Part 1: Complying with the Code, fundamental principles, and conceptual framework

The Public Audit Act 2001 places expectations on the Auditor-General that exceed the minimum requirements of PES 1, particularly in the application of the fundamental principle of objectivity (audit independence).

Those who carry out work on behalf of the Auditor-General shall comply with the Auditor-General’s expectations about how the fundamental principle of objectivity is to be applied, as specified in the Auditor-General’s Code and in this Guide.

In addition to paragraph 110.1 A1(c) the Auditor-General’s Code describes professional competence and taking due care as:

• “attaining and maintaining professional knowledge and skills at the level required to carry out one’s duties and functions; and
• acting diligently in keeping with relevant legislation and complying with the Auditor-General’s Auditing Standards”.

In addition to paragraph R112.1, the Auditor-General and those who carry out work on their behalf shall:

• not compromise professional judgements for any reason, including bias, conflict of interests, or the undue influence of others; and
• take appropriate measures to ensure that they are seen to be objective. The appropriate measures will normally be determined by applying the reasonable and informed third party test.

In addition to paragraph R113.1 the Auditor-General and those who carry out work on their behalf shall:

• attain and maintain professional knowledge and skills at the level required to carry out one’s duties and functions; and
• act diligently in keeping with relevant legislation and comply with the Auditor-General’s Auditing Standards.

Technical competence is one aspect of the fundamental principle of professional competence and due care. Those who carry out work on the Auditor-General’s behalf shall demonstrate technical competence that reflects their role when carrying out work on behalf of the Auditor-General. Technical competence requires those who carry out work on behalf of the Auditor-General to be responsive to the public sector environment. In particular, they shall have:

1. a clear understanding of the statutory mandate and role of the Auditor-General;
2. a clear understanding of the statutory obligations placed on public entities that specify their purpose, the way in which they are to be managed, and their accountability requirements;
3. an understanding of general issues of management and governance in the public sector that is sufficient to identify issues of effectiveness and efficiency, non-compliance with statutory obligations, waste, and a lack of probity and/or financial prudence when they are encountered;
4. a capacity to adapt audit planning to the risks that result from the differing nature and purposes of public entities;
5. such specialist skills as are required to form an opinion on performance information reported by a public entity (where necessary) or the ability to identify whether and which specialist skills are required; and
6. the ability to report completely, but succinctly, on audit issues, audit results, and the state of the public entity.

Behavioural competence is one aspect of the fundamental principle of professional competence and due care. Behavioural competence primarily relates to managing relationships with the OAG and with the public entity. Those who carry out work on behalf of the Auditor-General shall:

1. identify themselves with the Auditor-General, and the Auditor-General’s statutory role and independence, in any communications with a public entity, Parliament, or other key groups in the public sector; and
2. understand the Auditor-General’s interest as the statutory auditor of all public entities in being kept informed of matters of:
   1. effectiveness and efficiency;
   2. non-compliance with statutory obligations;
   3. waste;
   4. a lack of probity;
   5. a lack of financial prudence; and
   6. other sensitive matters or issues.

Those who carry out work on behalf of the Auditor-General shall not speak to the news media unless they are specifically authorised to do so by the OAG. In practice, those who carry out work on behalf of the Auditor-General shall refer media queries to the OAG (using the Independence@oag.parliament.nz email address).

Those who carry out work on behalf of the Auditor-General should advise the OAG that they have been in contact with the news media as soon as it is practicable to do so.

It is recognised that, when attending a public meeting, those who carry out work on behalf of the Auditor-General might be requested to make comment. This particularly applies in the case of the auditors of entities with public annual general meetings, such as local authorities and school boards of trustees. In this situation, even though the Chairperson might have been made aware of the auditor’s obligations to the Auditor-General, it might be difficult not to respond to questions. Accordingly, those who carry out work on behalf of the Auditor-General shall take the following measures:

1. before the meeting they:
   
   1. shall develop a list of questions that are likely to be asked and determine those that they can answer and those that should be referred to management or those charged with governance;
   2. may consult with the OAG (using the Independence@oag.parliament.nz email address); and
   3. shall ensure that any questions they are not in a position to answer are referred to management or to those charged with governance.
2. During the meeting, if they cannot avoid answering a question, then they shall keep to the facts and any professional opinions they have formed.

Those who carry out work on behalf of the Auditor-General shall ensure that compliance with the fundamental principles is achieved from two perspectives:

• actual compliance; and
• perceived compliance. The reasonable and informed third party test is applied to establish whether perceived compliance has been achieved. The reasonable and informed third party test requires a high acceptable level to be met in that the third party would likely reach the same conclusions about compliance as the assurance practitioner.

