Ethics and acceptance

The need for professional ethics

 

Professional accountants have a responsibility to act in the public interest. The purpose of assurance engagements is to increase the confidence of the intended users, therefore the users need to trust the professional who is providing the assurance.

 

In order to be trusted the assurance provider needs to be independent of their client.

 

Independence can be defined as having ‘freedom from situations and relationships where objectivity would be perceived to be impaired by a reasonable and informed third party.’

 

Practitioners need to behave and be seen to behave in an ethical, professional manner. This means taking active steps to comply with the Code of Ethics in every professional situation.

 

2      The IFAC and ACCA codes and the conceptual framework

 

IFAC, through the IESBA, has issued a code of ethics, as has the ACCA. The ACCA Code of Ethics is covered in this . However, both of these Codes have the same roots and are, to all intents and purposes identical.

 

Both follow a conceptual framework which identifies:

 

  • Fundamental principles of ethical behaviour

 

  • Potential threats to compliance with these fundamental principles

 

  • Possible safeguards which can be implemented to eliminate the threats identified, or reduce them to an acceptable level.

 

Ethical guidance can either use a principles-based approach or rules-based approach.

 

A conceptual framework relies on a principles-based approach.

 

Both IFAC and the ACCA adopt a principles-based approach.



 

Principles-based approach Rules-based approach
• Flexible, so can be applied to • May be easier to follow because
new, unusual or rapidly changing it is clearly defined.
situations. • Needs frequent updating to
•
Principles may be applied across ensure the guidance applies to
national boundaries where laws new situations.
may not. • May encourage accountants to
• Requires the accountant to use interpret requirements narrowly in
professional judgment. order to get round the spirit of the
• Requires compliance with the requirements.
•
spirit of the guidance. Virtually impossible to be able to
• Can still incorporate specific rules deal with every situation that may
arise, particularly across various
for ethical situations likely to
national boundaries and in a
affect many firms.
dynamic industry.

 

Consequences

 

Practitioners should apply the spirit of the code to everyday practice. Professional bodies such as the ACCA have the right to discipline members who fail to comply with the code of ethics through a process of disciplinary hearings which can result in:

 

  • Fines

 

  • Suspension of membership

 

  • Withdrawal of membership.

 

3      The fundamental principles

The formal definitions of the fundamental principles are as follows:

 

  • Objectivity: Members should not allow bias, conflicts of interest or undue influence of others to override professional or business judgments.

 

  • Professional behaviour: Members should comply with relevant laws and regulations and should avoid any action that discredits the profession.

 

  • Professional competence and due care: Members should maintain professional knowledge and skill at a level required to ensure that a client or employer receives competent professional services based on current developments in practice, legislation and techniques.

 

Members should act diligently and in accordance with applicable technical and professional standards.

 

  • Integrity: Members should be straightforward and honest in all professional and business relationships.

 

  • Confidentiality: Members 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 or unless there is a legal or professional right or duty to disclose. Confidential information acquired as a result of professional and business relationships should not be used for the personal advantage of members or third parties.

 

Illustration 1 – Fundamentals principles

 

The following are real précis hearings held and decisions made and published by the ACCA Disciplinary Committee:

 

  • A member was found guilty of misconduct because they signed the auditor’s report without conducting any audit work, contrary to the fundamental principle of integrity.

 

  • A member was found guilty of misconduct because they failed to advise a client to have an audit when an audit was required by law, contrary to the fundamental principle of professional competence and due care.

 

  • A member was found guilty of misconduct because they ‘failed to reply to correspondence sent by a third party and ACCA’ contrary to the fundamental principle of professional behaviour.

 

  • A member was found guilty of misconduct because they ‘lost possession of a client’s books and records to a third party’ contrary to the fundamental principle of confidentiality.

 

  • A member was found guilty of misconduct because they ‘carried out an audit of a company’ in which they owned shares ‘without implementing appropriate safeguards’ contrary to the fundamental principle of objectivity.

