Statutory Auditor when he assesses the significance of the
self-interest threat to his appearance of independence. An analysis should be performed of all fees received for audit and
non-audit services from a particular client or client group compared to the firm's or Network's total income, as well as of
the relevant amounts that are expected to be received during the current firm's or Network's reporting period. If this
analysis indicates a level of dependency and a need for safeguards, an Audit Partner who has not been engaged in any of
the audit or non-audit work for the client should carry out a review of the significant audit and non-audit work done for
the client and advise as necessary. The review should also take into consideration any audit and non-audit work that has
been contracted or is the subject of an outstanding proposal. Where doubts remain, or where, because of the size of the
firm, no such partner is available, the Statutory Auditor should seek the advice of his professional regulatory body or a
review by another statutory auditor.

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C e r t a i n o t h e r

f e e r e l a t i o n s h i p s

The Statutory Auditor should also consider whether there are, or appear to be, other types of fee relationships between a
single Audit Client or client group and himself or the Audit Firm that may cause a self-interest threat. For example, an
Audit Partner within an office or branch might be perceived to be dependent on fees from a certain Audit Client, if most
of that office's services are provided to that Audit Client, or if the same individual is responsible for selling both audit and
non-audit engagements to the Audit Client. To mitigate such self-interest threats, an Audit Firm may reconsider its
organisational structures and the responsibilities of certain individuals, or, where applicable, discuss the way services are
provided and charged with the Audit Client's Governance Body.

Independence may particularly be compromised when significant fees are generated from the provision of non-audit
services to an Audit Client or its Affiliates. The Statutory Auditor should therefore assess this risk to his independence. In
particular, he should consider the nature of the non-audit services provided, the different fees generated from the statutory
audit engagement and the non-audit engagements, and their respective relationship to the total fees received by the Audit
Firm or Network. If the analysis indicates the need for safeguards, particularly when the non-audit fees exceed the audit
fees, an Audit Partner who is not involved in any of the audit and non-audit engagements should carry out a review of the
work done for the client and advise as necessary.

8.3. Overdue fees

Unpaid fees for audit or other work could appear to be in effect a loan from the Statutory Auditor to the Audit Client.
This could threaten the Statutory Auditor's independence by creating a mutual financial interest with the Audit Client. In
such circumstances, a Statutory Auditor must assess the level of the threat and take any action that may be necessary. This
could include disclosing the extent of the potential mutual interest to all relevant third parties. Where the Statutory
Auditor is an Audit Firm, the circumstances may be reviewed by another Audit Partner who has not been involved in the
provision of any services to the Audit Client. In the case of a sole practitioner, or a small partnership where all the Audit
Partners have been involved with the Audit Client, the Statutory Auditor should either seek advice from his professional
regulatory body or ask for a review by another statutory auditor.

8.4.

Pricing

A Statutory Auditor must be able to demonstrate that the fee he charges for any audit engagement is reasonable,
particularly if it is significantly lower than that charged by a predecessor or quoted by other firms bidding for the
engagement. He must also be able to demonstrate that a quoted audit fee is not dependent on the expected provision of
non-audit services, and that a client has not been misled as to the basis on which future audit and non-audit fees would be
charged when negotiating the current audit fees. The Statutory Auditor should have policies and procedures in place to be
able to demonstrate that his fees meet these requirements. Where Statutory Audits of Public Interest Entities are
concerned, the Statutory Auditor should seek to discuss the basis for calculating the audit fee with the Governance Body.

9. LITIGATION

Whilst it is not possible to specify precisely for all cases the point at which it would become improper for a statutory
auditor to continue as Statutory Auditor of an Audit Client, the following criteria should be considered:

— if an Audit Client alleges deficiencies in statutory audit work, and the Statutory Auditor concludes that it is probable
that a claim will be filed, the Statutory Auditor should first discuss the basis of the allegations with the Governance
Body of the Audit Client or, where such body does not exist, with his professional regulatory body. If this confirms
the judgement that it is probable that a claim will be filed, then — subject to local legal requirements — the Statutory
Auditor should resign;

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— if the Statutory Auditor alleges fraud or deceit by current management of an Audit Client, the level of independence
risk and the decision as to whether or not he should resign also depends on safeguards such as discussion of all
relevant aspects with the Governance Body of the client, or, where such a body does not exist, with the Statutory
Auditor's professional regulatory body. (In some countries, however, the national law safeguards the independence of
the Statutory Auditor in cases of alleged fraud by requiring the Statutory Auditor to report the detected fraud to a
national authority and to continue his audit work on behalf of that authority which represents the national public
interest. In any case the Statutory Auditor should consider seeking legal advice, giving due consideration to his
responsibility to the public interest.);

— threatened or actual litigation relating to non-audit services for an amount not material to the Statutory Auditor or to
the Audit Client (for example, claims out of disputes over billing for services, results of consultancy services) would
not compromise the Statutory Auditors independence.

