1. Striving for Absolute Independence – Will the Prohibition of Non-Audit Services Result in Better Audits? Hardld RING Vice President, Institut der Wirtschaftsprufer Germany

2. Harald Ring President of the Institut der Wirtschaftspruefer, Germany Striving for Absolute Independence Will the Prohibition of Non-audit Services Result in Better Audits? Striving for Absolute Independence Will the Prohibition of Non-audit Services Result in Better Audits?

3. 3 Introduction (1)  Accountants: a profession that is bound to very strict ethical standards Responsibility not limited to satisfy the client’s needs Rather, acceptance of a particular responsibility to the public Particularly, when accountants act as auditors  Today: new debate about auditor independence Intensified by the Enron collapse and other accounting scandals One key issue: Scope of services the auditor may provide to his audit client  Accountants: a profession that is bound to very strict ethical standards Responsibility not limited to satisfy the client’s needs Rather, acceptance of a particular responsibility to the public Particularly, when accountants act as auditors  Today: new debate about auditor independence Intensified by the Enron collapse and other accounting scandals One key issue: Scope of services the auditor may provide to his audit client

4. 4 Introduction (2)  Opposing views as to the scope of permitted services Far going prohibition of non-audit services (“audit- only approach”) No general prohibition of non-audit services Both approaches can be found in current rule sets  Opposing views as to the scope of permitted services Far going prohibition of non-audit services (“audit- only approach”) No general prohibition of non-audit services Both approaches can be found in current rule sets

5. 5 Overview over the different rule sets (1)  IFAC Code of Ethics/EU Commission’s Recommendation on Auditor Independence Principles-based approach  Catalogue of possible independence risks and safeguards to mitigate the risks  Individual evaluation of each audit engagement is needed  Amended by “specific circumstances” (examples how to apply the principles-based approach in frequently occurring situations where independence may be compromised)  IFAC Code of Ethics/EU Commission’s Recommendation on Auditor Independence Principles-based approach  Catalogue of possible independence risks and safeguards to mitigate the risks  Individual evaluation of each audit engagement is needed  Amended by “specific circumstances” (examples how to apply the principles-based approach in frequently occurring situations where independence may be compromised)

6. 6 Overview over the different rule sets (2) Provision of non-audit services  Permitted if general safeguards (independent of the specific service) and specific safeguards (dependent of the specific service) exist  Application illustrated for different kinds of services (e.g., preparation of accounts and financial statements, design and implementation of financial information systems, valuation services, …)  Prohibition of the service only as an ultimate safeguard Provision of non-audit services  Permitted if general safeguards (independent of the specific service) and specific safeguards (dependent of the specific service) exist  Application illustrated for different kinds of services (e.g., preparation of accounts and financial statements, design and implementation of financial information systems, valuation services, …)  Prohibition of the service only as an ultimate safeguard

7. 7 Overview over the different rule sets (3)  Sarbanes-Oxley-Act in the U.S. Eliminated the exceptions and conditions of Rule 2-01 of Regulation S-X which could result in the admissibility of a non-audit service Uniformly prohibits the following services  Bookkeeping or other services related to the accounting records or financial statements of the audit client  Financial Information systems design and implementation  Actuarial services  Sarbanes-Oxley-Act in the U.S. Eliminated the exceptions and conditions of Rule 2-01 of Regulation S-X which could result in the admissibility of a non-audit service Uniformly prohibits the following services  Bookkeeping or other services related to the accounting records or financial statements of the audit client  Financial Information systems design and implementation  Actuarial services

8. 8 Overview over the different rule sets (4)  Appraisal or valuation services, fairness opinions or contribution-in-kind reports  Internal audit out-sourcing services  Management functions or human resources services  Broker or dealer, investment adviser, or Investment banking services  Legal services and expert services unrelated to the audit  Any other service that the PCAOB determines impermissible Shift towards an “audit-only approach“  Appraisal or valuation services, fairness opinions or contribution-in-kind reports  Internal audit out-sourcing services  Management functions or human resources services  Broker or dealer, investment adviser, or Investment banking services  Legal services and expert services unrelated to the audit  Any other service that the PCAOB determines impermissible Shift towards an “audit-only approach“

9. 9 Deficiencies of an “Audit-only Approach” (1)  Absolute versus relative independence Legislators’ view: absolute independence as the ideal state that should be strived for However, auditor independence as a concept of relative independence  Insufficient consideration of client-specific knowledge as the basis of today’s audit Improving independence is not automatically equivalent to improving audit quality Increasingly complex and rapidly changing business environment  Absolute versus relative independence Legislators’ view: absolute independence as the ideal state that should be strived for However, auditor independence as a concept of relative independence  Insufficient consideration of client-specific knowledge as the basis of today’s audit Improving independence is not automatically equivalent to improving audit quality Increasingly complex and rapidly changing business environment

10. 10 Deficiencies of an “Audit-only Approach” (2) Non-audit services assist the auditor in obtaining the knowledge required for high-quality audits  Negative impacts on auditor quality and recruiting Audit quality depends on auditor quality Non-audit services assist the auditor in recruiting “high potentials”  Inseparability of audit and certain non-audit services  Lack of empirical evidence as to negative trade-offs between non-audit services and audit quality Non-audit services assist the auditor in obtaining the knowledge required for high-quality audits  Negative impacts on auditor quality and recruiting Audit quality depends on auditor quality Non-audit services assist the auditor in recruiting “high potentials”  Inseparability of audit and certain non-audit services  Lack of empirical evidence as to negative trade-offs between non-audit services and audit quality

11. 11 Conclusion  Non-audit services have the potential of impairing auditor independence and these risks must be eliminated  However, a general ban on a wide range of non- audit services is not an appropriate solution Independence risks primarily depend on the circumstances of the individual case Thus, an “audit-only approach” may remove “non-existent” independence risks, thereby encumbering audit quality  Rather, a flexible concept like the one pursued by the IFAC Code or the EU Recommendation is needed  Non-audit services have the potential of impairing auditor independence and these risks must be eliminated  However, a general ban on a wide range of non- audit services is not an appropriate solution Independence risks primarily depend on the circumstances of the individual case Thus, an “audit-only approach” may remove “non-existent” independence risks, thereby encumbering audit quality  Rather, a flexible concept like the one pursued by the IFAC Code or the EU Recommendation is needed