 

As a result, a combination of the following sanctions were ordered by the

ACCA Disciplinary Committee in each case:

 

  • Suspension of membership

 

  • Exclusion from ACCA

 

  • A fine

 

  • Ordered to pay costs

 

  • Publication of the results of the decision and the member’s name on the ACCA website

 

  • Publication of the results of the decision and the member’s name in the local press.

 

  • Threats and safeguards

 

Firms must establish procedures to:

A safeguard is an action or measure that eliminates a threat, or reduces it to an acceptable level.

 

The ACCA Code of Ethics divides safeguards into two broad categories:

 

  • Safeguards created by the profession, legislation or regulation, these include: requirements for entry into the profession, continuing professional development, corporate governance, professional standards, monitoring and disciplinary procedures, etc.

 

  • Safeguards created by the work environment, these include: rotation/removal of relevant staff from the engagement team, independent quality control reviews, using separate teams, etc.

 

Identifying threats

Self-interest threats

 

Where the auditor has a financial or other interest that will inappropriately influence their judgment or behaviour.

 

Threat Safeguards
Fee dependency Non-listed clients
Over-dependence on an audit client If fees from an audit client represent a
could lead the auditor to ignore large proportion of the firm’s total fees,
adjustments required in the financial the firm should implement safeguards
statements for fear of losing the client. such as:
• Reducing dependency on the
client
• Consulting with a third party on
key audit judgments
• Having an external quality control
review.
[Section 290.215]
Listed clients
A firm’s independence is threatened,
and should be reviewed if total fees
from a listed audit client exceed 15%
of the firm’s total fees for two
consecutive years.
• The firm should disclose the
issue to those charged with
governance at the client.
• An independent engagement
quality control review should be
performed by a person not a
member of the audit firm
expressing the opinion or by the
professional regulatory body.
[Section 290.217]

 

 
Gifts and hospitality Gifts may be accepted if:
Acceptance of goods, services or • Trivial and inconsequential.
hospitality from an audit client can • Offered in the normal course of
create self-interest and familiarity
business without intention to
threats as the auditor may feel
influence decision-making.
indebted to the client.
• Approved by a partner.
[Section 290.225]
The offer of gifts and hospitality must
be documented in the audit file even if
refused.
Owning shares/financial interests Any member of the audit team or their
The auditor will want to maximise immediate family must not have a
financial interest in the audit client
return from the investment and
therefore they must dispose of the
overlook audit adjustments which
shares immediately or be removed
would affect the value of their
from the team.
investment.
[Section 290.104]
Any member of the audit team who
has a close family member who owns
shares should be removed from the
audit team or the family member
should dispose of their shares.
[Section 290.105]
A partner of the firm in the office
connected with the audit engagement,
or any partner providing non-audit
services to the audit client should not
have a financial interest in the client.
[Section 290.110]

 

 

Loans and guarantees Loans and guarantees between audit
A loan or guarantee from (or deposit clients and audit team members and
their immediate family that are not in
with) an assurance client will not
the normal course of business or not
create a threat to independence
on commercial terms are not
provided that:
permitted.
• it is on commercial terms, and
[Section 290.117]
• made in the normal course of If the loan is made to the firm (rather
business. than a member of the audit team), it
must be immaterial to both the firm
and the client. If it is material, a self-
interest threat may arise and
appropriate safeguards should be put
into place, e.g. an external review of
the work performed.
[Section 290.118]
Business relationships In the case of audit firms, or partners
If audit firms (or members) enter into of those firms, unless immaterial, no
safeguard can reduce this threat to an
business relationships with clients
acceptable level.
(e.g. joint ventures, marketing
arrangements), this leads to self- In the case of audit team members,
interest because the auditor would the individual with the connection to
have an interest in the successful the audit client should be removed
operation of the client. from the audit team.
The purchase of goods and services [Section 290.123]
from an assurance client would not If the purchase of goods and services
normally give rise to a threat to by an audit team member represents a
independence, provided the material amount, that person should
transaction is in the normal course of be removed from the audit team or
business and on commercial terms. they should reduce the magnitude of
the transactions.
[Section 290.125]
Potential employment with an audit The policies and procedures of the
client firm should require such individuals to
If a member of the engagement team notify the firm of the possibility of
employment with the client.
has reason to believe they may
become an employee of the client they Remove the individual from the
will not wish to do anything to affect assurance engagement.
their potential future employment. Perform an independent review of any
significant judgments made by that
individual.
[Section 290.136]

