FUNDAMENTAL PRINCIPLES AND GUIDANCE
ISA 200 sets out the general principles of an audit. The auditor should comply with the code of ethics for professional accountants issued by the International Federation of Accountants.
Accountants require ethics because people rely on them for their expertise in specific areas. Both the International Federation of Accountants (IFAC) and the Institute of Certified Public Accountants of Rwanda (ICPAR) have issued a code of ethics of which the fundamental principles of both associations are very similar.
The ICPAR ethical framework states principles and encourages the auditor to make their own judgements. On the other hand the ethics as laid down by the IFAC provides more guidance by way of examples of potential issues and safeguards to mitigate against those threats.
The ICPAR code of ethics lays out the fundamental principles as follows:
- Integrity. A member should be straightforward and honest in all professional and business relationships.
- Objectivity. A member should not allow bias, conflict of interest or undue influence of others to override professional or business judgements.
- Professional competence and due care. A member has a continuing duty to maintain professional knowledge and skill at the level required to ensure that a client or employer receives competent professional service.
- Confidentiality. A member should respect the confidentiality of information acquired as a result of professional and business relationships and should not disclose any such information to third parties without proper and specific authority unless there is a legal or professional right or duty to disclose. Any information acquired should not be used for the personal advantage of the member or third parties.
- Professional behaviour. A member should comply with relevant laws and regulations and should avoid any action that discredits the profession.
The circumstances in which members operate may give rise to specific threats to compliance with the fundamental principles. However, it is impossible to define every situation that creates such threats and to specify the appropriate mitigating action. In addition, the nature of engagements and work assignments may differ.
The ICPAR conceptual framework requires each member to identify, evaluate and address threats to compliance, rather than merely complying with a set of specific rules such as those laid down by the IFAC.
If the threats are significant, then you need to identify and apply safeguards to eliminate the risk or to reduce it to an acceptable manner. If no appropriate safeguards are available, then you need to eliminate the activities causing the threat or decline the engagement or discontinue it as the case may be.
Advantages of a framework over a system of rules
- A framework forces you to consider the threats for every given situation and to act accordingly.
- A framework prevents you from interpreting technical issues.
- Rules don’t always cover all situations.
- Rules need to be constantly amended to live in a rapidly changing environment.
INDEPENDENCE
An auditor needs to be and seen to be independent. He must have independence of mind and independence in appearance.
Independence is a state of mind that permits the provision of an opinion without being affected by influences that compromise professional judgement, allows an individual to act with integrity and exercise objectivity and professional judgement.
An auditor needs to avoid facts and circumstances that are so significant that a reasonable and informed third party would reasonably conclude an auditor’s integrity, objectivity or professional scepticism had been compromised.
Public confidence in the operation of capital markets and in the conduct of public interest entities depends upon the credibility of the opinions and reports issued by auditors.
What are the threats to independence?
ES 1 Integrity, objectivity and independence sets out the principal types of threats.
- Self interest:
A financial interest in a client, undue dependence on fees, close business relationship, concern over losing a client, potential employment with client or loans from client.
- Self review:
Reporting on the operation of financial systems after you were involved in their design and preparing the accounts now under audit.
- Management threat:
Making judgements and taking decisions which are the responsibility of management.
- Advocacy:
Acting as a legal advocate for client in litigation or promoting shares in the company.
- Familiarity:
Having close personal relationships developed with client personnel through long association or a family relationship. Auditor may not be sufficiently questioning the client’s point of view. Acceptance of gifts of significant value.
- Intimidation:
Threat of replacement due to disagreement.
Review the Institute of Certified Public Accountants of Rwanda code of ethics together with the IFAC code of ethics with regard to areas such as financial interests, loans and guarantees, close business relationships, family and personal relationships, employments connections with the client, long association with client personnel, provision of non-assurance services, fees, gifts and hospitality and actual or threatened litigation.