10. SENIOR PERSONNEL ACTING FOR A LONG PERIOD OF TIME

To mitigate a familiarity or trust threat to the independence of a Statutory Auditor who is engaged to audit an Audit
Client of public interest, the requirement to replace the Engagement Partner and the other Key Audit Partners of the
Engagement Team within a reasonable period of time cannot be replaced by other safeguards.

The Statutory Auditor should also consider the independence risk arising from the prolonged involvement of other
members of the Engagement Team, including the senior staff engaged on audits of entities which are consolidated into an
Audit Client's consolidated financial statements, and from the composition of the team itself. He should apply safeguards,
such as rotation and measures under the Audit Firm's quality assurance scheme, to seek to ensure that the engagement
may be properly continued without compromising his independence.

There might be situations, where due to the size of the Audit Firm internal rotation of the Engagement Partner and other
Key Audit Partners is not possible or may not constitute an appropriate safeguard. For example, in the case of a sole
practitioner's practice, or where the day to day relationship between a limited number of Audit Partners is too close. In
such situations, the Statutory Auditor should ensure that other safeguards are put in place within a reasonable period of
time. Such safeguards could include having the relevant audit engagement covered by an external quality review, or, as a
minimum, seeking the advice of his professional regulatory body. If no suitable safeguards can be identified, the Statutory
Auditor should consider whether it is appropriate to continue the audit engagement.

When any member of an Engagement Team is replaced because of time served on a particular audit, or because of a
related familiarity or trust threat, that individual should not be re-assigned to the team until at least two years have
elapsed since his replacement.

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Appendix

GLOSSARY

Affiliate

(a) of an Audit Firm: an undertaking within the meaning of Article 41 (1), (2) and (3) of

the 7th Company Law Directive (83/349/EEC);

(b) of an Audit Client: an undertaking within the meaning of Article 41 (1), (2) and (3) of
the 7th Company Law Directive (83/349/EEC) that together with the Audit Client is
required to be included by consolidation in consolidated accounts prepared in accord-
ance with the 7th Directive, or — in those cases where the 7th Company Law
Directive does not apply — would be required to be included by consolidation were
the requirements of that Directive to apply.

Without prejudice to (a) and (b) the term ‘Affiliate’ will include any undertaking, regard-
less of its legal form, which is connected to another by means of common ownership,
control or management.

Assurance Service

Engagement of a statutory auditor to evaluate or measure a subject matter that is the
responsibility of another party against identified suitable criteria, and to express a conclu-
sion that provides the audit client with a level of assurance about that subject matter.

Audit Client

Audit Firm

Audit Partner

The company or firm whose annual accounts are subject to Statutory Audit, or the parent
undertaking in the meaning of Article 1 of the 7th Company Law Directive (83/349/EEC)
whose consolidated accounts are subject to Statutory Audit.

The organisational — generally legal — entity that performs a Statutory Audit (e.g., a sole
practitioner's practice, a partnership or a company of professional accountants). The
Audit Firm and the Statutory Auditor who is appointed for the Statutory Audit might be
identical legal persons, but need not be (e.g., where an individual who is a member of a
partnership practice is appointed as the Statutory Auditor, the partnership as such forms
the Audit Firm).

An audit professional within an Audit Firm or Network who himself is an approved
person in the meaning of Article 2(1) of the 8th Company Law Directive (= statutory
auditor) and, as an individual, takes on ultimate responsibilities for the audit work
performed during a Statutory Audit; he, generally, is authorised to sign audit reports on
behalf of the Audit Firm which is the Statutory Auditor. He may also be a shareholder/
owner or principal of the Audit Firm.

Audit Team

All audit professionals who, regardless of their legal relationship with the Statutory
Auditor or Audit Firm, are assigned to a particular Statutory Audit engagement in order
to perform the audit task, such as Audit Partner(s), audit manager(s) and audit staff.

Chain of Command

Engagement Partner

Engagement Team

Comprises all those persons who have a direct supervisory, management, compensation
or other oversight responsibility over either any Audit Partner of the Audit Team or over
the conduct of the Statutory Audit at office, country, regional or global
levels. This
includes all Partners, principals and shareholders who may prepare, review or directly
influence the performance appraisal of any Audit Partner of the Audit Team or otherwise
determine their compensation as a result of their involvement with the audit engagement.