 

 
Overdue fees Do not perform any further work for, or
The overdue fees may be regarded as issue any reports to, the client until the
outstanding fees are paid or
a loan (loans are not permitted to an
arrangements have been agreed with
audit client).
the client for payment.
An independent review of the work
should be performed.
[Section 290.218]
Contingent fees Fees based on a particular outcome,
The auditor would have incentive to e.g. level of profits of the company, are
not permitted for assurance services.
ensure a particular outcome is
[Section 290.220]
achieved in order to maximise the
audit fee. E.g. overlook audit
adjustments that would reduce profit if
the fee is a percentage of the profit.
Compensation and evaluation A key audit partner shall not be
policies evaluated on or compensated based
A self-interest threat is created when a on that partner’s success in selling
non-assurance services to the
member of the audit team is evaluated
partner’s audit client.
on or compensated for selling non-
[Section 290.224]
assurance services to that audit client.
For other staff the firm shall either
The significance of the threat will
revise the compensation plan or
depend on:
evaluation process for that individual
• The proportion of the individual’s
or apply safeguards such as:
compensation or performance • Removing such members from
evaluation that is based on the
the audit team.
sale of such services.
• Having a professional accountant
• The role of the individual on the
review the work of the member of
audit team.
the audit team.
• Whether promotion decisions are
[Section 290.223]
influenced by the sale of such
services.
[Section 290.223]

 

 

Actual or threatened litigation It may be possible to continue other
Litigation could represent a breakdown assurance engagements, depending
of trust in the relationship between on the significance of the threat by:
auditor and client. This may affect the • Discussing the matter with the
impartiality of the auditor, and lead to a client’s audit committee.
reluctance of management to disclose • If the litigation involves an
relevant information to the auditor.
individual, removing that
The significance of the threat depends
individual from the engagement
on the materiality of the litigation and team.
whether the litigation relates to a prior • Obtaining an external review of
assurance engagement.
the work done.
If adequate safeguards cannot be
implemented the firm must withdraw
from or decline the engagement.
[Section 290.226]

 

Familiarity threats

 

When the auditor becomes too sympathetic or too trusting of a client and loses professional scepticism, or where the relationship between the auditor and client goes beyond professional boundaries.

 

Threat Safeguards
Long association of senior Non-listed clients
personnel • Rotate senior personnel.
Using the same senior personnel in an
• Independent partner/quality
engagement team over a long period
control reviews.
may cause the auditor to become too
trusting/less sceptical of the client [Section 290.148]
resulting in material misstatements Listed clients
going undetected.
• Key audit partners must be
The firm should consider:
rotated after no more than seven
•
The length of time on the audit years with a minimum break of
team. two years. If the client becomes
• The structure of the firm. listed, the length of time the
partner has served before
•
Whether the client’s management becoming listed is taken into
team has changed. account.
• Whether the complexity of the [Section 290.149]
subject matter has changed.
[Section 290.148]

 