Safeguards to independence
Safeguards that may eliminate or reduce threats to an acceptable level fall into two general categories:
• Safeguards created by the profession, legislation or regulation and
- Safeguards in the work environment whether within the auditor’s own systems and procedures or within the client company.
The first category includes:
- Educational, training and experience requirements for entry into the profession.
- Continuing professional development requirements.
- Corporate governance regulations.
- Professional standards.
- Professional or regulatory monitoring and disciplinary procedures.
- External review by a legally empowered third party of the reports, returns, communications or information produced by a member.
The second category includes:
Firm wide safeguards
- Such as firms stressing the importance of compliance with the fundamental principles.
- The expectation that members will act in the public interest.
- Documented policies and procedures to implement and monitor quality control of engagements.
- Documented policies regarding identification of threats, their evaluation and application of safeguards.
- Documented independence policies.
- Policies and procedures to enable identification of interests and relationships between auditor and client.
- Monitoring the fee income received.
- Timely communication of a firm’s policies and procedures to all staff and appropriate training thereof.
- Implementing a quality control system and appointing a member of senior management.
- Advising all staff of the clients from whom they must be independent.
- A suitable disciplinary mechanism to promote compliance with policies.
Engagement specific safeguards
- Involving an additional professional accountant to review the work done.
- Consulting independent third parties.
- Disclosing the nature of services provided and extent of fees charged to those charged with client governance.
- Rotating senior audit team personnel.
Safeguards within client systems and procedures
- Persons other than management ratify auditor appointment.
- Client has competent employees with experience to make decisions.
- The client has a corporate governance structure that provides appropriate oversight and communications regarding the firm’s service.
Specific safeguards in relation to independence are mentioned in the ICPAR and IFAC guidance and cover such areas are financial interest, loans, close business relationships, fees and litigation.
International standard on quality control sets out the standards and provides guidance regarding a firm’s responsibilities for its system of quality control for audits.
- The firm should establish a system of quality control designed to provide it with reasonable assurance that the firm and its personnel comply with professional standards and regulatory and legal requirements.
- The firm’s system of quality control should include policies and procedures addressing elements such as leadership responsibilities, ethical requirements, acceptance of engagements, human resources, engagement performance and monitoring.
The quality control policies and procedures should be documented and communicated to the firm’s personnel.
CONFIDENTIALITY
There is a duty of confidence to the client but there are several exceptions noted.
The principle is twofold. One, you should refrain from disclosing any information acquired without proper authority to do so unless there exists a legal or professional right or duty to disclose.
Secondly, you should refrain from using any information acquired for your own personal advantage or that of a third party.
A member should maintain confidentiality even in a social environment and even needs to comply with the principle even after the end of the professional relationship. The member can only use prior experience.
Exceptions when member may be required to disclose:
- Disclosure permitted by law and authorised by client.
- Disclosure by law e.g. production of documents during course of legal proceedings or disclosure to appropriate public authorities of infringements of law that have come to light.
Money Laundering
Theft and Fraud Offences Duty to report where books of account are not been kept.
- Professional duty or right to disclose when not prohibited by law, such as to comply with quality assurance reviews, to respond to an inquiry by an institute, to protect the professional interests of a member in legal proceedings or to comply with technical standards and ethical requirements.
Having decided that there should be some disclosure, the auditor must consider-
- Whether the interests of any parties could be harmed by such disclosure and whether the auditor will incur legal liability as a result of the disclosure.
- Whether all relevant facts are known and substantiated.
- The type of communication that is expected and to whom it should be addressed.
Under ISA 250 consideration of laws and regulations in an audit of financial statements, if auditors become aware of a suspected or actual occurrence of non-compliance with law and regulation which give rise to a statutory right or duty to report, they should report it to the proper authority immediately.
In all cases of disclosure where there is a duty of confidentiality, you should seek legal advice.
