Auditor independence and rotation: what the Corporations Act requires

The general requirement, and whom it binds

Division 3 of Part 2M.4 opens with three sections: s 324CA binds an individual auditor or an audit company, s 324CB a member of an audit firm, and s 324CC a director of an audit company. Each turns on one definition:

“(1) For the purposes of sections 324CA, 324CB and 324CC, a conflict of interest situation exists in relation to an audited body at a particular time if, because of circumstances that exist at that time: (a) the auditor, or a professional member of the audit team, is not capable of exercising objective and impartial judgment in relation to the conduct of the audit of the audited body; or (b) a reasonable person, with full knowledge of all relevant facts and circumstances, would conclude that the auditor, or a professional member of the audit team, is not capable of exercising objective and impartial judgment in relation to the conduct of the audit of the audited body.”

Corporations Act 2001, s 324CD(1)

Section 324CD(2) adds that relationships, past, present or likely, are to be weighed, and its table names whose: for a company or a disclosing entity, the body itself and its current or former directors and managers; for a registered scheme, the responsible entity and the people around it; for a registrable superannuation entity, its RSE licensee and the people and connected entities around them.

If a conflict remains 7 days after the auditor becomes aware of it and ASIC has not been told in writing, the auditor contravenes s 324CA(1A).

The specific requirements: listed relationships

Sections 324CE, 324CF and 324CG apply the same idea to an individual auditor, an audit firm and an audit company, triggered when an item in the table of relevant relationships in s 324CH(1) applies. The items include, among others, a person who is an officer of the audited body, an audit-critical employee of it, or a partner of either; several do not apply to a small proprietary company covered by s 324CH(3A). The full table is in the Act, volume 2.

Three more sections cover people moving from the audit side to the client side, each excluding a small proprietary company covered by s 324CH(3A):

• s 324CI: a former audit firm member or audit company director who was on the audit team becomes, or stays, an officer of the audited body within 2 years of the latest audit report.
• s 324CJ: the same 2 years, for a former professional employee of an audit company who was its lead or review auditor.
• s 324CK: a former member or director becomes an officer within 5 years of leaving, while another who was there when the firm or company audited that body is also an officer.

Rotation: five years on, at least two off

Division 5 reaches “a listed company, listed registered scheme or registrable superannuation entity”: all three, though ASIC’s overview, among the areas an auditor must be aware of, mentions rotation for listed companies only.

An illustration of s 324DA(1), written for this guide

1. Year 1
2. Year 2
3. Year 3
4. Year 4
5. Year 5
6. Year 6 out
7. Year 7 out

Under s 324DA(1), an individual who plays a significant role in the audit for 5 successive financial years is not eligible for a later year until they have sat out at least 2 successive financial years. Under s 324DA(2), they are not eligible for a year if it would mean playing that role for “more than 5 out of 7 successive financial years”. Years played under a directors’ extension (s 324DAA) or an ASIC declaration under s 342A(1)(a) are left out of that count (s 324DA(3)).

When the directors extend it

Before the 5 years end, the directors may approve, by resolution, “not more than 2 successive financial years” more (s 324DAA). Where there is an audit committee, the approval must follow its written recommendation stating that the committee is satisfied the approval “is consistent with maintaining the quality of the audit” and “would not give rise to a conflict of interest situation” (s 324DAB(1), (2)). A listed company or listed registered scheme without an audit committee can still approve, if the directors themselves are satisfied of those two things (s 324DAB(3)). Either way the resolution gives reasons, the auditor agrees in writing, and within 14 days the directors lodge a copy of the resolution with ASIC, give one to APRA for a registrable superannuation entity, and give one to the auditor or the auditor’s firm or company (ss 324DAB(4), 324DAC). An approval that misses a step is ineffective (s 324DAD).

When ASIC changes the count

On application, ASIC may declare that the 5 years read as 6 or 7, or that “5 out of 7” reads as “6 out of 7”, if satisfied that otherwise the rules would impose an “unreasonable burden”, having regard to things such as the specialist knowledge the audit needs and the availability of other registered company auditors (s 342A). It consults APRA first for a registrable superannuation entity. An individual who plays the role while not eligible contravenes s 324DB, and a member of the audit firm, or the audit company and its directors, aware of it must as soon as possible take the steps to have the firm or company resign or the individual stop acting as lead or review auditor (ss 324DC, 324DD).

The declaration to the directors

When a yearly or half-yearly financial report is audited or reviewed, or a sustainability report audited, s 307C requires the individual auditor, or the lead auditor of a firm or company, to give the directors a written declaration that, to the best of their knowledge and belief, there have been no contraventions of “the auditor independence requirements of this Act” or of any applicable code of professional conduct, or setting out the only ones. It comes with the auditor’s report, or earlier on the conditions in s 307C(5A).

A registered charity’s auditor or reviewer gives a declaration under the ACNC Act about the code of professional conduct, set out in the guide to charities, review or audit; who may sign a company’s audit at all is in the guide to registered company auditors.