6 warning signs the ATO uses when monitoring SMSF auditors

There are red flags that could point to problems with auditor independence

The growth in self-managed superannuation funds (SMSFs) shows no signs of slowing, and as the number of funds approaches 600,000, regulators have had to prioritise and set criteria to monitor the sector.

In 2016-17, the Australian Taxation Office (ATO) conducted more than 160 reviews and sought information from another 50 auditors when it specifically had concerns about the auditor’s independence.

The ATO referred 22 auditors to the Australian Securities and Investments Commission (ASIC), which manages SMSF auditor registration and can disqualify or suspend an auditor’s registration.

Craig Blair, ATO director of superannuation, who is responsible for SMSF auditors, says that in 2017-18 this work will continue but the ATO will also be contacting auditors identified through risk profiling. They will be subject to targeted reviews.

Related video: ATO's red flags for targeting SMSF auditors

The ATO has identified three red flags that could point to problems with auditor independence, as well as three red flags it uses to identify auditors at risk of poor audit quality.

Blair is keen to share insights with the profession so auditors can pre-empt the ATO’s concerns by modifying their practice to avoid attracting the regulator’s notice or be prepared to support their business model. The message is simple: check if your practice could raise red flags and, if so, proactively address any underlying independence or audit quality concerns.

Red flags indicating lack of independence

1. Auditor and tax agent are the same practitioner or firm

The ATO focused on this in 2016-17, particularly for sole practitioners where the principal or staff were providing accounting and tax services for a fund that they were also auditing.

It also saw instances where staff involved in accounting and audit services were reporting to one principal and the ATO did not accept the argument that there was segregation of duties.

CPA Australia’s policy adviser on audit and assurance, Claire Grayston, points out that regardless of whether a firm has separate staff providing accounting and audit services to SMSFs, “If they are overseen by the same principal there is a self-review threat to independence, which cannot be mitigated unless, at a minimum, a different principal takes on one of those services.”

2. Auditors audit their own fund

Instances of this breach have dropped from about 100 in 2014 to about 20 a year now, although Blair says it is concerning that it’s happening at all.

“The self-interest threat to independence is unavoidable in the circumstances of the auditor auditing their own fund,” says Grayston.

3. The auditor and tax agent/accountant are related

The ATO is also noting cases involving referrals from the auditors’ relatives, where the relative is doing the accounting work and the auditor audits the fund. Receiving such referrals from a relative creates a familiarity threat to independence and may also create a self-interest threat, if all the relative’s audits are referred to the same auditor.

Red flags indicating poor audit quality

1. Low-cost audits

Blair says low-cost audits were a focus in 2016-17 due to industry feedback that low fees might equal low quality.

The ATO found “some level of deficiency” in the majority of cases it investigated. This work continues and cases have been referred to ASIC.

Problems included gaps in audit evidence needed to support the opinion, or contraventions that had been identified but not reported.

“We saw instances where there was no written audit plan, limited-to-no use of checklists, and perhaps a lack of key documentation like trustee representation letters,” says Blair.

Sometimes there was a failure to retain relevant information. Blair says the ATO investigator or another auditor should be able to pick up the file and see how the work was undertaken, including documentation to support significant judgements.

A key issue was failure to verify ownership of assets and limited recourse borrowing arrangements, where a trustee takes out a loan from a third party lender to purchase an asset. The asset must be held in a separate trust, and if the loan defaults, the lender only has recourse to the asset in the trust, not the other assets in the fund.

“Low cost does not necessarily result in low quality,” Grayston says. “Auditors may be able to offer a low cost audit through clever use of technology, off-shoring or efficient systems.”

A firm might be outsourcing but have strong controls in place, or it might have captured efficiency gains that allow it to lower costs. A fund may have very simple affairs, and auditors that seem to have low costs may use a sliding scale of fees that mean charges rise with the complexity of the work.

“The critical thing,” Grayston says, “is that SMSF auditors are prepared to justify to the ATO how their business model supports quality audits.”

2. High volume of audits

An auditor is not necessarily risky simply because they conduct a large number of audits, but the ATO wants to know that the firm has the resources necessary to conduct and review that volume of work because if there are issues with quality, this will impact a large number of SMSFs.

Blair says the ATO plans to engage with high-volume auditors in 2017-18 to gain some assurance around their processes and the quality of their work.

3. No auditor contravention reports submitted

The ATO receives 8000-9000 auditor contravention reports (ACRs) a year. It expects auditors to come across at least some contraventions every year although most will not require ATO action.

Grayston warns that if an auditor never submits an ACR, it rings alarm bells with the ATO as it throws into question the auditor’s level of competence in understanding the compliance requirements, or suggests they have not gathered adequate evidence of compliance.

“These red flags do not automatically mean that the auditor lacks independence or is delivering poor quality audits,” she says, “but we suggest all SMSF auditors consider whether they may fall into these categories and make sure it does not reflect an underlying problem with those audits, in advance of being targeted for an ATO review.”

CPA Australia Podcast: SMSF auditor compliance program findings for 2016-17. Listen now.

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