 
• In exceptional circumstances, a
maximum one year extension is
permitted where necessary to
maintain audit quality.
[Section 290.150]
Tutorial note: Large listed companies
must put the audit out to tender at
least every ten years. However, this is
the responsibility of the company not
the audit firm.
Family and other personal Remove the individual from the
relationships engagement team.
A familiarity threat (and self-interest Structure the engagement team so
threat or intimidation threat) may occur that the individual does not deal with
when a member of the engagement matters that are the responsibility of
team has a family or personal the close family member.
relationship with someone at the client [Section 290.128]
who is able to exert significant
influence over the financial statements
(or subject matter of another
assurance engagement).
Consideration should be given to the
possibility that such a threat may also
arise when a partner (or employee) of
the firm has a family or personal
relationship with someone at the client
who is able to exert significant
influence over the subject matter, even
when the individual is not a member of
the engagement team.
[Section 290.130]
Recruitment services Listed clients
Familiarity, self-interest and The firm cannot provide recruitment
intimidation threats may occur if the services in respect of directors or
firm is involved in recruiting senior senior management who would be in a
personnel for the client. position to exert significant influence
The firm may also be considered to be over the financial statements.
[Section 290.210]
assuming management
responsibilities.
Reviewing qualifications and
interviewing applicants to advise on
financial competence is allowed.
[Section 290.209]

 

Audit staff leave the firm to join the Assign individuals to the audit team
client who have sufficient experience in
A self-interest, familiarity or relation to the individual who has
joined the client.
intimidation threat may arise where an
employee of the firm becomes a Perform a quality control review of the
director or employee of an assurance engagement.
client (in a position to exert significant [Section 290.134]
influence over the financial statements
For partners joining public interest
or subject matter of another assurance
engagement). The threat is significant entities, independence would be
if significant connection remains deemed to be compromised unless,
between the employee and the firm subsequent to the partner ceasing to
such as entitlement to benefits or be a key audit partner or senior
payments from the firm, or partner, the public interest entity had
participation in the firm’s business and issued audited financial statements
professional activities. covering a period of not less than
[Section 290.133] twelve months and the partner was not
The firm should consider: a member of the audit team with
respect to the audit of those financial
• The position taken at the client. statements.
• The involvement the person is [Section 290.137]
likely to have with the audit team.
• The length of time since the
individual was a member of the
audit team.
[Section 290.134]

 

Self-review threats

 

Where non -audit work is provided to an audit client and is then subject to audit, the auditor will be unlikely to admit to errors in their own work, or may not identify the errors in their own work.

 

Threat Safeguards
Accounting and bookkeeping services Non-listed clients
• A firm can provide a non-listed
audit client with accounting and
bookkeeping services, including
payroll services, of a routine or
mechanical nature.
• Separate teams must be used.

 

 
• Managerial decisions must not be
made by the firm, and the source
data, underlying assumptions,
and subsequent adjustments
must be originated or approved
by the client.
[Section 290.168]
Listed clients
• A firm cannot provide a listed
audit client with accounting and
bookkeeping services.
[Section 290.169]
• A firm can provide accounting
services for divisions or related
entities of a listed client if
separate teams are used and the
service relates to matters
immaterial to the division/related
entity.
[Section 290.170]
Internal audit services A firm cannot provide internal audit
In addition to the self-review threat, the services for a listed audit client, where
auditor needs to be careful not to the service relates to internal controls
over financial reporting, financial
assume management responsibilities.
accounting systems, or in relation to
amounts or disclosures that are
material to the financial statements.
[Section 290.195]
Where services are provided, separate
teams must be used.
[Section 290.194]
Taxation services Non-listed clients
Tax calculations for inclusion in the • Advice should be obtained from
financial statements and tax planning an external tax professional.
advice create a self-review threat. • Where an audit team member
Completion of tax returns is not
performs the tax calculation the
deemed to create a self-review threat. work should be reviewed by a
[Section 290.179] senior person with appropriate
expertise that has not been
involved with the audit.
[Section 290.180]

 

