## Threats to Independence

Five major threats to auditor independence must be identified and managed:

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### 1. Self-Interest Threat

Occurs when the audit firm or its members could benefit from a financial interest in an audit client.

Examples:

Potential employment with the client
Contingent fees for the audit engagement
Undue fee dependence on one client (e.g., >40% of total fees from a single client)
Direct financial interest or materially significant indirect financial interest in the client
Loan or guarantee to/from the client
Close business relationship with the audit client

---

### 2. Self-Review Threat

Occurs when the auditor reviews their own previous work or judgements.

Two key scenarios:

Case (i): A team member was previously a Director or senior employee of the client company
Case (ii): The auditor reviews judgements/conclusions made in a prior audit or non-audit engagement for the same client

Non-audit services that create self-review risk:

Management consultancy
Internal audit
Investment advisory

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### 3. Advocacy Threat

Arises when the auditor promotes or is perceived to promote a client's position to the extent that it compromises the auditor's objectivity.

Example:

Dealing in/promoting the client's securities
Acting as the client's advocate in litigation

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### 4. Familiarity Threat

Occurs when the auditor becomes too sympathetic to client interests due to a close or long-standing relationship.

Examples:

Receiving gifts or hospitality from the client
Close relative of an audit team member working in a senior position in the client company
Former partner of the audit firm being a Director of the client company
Long association of an auditor with the same client (audit-client relationship over many years)

> Safeguard: Rotation of auditors is a key safeguard against familiarity threat.

---

### 5. Intimidation Threat

Occurs when auditors are discouraged from acting objectively or maintaining professional skepticism due to pressure.

Examples:

Threat of replacement over a disagreement with management
Threat of litigation by the client

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## Safeguards Against Threats to Independence

For public confidence in audit quality, the auditor must always:

1. Be independent (independence of mind)

2. Appear to be independent (independence by appearance)

Before accepting any work, the auditor must conscientiously consider whether it involves any threat to independence.

When a threat exists, the auditor should:

Option	Action
i	Desist from the task entirely
ii	Eliminate the threat
iii	At minimum, put in place safeguards that reduce the threat to an acceptable level

> All safeguards must be documented.

If the auditor is unable to fully implement credible and adequate safeguards:

The auditor must not accept such work.

Worked example

### Example 1

Self-Interest Threat: An audit firm earns 55% of its total revenue from one client. This undue fee dependence creates a self-interest threat — the firm may be reluctant to issue an adverse opinion for fear of losing the client. Safeguard: cap client fee dependence at an acceptable threshold and disclose to TCWG.

### Example 2

Self-Review Threat: Last year, the audit team prepared the financial statements (a non-audit service) for the client. This year, they are also the statutory auditors reviewing those same statements. The auditor is reviewing their own work — classic self-review threat. Safeguard: different personnel/teams for preparation and audit.

### Example 3

Advocacy Threat: The auditor appears as a witness supporting the client's position in a tax tribunal. This goes beyond advising and into actively promoting the client's position — objectivity is compromised.

### Example 4

Familiarity Threat: An audit partner has audited the same company for 12 consecutive years. The long association creates a familiarity threat as the partner may have developed personal loyalty to management. Safeguard: mandatory partner rotation (e.g., every 7 years under ICAI norms for listed entities).

### Example 5

Intimidation Threat: Management tells the auditor that if the going concern paragraph is included in the audit report, they will terminate the engagement and file a complaint with ICAI. This is a direct intimidation threat. The auditor must maintain professional skepticism and objectivity despite this pressure — and may ultimately need to resign.

### Example 6

Safeguard Example: An audit firm identifies that a team member holds shares in the client (self-interest threat). Safeguard applied: team member is removed from the engagement and the shareholding is disclosed and documented. This reduces the threat to an acceptable level.

⚠️ Common exam mistakes

Confusing Familiarity Threat and Self-Interest Threat — familiarity arises from personal/emotional closeness; self-interest arises from financial benefits or employment prospects.
Forgetting that Self-Review Threat includes non-audit services like internal audit, management consultancy, and investment advisory — not just prior audit work.
Stating only two options when a threat exists — the three options are: desist, eliminate, or reduce to acceptable level with safeguards.
Not mentioning that all safeguards must be documented — this is a direct exam mark point.
Missing the consequence of being unable to implement adequate safeguards: the auditor must NOT accept the work.
Treating rotation of auditors as an ICAI preference rather than a specific safeguard against familiarity threat.
Confusing Advocacy Threat with Intimidation Threat — advocacy is the auditor promoting the client's position; intimidation is the client pressuring the auditor.

Reference: Section 290 — Threats to Independence and Applicable Safeguards — ICAI Code of Ethics (Volume I) — Section 290/291

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Threats to Independence and Safeguards

Worked example

⚠️ Common exam mistakes