What is an Advocacy Threat in Accounting?
An advocacy threat happens when an auditing firm accepts a project that requires that the firm acts as an advocate for a business or any entity.
The threat is more likely when the firm has to support the management’s stance in a standoff or promotional scenario. Such scenarios can be lawsuits, regulatory investigations, IPOs, or any form of stock issuance.
When audit team members have to push or support such a client’s stance to a degree where the intrinsic neutrality of an audit team is compromised, an advocacy threat occurs. This usually occurs when the objectivity expected from an audit perspective is removed.
Why is it Important to Avoid an Advocacy Threat?
An auditor is usually hired to go over a company's financial statements to make sure that the financial statements are genuine and that the company complies with regulatory requirements.
The primary purpose is to make sure that businesses do not inflate their income or reduce it to avoid taxes. Auditors are also vital in identifying errors. Their findings and observations are often used to improve organizational internal controls and increase efficiency.
Before accepting any audit assignment, auditors need to ensure that they are independent and objective toward the company they are going to audit.
This means that if any threats emerge toward independence and neutrality, auditors need to manage these threats.
How an Advocacy Threat Occurs
The concern for an advocacy threat being present is raised when audit firm staff backs a situation or position aligned with that of the management of the business.
While the advocacy may be in line with the audit firm’s business strategy, the situation (and the position of the management) can impact the firm’s integrity and independence perception.
Audit staff on audit assignment in such an entity end up facing objectivity challenges when auditing financial statements of these businesses.
However, the provision of advocacy services is linked to offering non-audit, or advisory services, which are supplemental services many audit firms offer as a value-added offering for their clients.
These services are linked with advocating the client’s interest or perspective in public, particularly in matters concerning the financial statements. This means that the advocacy threat is directly linked to such services.
No safeguards or protections can reduce the threat to auditory independence significantly.
Advocacy Threat and Independence Of Auditors
As we discussed above, auditors can act as a client’s publicist or spokesperson in some cases which raises concerns regarding advocacy threats. Being closely aligned with a client on matters of business or regulatory concern raises questions about the independence of the auditors.
A core requirement of an audit firm or team is that it remains objective, independent, and truthful. If the impact of an advocacy assignment on audit activities is minor, the threat is considered small and can be ignored. If the impact is high, then the threat is considered material to the audit’s performance.
The risk of advocacy threat is high if the matter is highly pertinent to the financial statements and can impact them significantly.
If an auditor is representing a client in court or in legal matters, or negotiations, these are all within the audit-client relationship, but the precautions against advocacy hazards need to be taken to satisfy the broader requirements of an audit firm.
Being cautious about threats and questions about full-scale job performance is something that should not be discouraged.
Effective Safeguards Against Advocacy Threat
Like most other threats, auditors can safeguard themselves from advocacy threats by employing suitable measures.
For instance, auditors should examine the assurance plan for the audit engagement, to see if it needs modification.
Separating audit team members is a basic step in the prevention of many threats. In most cases, audit managers need to assess if the threats and their underlying issues will have an impact on the financial statements.
They also need to evaluate the extent of the impact. If there is a significant impact, they must reject requests to advocate for the client.
In case the request to represent the client is more lucrative than to retain the client as an audit customer, the firm can step down from its audit services and decide to represent the client.
In case the impact of the assignment that requires advocacy is not material to the financial statements, the client can be retained for audit services as well as representation.
As a matter of practice, auditors can apply either of two options:
- They can form separate and independent teams for the two dissimilar assignments. This helps to keep opinions and information separate and helps maintain objectivity and independence.
- The other option is to have an advisor on board to advise the audit team on how to approach the audit assignment. The advisor needs to be independent and not linked with the client.
Other possible measures can be:
- Make sure that the team for the representation task is experienced and trained in handling multiple assignments,
- Bringing on an additional chartered accountant, who is not part of the representation team, for a final review or advisory purposes
- Conduct a quality control session of both the assignments
- Make sure that the audit team members are not linked in any way to the client or their staff. This will particularly include the debt details of the audit and representation team members.
- Ensure that any staff member is not working or going to work in the client’s business or businesses.
In cases where the auditors represent or support their clients in regulatory matters, their role can put the audited statements of the client in question.
When the issue in which the auditor is advocating is one that impacts the financial statements directly, the risk is very high.
The International Standards for Auditing advise auditors to decline to offer such services as the acceptance can impact the past financial statements and adversely impact the audit firm as well as the client’s veracity.