How a routine or mechanical service impacts SMSF auditor independence
There has been much discussion surrounding the updated Independence Guide, published by the APESB and professional accounting bodies, concerning how a routine or mechanical service impacts SMSF auditor independence.
Mirroring the recent changes made to the APES 110 Code of Ethics released by the APESB in January 2020, the guidelines specifically encompass a new direction for independence that challenges SMSF auditors in every way.
The guidelines state that an auditor cannot audit an SMSF where the auditor, their staff or firm has prepared the financial statements unless it is a routine or mechanical service.
Within the SMSF industry, some believe that the concept of routine and mechanical is open to interpretation and that it throws up a new grey area for SMSF practitioners.
Nothing could be further from the truth.
The new guidelines align with APES 110 section 601.4 A1, which provides a thorough explanation about how the concept of “routine or mechanical” works.
Services that are routine or mechanical
Services provided by an SMSF firm that is “routine or mechanical” require little or no professional judgement by the accounting firm. Under this context, the financials could mostly be prepared by administration staff as all instructions come solely from the trustee.
Examples cited in APES 110 include the accounting firm:
- Posting transactions coded by the trustee to the general ledger
- Posting trustee-approved entries to the trial balance
- Preparing financial statements based on information in the trustee-approved trial balance
- Preparing related notes based on trustee-approved records
It is evident from these examples that the trustee cannot simply “approve” everything after the fact, as they now squarely sit in the seat of decision-maker.
The new era of management responsibility
Another pitfall faced by SMSF firms is that they must not assume management responsibility for an audit client. The guidelines show how the firm can avoid this issue — the firm must be satisfied the trustee makes all judgements and decisions that are the proper responsibility of management.
Most importantly, the firm must demonstrate and document that the trustee has the suitable skills, knowledge and experience to remain responsible for their decisions. The trustee is also required to oversee the service and understand the objectives, nature and results of the firm’s services.
Practically, an accounting firm can no longer provide administrative or operational advice to trustees such as offering tax minimisation strategie, advising when to commence a pension and the required amount to meet the minimum or how much to contribute so as not to exceed the contributions caps.
Even the most steadfast SMSF firm must now concede that it is time to outsource the in-house SMSF audit.
What about recurring transactions
One may argue that a recurring transaction is routine or mechanical by nature, but let’s remember that it is the trustee who must initially approve the appropriate account classification.
By way of example, SGC monies coming into a fund’s bank account through SuperStream can be pre-approved and coded as a contribution by the SMSF trustee, but that represents only 12 transactions out of potentially hundreds throughout the year.
All other withdrawals and deposits have to be approved by the client, with the accounting firm keeping a record of the approval process for every single transaction.
What is considered routine or mechanical?
Those who consider “easier” funds with an asset allocation of, say, listed shares and cash as routine or mechanical will also be disappointed.
The concept of routine or mechanical has nothing to do with the type of assets in a fund. It has everything to do with the trustee being responsible for coding all transactions so that the service provided by the firm becomes routine or mechanical.
In real terms, it appears that meeting the criteria of a routine or mechanical service involves the trustee providing an Excel spreadsheet containing a trial balance to the SMSF firm, who uploads it into their SMSF administration software for processing.
The difficulty will be finding an SMSF accounting firm willing to work in this manner.
SMSF auditor sets up own firm
What about the situation where the SMSF auditor sets up their firm to accept audits from the firm where they were previously a consultant, partner or employee of that firm?
Not only do self-review and familiarity threats arise, but there is also the threat of fees coming from one referral source posing an additional intimidation threat.
Paragraph 8.5.3 of the new guidelines outline this very situation and concludes that the only safeguard available is to have an appropriate reviewer who is not involved in the audit, or who is not from the firm who prepares the financials, to review the work. Otherwise, they must decline the engagement.
While this defeats the very purpose of setting up a separate entity, it also demonstrates that looking for alternative solutions will only create new independence issues.
The outcome for the SMSF industry
There is no doubt that the new guidelines present a disruption to the entire SMSF industry. With the number of SMSF auditors standing at 5,294 (source: ATO SMSF statistical overview 2017–18), it would be folly to think that outsourcing the entire book of SMSFs currently audited in-house will be without incident.
While anecdotal evidence suggests that there are around 30 per cent to 40 per cent of these funds, the business models of SMSF firms flagged with independence issues now require careful consideration.
Capacity, workflow, staffing issues, technology and lodgement deadlines, to name but a few business concerns, mean any transitional period will require high-level planning to ensure the continued integrity of the superannuation system.
The ATO has said that they will not be taking compliance action against SMSF auditors who breach the new independence guidelines during the 2020–21 financial year. Instead, they will be writing to auditing firms where their data indicates that the auditor could also be auditing financial statements prepared by the same firm.
While this measured approach from the ATO provides SMSF auditors with the confirmation that they have time to comply with the requirements under the restructured code, the necessary steps will have to be put in place sooner rather than later.
While the process of outsourcing SMSF audits as a result of the new independence guidelines may appear daunting, SMSF firms are well advised to start thinking about how they can transition across to this new business model.
Identifying a checklist of requirements for any new SMSF auditor is essential. But it’s critical to ensure that both firms can work collaboratively together through a set of common goals and values, transparent communication, trust, mutual respect and problem resolution.
It is this approach that provides the blueprint for success.
Shelley Banton, executive general manager, technical services, ASF Audits