AREAS OF CONTROVERSY
Independence
• Multiple services
Many audit firms are moving away from their traditional roles and are offering a wider variety of work to their clients. Audit is sometimes even seen as a loss leader in gaining other lucrative work.
Having more legislation in this area, could restrict clients in whom they could choose to give them business and any synergies found in the auditor also providing additional services would be lost.
Note, in the USA, SEC guidance suggests that an auditor is not independent in relation to a listed company if they provide certain non-audit services, such as bookkeeping, internal audit, management or human resources functions.
• Specialist services
Services such as valuation of intangible assets, property or unquoted investments where carried by a firm who are also a company’s auditors can lead to a self review threat. A firm should not therefore audit a client’s accounts which include specialist work carried out by themselves.
• Second opinions
Second opinions are acceptable but not if the current auditors are pressurised to accept the second opinion. In order to avoid this, there should be constant communication between the two auditors.
The second firm has a duty to seek permission from the client to approach the current auditors. Without such communication, the second opinion may be formed negligently, as the second opinion may not be based on the same set of facts or is based on inadequate evidence.
Confidentiality
• Conflicts of interest
Conflicts of interest can arise when a firm has two or more audit clients, and the clients are in direct competition with each other e.g. major banks.
An audit firm can argue that different audit teams are involved and this can maintain independence and confidentiality. However, clients may not perceive it this way and could well move the audit to another firm.
Takeovers also need special consideration. You could be the auditor to both companies in a takeover. In these cases, the auditor should not be the principal advisors to either and should not issue any assessment reports on either party other than the actual audit reports.
• Insider dealing
Auditors can be seen as insiders as they often have access to very sensitive information. Auditors should see the duty not to deal as an insider as an extension of their duty of confidentiality to their clients. Again, it is not just in relation to third parties but also to their own personal gain.
Question 2.1
You are a partner in an audit firm. A number of issues have emerged in relation to some of your clients. You are asked to document your considerations on each of the issues, noting the threat arising, the significance of that threat and any factors you have taken into account, and, if relevant, any safeguards you could apply to eliminate or mitigate against that threat.
- JNS Ltd
- John is the most junior member of your audit team of eight. He has just invested in a personal pension plan that invests in all listed companies.
- White LTD
- You are the partner leading up a high powered team carrying out due diligence work on Black LTD, a company, your client, White LTD, is considering taking over. Paul, your deputy has mentioned that he met the daughter of the MD of Black LTD during the initial phases of the work and is going to ask her out.
- Take it Easy LTD
- You have been associated with this audit for ten years, four as audit engagement partner. You are just back from a six week cruise with the MD on his yacht.
Question 2.2
Here is an example of a press report which appeared in recent years which dealt with issues of objectivity and independence within a firm of multinational firm of accountants.
“..a partner in the firm was told by the regulatory body that he must resign because he was in breach of the body’s independence rules, as his brother in law was the financial controller of an audit client. He was told that the alternative was that he could move his home and place of work at least 400 miles from the offices of the client, even though he was not the reporting partner. This made his job untenable. The regulatory body was seen as taking its rules to absurd lengths by the accounting firm. Shortly after this comment, the multinational firm announced proposals to split the firm into three areas between audit, tax and business advisory services; management consultancy; and investment advisory.”
Discuss the above events and the impact they may have on the public perception of integrity, objectivity and independence.
Question 2.5
Where auditors are perceived not to be independent is a real cause for concern. Where auditors provide non audit services to their clients, their objectivity may well be impaired by undue dependence on those clients. In addition, further concerns may arise in the situation where audit clients hire staff who were previously employed by their auditors. In this case the objectivity of future audits may be at risk.
- Describe the problems that may arise if an audit client hires, as finance director, a former audit partner.
- Are there any advantages to a client of their auditor becoming an executive in their company?
- How does current ethical guidance attempt to deal with these potential problems surrounding an auditor becoming an executive and what additional safeguards if any may help the situation?