It is important that there is no mismatch between the conclusions that are reached about compliance when assessing actual compliance and in applying the reasonable and informed third party test in assessing perceived compliance.

It is acknowledged that the proper application of the reasonable and informed third party test can only be carried out on the basis that the relevant facts and circumstances that are necessary to reach a conclusion are available to those parties who are affected by the assurance practitioner’s work. Otherwise, there is a possibility that the reasonable and informed third party might form a different conclusion from the assurance practitioner, or might not be able to conclude, on compliance with the fundamental principles.

In the situation where relevant facts and circumstances are not available to those parties who are affected by the assurance practitioner’s work (and where those facts and circumstances are important to the proper application of the reasonable and informed third party test), then the reasonable and informed third party test cannot be satisfied. The consequence of this situation is either:

1. that all of the relevant facts and circumstances that allow the reasonable and informed third party to form a conclusion about compliance with the fundamental principles must be made available to those parties who are affected by the assurance practitioner’s work; or
2. that the action subject to the reasonable and informed third party test is not pursued.

Paragraph AG 120.7 A1.1 establishes that the acceptable level to be achieved in applying the reasonable and informed third party test to assess compliance with the fundamental principles is the would likely conclude standard.

The Public Audit Act 2001 places expectations on the Auditor-General that mean the requirements of PES 1 do not adequately meet the professional and ethical standards that are expected of the Auditor-General. The Auditor-General’s requirements for applying the reasonable and informed third party test to the fundamental principle of objectivity (audit independence) are specified in paragraphs AG R120.15 A1.2 to AG R120.15 A1.4 and the accompanying application material in paragraph AG 120.15 A1.5. These requirements, and the accompanying application material, are more demanding than the approach described in paragraph 120.15 A1(b) of PES 1.

Those who carry out work on behalf of the Auditor-General shall not use the internal separation of activities within a firm as a safeguard to reduce the threat to compliance with the fundamental principles to an acceptable level.

Internal separation is sometimes used by firms as a safeguard to permit different (and sometimes incompatible) activities to be carried out for an entity. An example of internal separation is where different partners and engagement teams within the same firm provide non-assurance services for an entity that is also audited by the firm.

The internal separation safeguard can never mitigate the perceived compliance requirement. The perceived compliance requirement is met through the application of the reasonable and informed third party test in paragraphs AG R120.5 A6.1 and AG R120.5 A6.2.

The more stringent test for assessing independence in appearance is based on the following criteria:

1. The assessment of independence in appearance must take into account any facts and circumstances that are relevant to that assessment. The proper application of the reasonable and informed third party test requires an assessment of any facts and circumstances that might influence the application of the test. To limit the reasonable and informed third party test to facts and circumstances that are “so significant” is not appropriate. This is because the highly subjective term “so significant” does not establish a sufficiently high or rigorous threshold to ensure that independence in appearance is maintained. Those applying the “so significant” test are required to discount all facts or circumstances unless they meet a level of significance that exceeds “normal” significance. This interpretation can be taken from the term “so significant”. The Auditor-General and those who carry out work on their behalf are required to take account of all facts and circumstances that are relevant when assessing independence in appearance – irrespective of whether the facts or circumstances meet the “so significant” criterion.
2. The assessment of independence in appearance is based on whether the reasonable and informed third party might conclude that integrity, objectivity, or professional scepticism has been compromised. Any element of doubt as to independence will mean that the reasonable and informed third party test fails. The independence in appearance test in paragraph 120.12.A1(b) requires that the reasonable and informed third party “would be likely to conclude” that integrity, objectivity, or professional scepticism has been compromised. The “would be likely to conclude” test is a relatively low standard in that the facts and circumstances need to be persuasive before those applying the test would be likely to conclude that integrity, objectivity, or professional scepticism has been compromised. When applying the reasonable and informed third party test to assess independence in appearance, the “would be likely to” standard shall be replaced with the “might” standard. In other words, any reasonable doubt must be dispelled if the test is to be met.
3. The facts and circumstances that are relevant to the reasonable and informed third party test must be publicly available. The reason for this requirement is that the reports of the Auditor-General, in most instances, are made available to the public. If information that is influential to applying the reasonable and informed third party test is not publicly available, then the perception that the Auditor-General is not independent will remain. In this situation, the reasonable and informed third party test fails.