Listed clients
• A firm cannot prepare tax
calculations for a listed audit
client.
[Section 290.181]
Tax advice The firm should not provide tax advice
that depends on a particular
accounting treatment and is material to
the financial statements.
[Section 290.185]
Other tax advice is allowable with
safeguards.
[Section 290.184]
IT services The firm can only provide IT services
IT services may create a self-review which involve:
threat and also be considered to be • Design or implementation of IT
assuming management systems unrelated to internal
responsibilities. controls or financial reporting.
• Implementation of off-the-shelf
accounting software.
• Evaluating and making
recommendations on a system
designed or operated by another
service provider or by the entity.
[Section 290.197]
Valuation services Non-listed clients
• Valuation of matters that are
material to the financial
statements and involve a
significant degree of subjectivity
should not be provided.
• Where the threat is not deemed
significant, different personnel
should be used.
[Section 290.172]
• A professional should review the
valuation work performed.
[Section 290.175]

 

Listed clients
• Valuation services that are
material to the financial
statements (regardless of
subjectivity) should not be
provided to listed audit clients.
[Section 290.176]
Temporary staff assignments Staff may be loaned to the client
A self-review threat will be created if provided:
staff are loaned from the audit firm to • The loan period is short.
the client. • The person does not assume
If the person was assigned to the audit
management responsibilities.
they would be evaluating work for • The client is responsible for
which they had been responsible
directing and supervising the
during the temporary assignment and
person.
may not detect errors in their work.
• The loaned staff member is not a
member of the audit team.
[Section 290.140]
Corporate finance services If there is doubt over the accounting
Self-review and advocacy threats may treatment or if the outcome will
materially affect the financial
be created if a firm:
statements, the service should not be
• Assists an audit client in
provided.
developing corporate strategies [Section 290.213]
• Identifies possible targets for the Where services can be provided, the
audit client to acquire firm should:
• Advises on disposal transactions • Use professionals who are not
• Assists finance raising members of the audit team to
perform the service, or
transactions
• Have a professional who was not
• Provides structuring advice.
involved in providing the
Consideration should be given to:
corporate finance service to the
• The degree of subjectivity client advise the audit team on
the service and review the
involved.
accounting treatment and any
• Whether the outcome will have a
financial statement treatment.
material impact on the financial [Section 290.212]
statements.
• Whether the effectiveness of the
corporate finance advice
depends on a particular
accounting treatment.

 

Client staff joins audit firm

 

  • self-interest, self-review, or familiarity threat may arise where a director or employee of an assurance client (in a position to exert significant influence over the financial statements or subject matter of another assurance engagement) becomes an employee of the firm.

 

Such individuals should not be assigned to the audit if that person would be evaluating elements of the financial statements for which they had prepared accounting records.

 

[Section 290.141]

 

An employee or partner of a firm cannot also be an employee or director of an assurance client, as the self-interest and self -review threats created would be so significant that no safeguard could reduce the threats to an acceptable level.

 

[Section 290.142]

 

 

 

Advocacy threats

 

Promoting the position of a client or representing them in some way would mean the audit firm is seen to be ‘taking sides’ with the client.

 

Examples include:

 

  • Representing the client in court or in any dispute where the matter is material to the financial statements.

 

  • Negotiating on the client’s behalf for finance.

 

Where the amounts are material the audit firm must not act for the audit client in this way. Any request for such services must be politely declined.

 

[Section 290.206]

 

Where the matter is not material to the financial statements the firm should:

 

  • Use professionals who are not members of the audit team to perform the service, or

 

  • Have a professional who was not involved in providing the legal services advise the audit team on the service and review any financial statement treatment.

 

[Section 290.207]

 

Providing services involving promoting, dealing in, or underwriting an audit client’s shares would create an advocacy or self-review threat so significant that no safeguards could reduce the threat to an acceptable level. Accordingly, a firm shall not provide such services to an audit client.

[Section 290.214]

 

Intimidation threats

 

Actual or perceived pressures from the client, or attempts to exercise undue influence over the assurance provider create an intimidation threat, e.g. actual or threatened litigation between the auditor and audit client (in which case it may be necessary to resign from the engagement).

 

Intimidation can arise from some of the same situations mentioned above, for example:

 

  • Fee dependency

 

  • Personal relationships

 

  • Audit partner joining the client

 

  • Litigation between the audit firm and client.

