The new rules for SMSF auditor independence are clear about the choice facing SMSF firms undertaking both the audit and accounting functions in-house: they can either continue doing the audit or the accounting work, but not both.
Choosing the audit work means SMSF firms enter a new paradigm that creates limitations for routine or mechanical accountants.
What is a Routine or Mechanical Service?
The restructured APES 110 Code of Ethics makes it clear that an SMSF 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. Safeguards must also be put in place to address threats (APES 110, paragraph 601.5).
While a routine or mechanical service requires little or no professional judgement (paragraph 601.4 of the restructured code), the concept continues to be a very grey area in the SMSF industry.
Some believe that where client assets are on data feeds through SMSF-specific software may constitute a routine and mechanical service under the new independence requirements.
But we need to be clear on one fact: the only criteria for a routine and mechanical service is having the client responsible for making decisions in the preparation of accounting records and financial statements.
Data feeds, technology, asset allocation or specific SMSF software has nothing to do with an accounting service being routine and mechanical.
Where the data feed is in place for the full year, the software will still require intervention to match transactions, establish the processing rules and make behind the scenes adjustments.
Even the simplest of funds will need the involvement of an accountant because asset allocation has no impact on whether the preparation of accounts can be routine or mechanical. After all, it is client-specific.
Choosing Audit over Accounting
An SMSF firm may decide to choose the audit and offer a routine or mechanical accounting service. If we use the example of a newly established fund with some rollovers and in-specie contributions of shares, all is not as simple as it seems.
Will the trustee provide instructions to process the rollover and allocate it correctly to ensure it’s not double counted as a contribution?
How will the in-specie contributions be classified? What happens when the SMSF trustee incorrectly fills out the off-market share transfer form?
The routine or mechanical accountant cannot provide advice or assistance in these and any other situations. Additionally, they won’t be able to set the fund up in the software without instructions from the trustee.
What will happen when the trustee submits a ledger with errors? The accountant can’t make corrections to it because that breaches the routine and mechanical service ethic.
Limitations of Routine or Mechanical Accountants
The routine or mechanical accountant is limited because they never help their SMSF clients regardless of whether members divorce; die; start a pension; are below their contribution limits or need help with estate or succession planning.
The question is, why would a client stay with an accounting firm offering a routine or mechanical service when their accountant cannot resolve their SMSF issues?
The in-house auditor won’t be able to help either because then they will be auditing their own work and create an independence threat.
Interestingly, making this decision goes against the grain of the very reason why most accountants are in practice: because they love helping their clients.
Firms need to choose which service is most important to them and realise that they are putting their business and clients at risk where they continue to provide both services.
Another interesting point to note under the updated guidelines: a firm (or network firm) must not assume the management responsibility for an audit client. The firm must be satisfied that the trustee is making all judgements and decisions themselves. (para 600.7)
Regardless of whether the preparation of the financial statements is routine or mechanical, if the firm is making decisions on behalf of the fund, they can not accept the audit.
To avoid assuming a management responsibility, the trustee will need to demonstrate that they make all decisions concerning the fund that are the proper responsibility of management (para 600.8)
The ATO will expect to see evidence on the auditor’s file that the SMSF trustees took responsibility for the financial statements and had sufficient knowledge, skills and experience to do so.
Signed copies of financial statements and trustee rep letters and won’t meet this requirement. Nor would passing an online SMSF trustee course, as both are considered insufficient audit evidence to demonstrate that the trustees understand the operations of the firm and how the SMSF software works.
The ATO has also said it will contact trustees directly in some cases to test their knowledge on the preparation of the financial statements.
Where the firm is unable to demonstrate the trustee’s ability to take responsibility, the SMSF audit would not be able to be done in-house where preparation of the financial statements also took place.
To use the argument that SMSF trustees must be financially literate and have responsibility for the financial statements because that’s the role of a trustee doesn’t take into account case law.
By way of example, the trustees in the Cam & Bear vs McGoldrick case were not financially sophisticated. They further acknowledged they would have continued to invest monies in high-risk assets administered by their financial adviser/accountant irrespective of a modified audit report.
Here’s a clear example of an SMSF trustee putting their hand up and saying they weren’t financially literate. Still, they were not required to take any ownership of the losses incurred by the fund as a result of their own investment decisions.
Embedded in case law, this should ring alarm bells for SMSF firms in the light of the new independence guidelines.
SMSF Administration Firms
Remember, too, that independence is compromised where an SMSF administration firm prepares the financial statements and performs the audit but “white labels” the financial statements, so they are lodged under a different firm’s tax agent number.
While there are SMSF administration firms who are genuinely independent, ‘routine and mechanical’ does not refer to who lodges the SMSF annual return; it relates to who does the work.
In this context, where SMSF administration firms perform both functions, regardless of who lodges the tax return, independence has been compromised.
The ATO has previously said this practice is not acceptable, and more information will be forthcoming from them in the future.
Integrity, innovation and independence are of the utmost importance when we consider the superannuation industry.
These discussions must take place because a balanced conversation is the best way forward and provides the optimum outcome for all participants.
SMSF firms have a difficult decision to make but need to start thinking about how they will transition across to a new business model.
One thing is certain: there are limitations involved in choosing to be a routine or mechanical accountant.
ASF Audits is the home of one-click SMSF auditing. Contact us on 1800 327 872 to find out more.
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