Everyday ethics: Cross-selling services to audit clients

As told to Susan Muldowney

Question: “My firm is considering a new compensation framework for audit partners, which would include a base salary plus a profit-sharing element – linked to the level of fees above target or budget and the level cross-selling of other services that partners achieve.

We see this as providing further motivation for partners to go above and beyond in their work. Does this present any ethical red flags or potential conflicts of interest that we could manage?”

Answer: Accountants must be independent of mind and in appearance. The situation you’ve outlined creates a serious ethical conflict. It would most likely compromise the independence of your audit partners, as well as their independence in appearance to another. 

APES 110 Code of Ethics for Professional Accountants outlines the fundamental principles of ethics for professional accountants and establishes the standard of behaviour that is expected. 

It provides a conceptual framework that helps accountants to identify, evaluate and address any threats to independence for audit and review engagements, as well as for other assurance engagements. These threats fall into a number of categories, including self-interest threats. 

In the situation you’ve outlined, your audit partners would have a self-interest threat of gaining more compensation by providing other services or promoting other services, and this is in fact prohibited for all audit clients. 

Cross-selling services to audit clients steps over an ethical line, because you've been charged with auditing their business, and one of the cornerstones of audits is that you have an independent auditor. 

If remuneration is linked to other services that the client is buying from your auditors, this creates a significant conflict of interest. For example, what if the client doesn’t like the findings of your audit and threatens to stop buying the other services from the practice? 

This puts your auditors in a precarious position – if they hold the line on their audit findings, not only will your firm lose revenue from the other services, but their personal remuneration is affected.

Ethics requirements expressly prohibit that auditor remuneration be based on the success in selling non-assurance services to any audit clients. 

On top of that, you are also required to take reasonable steps to ensure that in any profit-sharing agreement, there is no cross-subsidising of audit by other services. 

For example, you don't want the audit to be a loss leader, and so the client signs up for the audit because it's so cheap, but you're making money on other engagements that provide sufficient profitability to cover the losses on the audit. 

You shouldn't be taking on an audit where you're going to be losing money, because that just creates pressure to provide a lower level of service than is required in order to at least break even, if not make a profit. 

The compensation framework for audit partners that you’ve outlined is in breach of ethics requirements, so disregard the profit-sharing element linked to the level cross-selling of other services. 

For any profit-sharing arrangement, you need to ensure that 1) the scheme is not a cross-subsidisation of the assurance services by other services provided to clients and 2) that it does not provide indirect incentives based on the ability to sell non-assurance services to assurance clients.

If you want to add incentives, you might link them to bringing in new audit clients, but they must not create any conflicts of interest or threats to independence.