 

The safeguards to address these threats are the same as to address the other threats.

 

If the threat cannot be eliminated or reduced to an acceptable level, the assurance provider must decline or resign from the engagement.

 

5         Confidentiality

 

External auditors are in a unique position of having a legal right of access to all information about their clients. The client must be able to trust the auditor not to disclose anything about their business to anyone as it could be detrimental to their operations.

 

Confidential information may be obtained from:

 

  • The firm or employing organisation

 

  • Business relationships i.e. current clients

 

  • Prospective clients and employers.

 

Members of an assurance team should not disclose any information to anyone outside of the engagement team, whether or not they work for the same firm.

 

Information should only be disclosed with proper and specific authority or when there is a legal or professional right or duty to disclose.

 

Disclosure of confidential information should only be made if:

 

  • Disclosure is permitted by law and is authorised by the client or the employer.

 

  • Disclosure is required by law, for example:

 

Production of documents or other provision of evidence in the course of legal proceedings.

 

Disclosure to the appropriate public authorities of infringements of the law that come to light.

 

 

  • There is a professional duty or right to disclose, when not prohibited by law:

 

– To comply with the quality review of ACCA or another professional body.

 

– To respond to an inquiry or investigation by ACCA or a regulatory body.

 

– To protect the professional interests of a professional accountant in legal proceedings.

 

– To comply with technical standards and ethics requirements. [ACCA Rulebook, Section 140]

 

Disclosure of confidential information: specific examples Permitted or required by law

The most common offences members are likely to encounter in their professional work are in relation to:

 

  • Fraud or theft including fraudulent financial reporting, falsification or alteration of accounting records or other documents and misappropriation of assets

 

  • Taxation law

 

  • Money laundering

 

  • Insider dealing, market abuse, and bribery

 

  • Health and safety law

 

  • Employment law

 

  • Environmental offences.

 

Public interest

 

An auditor may disclose information if they consider it to be in the public interest. There is no official definition of ‘public interest’. The auditor must employ a combination of judgment and legal advice. A good rule of thumb is that if a member of the public could incur physical or financial damage that the auditor could knowingly have prevented it is likely that the auditor has failed in their public duty.

 

In determining the need to disclose matters in the public interest the auditor should consider:

 

  • Whether those charged with governance have rectified the matter or are taking effective corrective action

 

  • Whether members of the public are likely to be affected

 

  • The gravity of the matter

 

  • The likelihood of repetition

 

  • The reasons for the client’s unwillingness to make the disclosures

 

  • Relevant legislation, accounting standards and auditing standards

 

  • Legal advice obtained.

 

The auditor will be protected from the risk of liability for breach of confidence provided that disclosure is made in the public interest, disclosure is made to an appropriate body or person, and there is no malice motivating the disclosure.

 

Conflicts of interest

 

A conflict of interest arises when the same audit firm is appointed for two companies that interact with each other, for example:

 

  • Companies which compete in the same market

 

  • Companies which trade with each other

 

A conflict of interest may create a threat to the fundamental principles of objectivity and confidentiality.

 

It may be perceived that the auditor cannot provide objective services and advice to a company where it also audits a competitor.

 

Professional accountants should always act in the best interests of the client. However, where conflicts of interest exist, the firm’s work should be arranged to avoid the interests of one being adversely affected by those of another and to prevent a breach of confidentiality.

 

In order to ensure this, the firm must notify all affected clients of the conflict and obtain their consent to act. The following additional safeguards should be considered:

 

  • Separate engagement teams (with different engagement partners and team members).

 

  • Procedures to prevent access to information, e.g. physical separation of the team members and confidential/secure data filing.

 

  • Signed confidentiality agreements by the engagement team members.

 

  • Regular review of the application of safeguards by an independent person of appropriate seniority.

 

  • Advise the clients to seek independent advice.

 

If adequate safeguards cannot be implemented (i.e. where the acceptance/ continuance of an engagement would, despite safeguards, materially prejudice the interests of any clients) the firm must decline or resign from one or more conflicting engagements.