The Audit Partner who has ultimate responsibilities for the Statutory Audit of a particular
Audit Client, who co-ordinates the work of the Audit Team and that of professional
personnel from other disciplines involved, ensures that this work is subject to quality
control, and, if applicable, co-ordinates all statutory audit activities of a Network which
relate to a Statutory Audit, particularly on consolidated accounts where different Audit
Partners have different responsibilities for the audits of the entities to be consolidated.

All persons who, regardless of their legal relationship with the Statutory Auditor or Audit
Firm, are directly involved in the acceptance and performance of a particular Statutory
Audit. This includes the Audit Team, employed or subcontracted professional personnel
from other disciplines involved in the audit engagement (e.g., lawyers, actuaries, taxation
specialists, IT-specialists, treasury management specialists), and those who provide quality
control or direct oversight of the audit engagement.

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Governance Body

A body or a group of persons which is embedded in the Audit Client's corporate
governance structure to exercise oversight over management as a fiduciary for investors
and, if required by national law, for other stakeholders such as employees, and which
consists of or, at least, includes individuals other than management, such as a supervisory
board, an audit committee, or a group of non-executive directors or external board
members.

Key Audit Partner

An Audit Partner of the Engagement Team (including the Engagement Partner) who is at
group level responsible for reporting on significant matters, such as on significant
subsidiaries or divisions of the Audit Client, or on significant risk factors that relate to the
Statutory Audit of that client.

Key Management Position

Any position at the Audit Client which involves the responsibility for fundamental
management decisions at the Audit Client, e.g. a CEO or CFO. This management responsi-
bility should also provide influence on the accounting policies and the preparation of the
financial statements of the Audit Client. A Key Management Position also comprises
contractual and factual arrangements which by substance allow an individual to partici-
pate in exercising this management function in a different way, e.g. via a consulting
contract.

Network

‘Office’

Partner

Includes the Audit Firm which performs the Statutory Audit, together with its Affiliates
and any other entity controlled by the Audit Firm or under common control, ownership
or management or otherwise affiliated or associated with the Audit Firm through the use
of a common name or through the sharing of significant common professional resources.

The term ‘Office’ means a distinct sub-group of an Audit Firm or Network, whether
distinguished along geographical or practice lines, in which a Key Audit Partner primarily
practices.

A main criterion for identifying this sub-group should be the close working relationship
between its members (e.g. working on the same kind of subjects or clients). In particular,
it should be taken into account, that such working relationships are more and more
evolving by means of a ‘virtual’ office, due to technical developments and the increasing
multinational activities of Audit Clients.

In the case of smaller partnerships, the ‘Office’ may encompass the whole firm, in which
case all of the Partners and employees will be subject to the relevant requirements.

A professional within an Audit Firm or Network who, as an individual, takes on ultimate
responsibilities for the work performed during an (audit or non-audit) engagement; he,
generally, is authorised to sign on behalf of the Audit Firm, and may also be a share-
holder/owner or principal of the Audit Firm.

Public Interest Entities

Entities which are of significant public interest because of their business, their size, their
number of employees or their corporate status is such that they have a wide range of
stakeholders. Examples of such entities might include credit institutions, insurance compa-
nies,

investment firms, UCITS(1), pension firms and listed companies.

Statutory Audit

The audit service which is provided by an approved person in the meaning of Article 2(1)
of the 8th Company Law Directive (= statutory auditor) when

(a) carrying out an audit of the annual accounts of a company or firm and verifying that
the annual report is consistent with those annual accounts in so far as such an audit
and such a verification is required by Community law; or

(b) carrying out an audit of the consolidated accounts of a body of undertakings and
verifying that the consolidated annual report is consistent with those consolidated
accounts in so far as such an audit and such a verification is required by Community
law.

For the purpose of this Recommendation, the term ‘statutory audit’ would also include an
attest service which, dependent on national law, is provided by a statutory auditor when
companies are required to have financial reporting information other than the above (e.g.
companies' interim financial accounts and reports) reviewed by a Statutory Auditor who
has to give an opinion on this information.

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Statutory Auditor

The approved person in the meaning of Article 2(1) of the 8th Company Law Directive
(= statutory auditor) who, either being a natural or a legal person, is appointed for a
certain Statutory Audit engagement by means of national law and — as a consequence —
in whose name the audit report is signed.

(1) Undertakings for Collective Investment in Transferable Securities