An advocacy threat can occur when a firm does work that requires acting as an advocate for an entity related to an engagement. Furthermore, in an antagonistic or promotional situation, backing management’s viewpoint.
For example, it serves as an entity’s legal advocate in a lawsuit or a regulatory probe or plays an active role in marketing its stock.
When members push a stance or perspective on behalf of a client to the extent where neutrality is jeopardized, this is known as an advocacy threat. This can happen when a chartered accountant advocates a position or viewpoint to the degree where objectivity is compromised as a result.
In order to operate as an advocate, the firm must take a viewpoint that is closely aligned with management. This poses a real and perceived threat to the firm’s and covered persons’ integrity, objectivity, and independence.
It may be difficult for the personnel performing the engagement to take an objective perspective of this in the context of an audit of the financial statements if the firm, acting as an advocate, has supported a particular management claim.
Providing a non-audit or supplementary service necessitates the firm, its partners, or staff to act as the entity’s advocate in topics relevant to the financial statements. Any protections are unlikely to prevent or decrease the threat of advocacy to a level where independence is not threatened.
What Is Advocacy Threat To the Independence Of Auditors?
Auditors may serve as a client’s publicist or representative in some cases. The auditor acts as the client’s advocate in these situations.
When auditors promote a client’s perspective or stance on their behalf, they pose an advocacy threat to their independence. In most cases, if the impact is minor, it can be overlooked. The advocacy threat occurs if the auditor’s judgment or objectivity is harmed due to such advocacy.
The majority of audit firms do not limit their services to auditing. Additional services, such as accounting, taxation, and advice may be offered.
Auditors may also act in clients’ interests to represent, defend, or promote them in some cases. If siding with the client jeopardizes the auditor’s independence, advocacy is the most serious threat.
Example:
- Representing an assurance client in a lawsuit or a disagreement with a third party.
- Selling stock in a publicly traded company when the company is a financial statement audit customer.
- Serving as an advocate for an assurance client in court or in a dispute with a third party.
How Does The Advocacy Threat Work?
When auditors represent clients in matters that have a meaningful impact on the financial statements, the advocacy risk is significant.
For example, when an auditor represents a client in court or on other legal matters. Similarly, in financial affairs, bargaining on behalf of a client qualifies auditors for an advocacy threat.
The majority of the time, auditors do not have to think about the repercussions of representing their clients. They must, however, apply precautions against such hazards if the amounts become considerable.
Having countermeasures in place is smart even if the issue isn’t material or has no impact on the financial statements.
An example of an advocacy threat is given below
An auditor provides client services linked to promoting newly issued shares in the market. The bigger the amount of money raised by the auditor, the better.
As a result, they always aim to get the most money out of whatever stock they sell. Meanwhile, they are a member of the team that is in charge of auditing the customer.
Except for one area, sales, there are no substantial misstatements in the client’s financial accounts. The auditor recognizes that the customer is attempting to maximize profits by inflating sales.
This increase in profits will result in greater market share prices and increasing demand. As a result of the increasing demand, the client will receive additional funding.
In this situation, the auditor has two options. It is critical for auditors to realize that failing to disclose misstatements is unethical and unprofessional. Furthermore, it reflects the auditor’s lack of objectivity and independence from the customer.
They can, on the other side, reveal the knowledge, lowering the client’s stock values. This reduction may have an impact on the auditor in the other service.
In this scenario, the error is broad. As a result, it will have a considerable impact on the decisions of stakeholders. The auditor faces a significant advocacy risk in this circumstance. It’s because they’ve been so enamored with the client that they’ve lost their impartiality.
What Are The Safeguards Against Advocacy Threat?
Auditors, like most other dangers, can protect themselves from advocacy threats by applying appropriate measures. First and foremost, auditors must examine if the assurance plan for the audit engagement needs to be modified.
Furthermore, separating audit team members is crucial in preventing these issues. However, it is possible that the audit firm, rather than specific members, is the source of this threat.
In the majority of cases, auditors must determine if the issues are relevant to the financial statements. If that’s the case, they’ll have to turn down any requests from the client to act on their behalf.
Auditors can also choose to continue representing the customer rather than continuing their audit services. Immaterial matters, on the other hand, are not subject to the same safeguards.
Auditors have two choices in circumstances when the problem is not relevant to the financial statements. As previously said, they can separate both teams in order to prevent prejudiced opinions from transferring from one assignment to the next.
Alternatively, they could have a professional advisor advise the audit team on how to handle the audit engagement. This professional, however, must not be involved in representing or marketing the client.
Other safeguards could include:
- Assigning an assurance team with sufficient experience in relation to the individual who has joined the assurance client;
- Involving an additional chartered accountant who was not a member of the assurance team to review the work or advise as needed; or
- Quality control review of the assurance engagement
- Ensuring that the person in question is not entitled to any benefits or payments from the company unless they are made in accordance with specified set arrangements. Furthermore, any debt owing to the individual should not be so large as to compromise the firm’s independence.
- Making sure that the individual does not continue to engage in or appear to engage in the firm’s business or professional operations.
When auditors represent or support their clients, they may put the audit of the client in jeopardy. While when the issue is material to the financial statements, the risk is greatest.
The International Standards for Auditing instruct auditors to refuse to provide these services in these circumstances. In the event that it is irrelevant, auditors have two options, as previously stated.