 

[ACCA Rulebook, Section 220]

 

 

Test your understanding 1

 

Murray case study: Ethical issues

 

You are an audit manager in Wimble & Co, a large audit firm which specialises in providing audit and accountancy services to manufacturing companies. Murray Co has asked your firm to accept appointment as external auditor. Murray Co manufactures sports equipment. Your firm also audits Barker Co, another manufacturer of sports equipment, and therefore your firm is confident it has the experience to carry out the audit.

 

You have been asked to take on the role of audit manager for Murray Co, should your firm accept the engagement. You own a small number of shares in Murray Co, as you used to be an employee of the company. Don Henman, who has been the engagement partner for Barker Co for twelve years, will take the role of engagement partner for Murray Co. The audit senior will be Tim Andrews, as his sister is the financial controller at Murray Co and therefore he knows the business well.

 

Your firm recently purchased some bibs, footballs and other equipment from Murray Co for the firm’s annual football tournament. Murray Co has offered to provide this equipment free of charge to the firm if they accept the role as auditor.

 

Murray Co would also like your firm to provide taxation and accounting services. Specifically, the company would like you to prepare the financial statements and represent the company in a dispute with the taxation authorities.

 

The fees for last year’s audit of Barker Co have not yet been paid, and you have been asked by Don Henman to look into the matter.

 

Required:

 

  • Describe the steps Wimble & Co should take to manage the conflict of interest arising from performing the audit of Murray Co and Barker Co.

 

  • Explain the ethical threats which may affect the independence of Wimble & Co in respect of the audit of Murray Co or Barker Co, and for each threat identify ways in which the threat might be reduced.

 

6         Accepting/continuing an audit engagement

 

An audit firm should only take on clients and work of an appropriate level of risk. For this reason, the firm will perform ‘client screening’. The firm will consider the following matters before accepting a new engagement or client:

Professional clearance

 

If offered an audit role, the prospective audit firm must:

 

  • Ask the client for permission to contact the existing auditor (and refuse the engagement if the client refuses).

 

  • Contact the outgoing auditor, asking for all information relevant to the decision whether or not to accept appointment (e.g. overdue fees, disagreements with management, breaches of laws & regulations).

 

  • If a reply is not received, the prospective auditor should try and contact the outgoing auditor by other means e.g. by telephone.

 

  • If a reply is still not received, the prospective auditor may still choose to accept but must proceed with care.

 

  • If a reply is received, consider the outgoing firm’s response and assess if there are any ethical or professional reasons why they should not accept appointment.

 

  • The existing auditor must ask the client for permission to respond to the prospective auditor.

 

  • If the client refuses permission, the existing auditor should notify the prospective auditor of this fact.

 

Independence and objectivity

 

If the assurance provider is aware, prior to accepting an engagement, that the threats to objectivity cannot be managed to an acceptable level, the engagement should not be accepted.

 

Management integrity

 

If the firm has reason to believe the client lacks integrity there is a greater risk of fraud and intimidation.

 

Money laundering (client due diligence)

 

The firm must comply with money laundering regulations which require client due diligence to be carried out. If there is any suspicion of money laundering, or actual money laundering committed by the prospective client, the firm cannot accept the engagement.

 

Resources

 

The firm should consider whether there are adequate resources available at the time the engagement is likely to take place to perform the work properly. If there is insufficient time to conduct the work with the resources available the quality of the work could be affected.

 

Risks

 

Any risks identified with the prospective client (e.g. poor performance, poor controls, unusual transactions) should be considered. These risks can increase the level of engagement risk, i.e. the risk of issuing an inappropriate report.

 

Fees

 

The firm should consider the acceptability of the fee. The fee should be commensurate with the level of risk.

 

In addition, the creditworthiness of the prospective client should be considered as non-payment of fees can create a self-interest threat.

 

Professional competence

 

An engagement should only be accepted if the audit firm has the necessary skill and experience to perform the work competently.

 

Reputation of the client

 

The audit firm should consider the reputation of the client and whether its own reputation could be damaged by association.

 

If there are any reasons why the firm believes they may not be able to issue an appropriate report, they should not accept the engagement.

 

Preconditions for an audit

 

ISA 210 Agreeing the Terms of Audit Engagements and the Code of Ethics and Conduct provides guidance to the professional accountant when accepting new work.

 

Before accepting (or continuing with) an engagement the auditor must establish whether the preconditions for an audit are present and that there is a common understanding between the auditor and management and, where appropriate, those charged with governance. [ISA 210, 3]

 

The preconditions for an audit are that management acknowledges and understands its responsibility for:

 

  • Preparation of the financial statements in accordance with the applicable financial reporting framework.

 

  • Internal control necessary for the financial statements to give a true and fair view.

 

  • Providing the auditor with access to all relevant information and explanations.

 

[ISA 210, 6]

 

If the client imposes a limitation on the scope of the auditor’s work to the extent that the auditor believes it likely that a disclaimer of opinion will ultimately be issued then the auditor shall not accept the engagement, unless required to do so by law. [ISA 210, 7]

 

Continuance

 

Once the engagement is complete, the audit firm must revisit the acceptance considerations again to ensure it is appropriate to continue for the following year. If any significant issues have arisen during the year such as disagreements with management or doubts over management integrity, the firm may consider resigning.

 

7         Engagement letters

 

Purpose

 

The engagement letter specifies the nature of the contract between the firm and client.

 

Its purpose is to:

 

  • Minimise the risk of any misunderstanding between the practitioner and client

 

  • Confirm acceptance of the engagement

 

  • Set out the terms and conditions of the engagement.

 

The letter will be sent before the audit commences.

 

Changes to the engagement letter

 

The engagement letter should be reviewed every year to ensure that it is up to date but does not need to be reissued every year unless there are changes to the terms of the engagement.

 

ISA 210 requires the auditor to consider whether there is a need to remind the entity of the existing terms of the audit engagement for recurring audits. Some firms choose to send a new letter every year to emphasise its importance to clients.

 

The auditor should issue a new engagement letter if the scope or context of the assignment changes after initial appointment, or if there is a need to remind the client of the existing terms.

 

Reasons for changes would include:

 

  • Changes to statutory duties due to new legislation

 

  • Changes to professional duties, for example, due to new or updated ISAs

 

  • Changes to other services as requested by the client.

 

[ISA 210, A30]

 

The contents of the engagement letter

 

The auditor will agree the terms of the audit engagement with management or those charged with governance, as appropriate. [ISA 210, 9]

 

The terms are recorded in a written audit engagement letter and should include:

 

  • The objective and scope of the audit of the financial statements

 

  • The responsibilities of the auditor

 

  • The responsibilities of management

 

  • Identification of the applicable financial reporting framework for the preparation of the financial statements

 

  • Reference to the expected form and content of any reports to be issued by the auditor.

 

[ISA 210, 10]

 

In addition the following items will be included:

 

  • Reference to professional standards, regulations and legislation applicable to the audit

 

  • Limitations of an audit

 

  • Expectation that management will provide written representations

 

  • Basis on which the fees are calculated

 

  • Agreement of management to notify the auditor of subsequent events after the auditor’s report is signed

 

  • Agreement of management to provide draft financial statements in time to allow the audit to be completed by the deadline

 

  • Form (and timing) of any other communication during the audit.

 

Other matters that the engagement letter may cover include:

 

  • Arrangements concerning the involvement of internal auditors and other staff of the entity

 

  • Limitations to the auditor’s liability.

 

[ISA 210, A24]

 

The content of the engagement letter should be agreed with the client before any engagement related work commences.

 

The client’s acknowledgement of the terms of the letter should be formally documented in the form of a director’s signature.

 

 

Illustration 2 – Murray Co engagement letter

 

Wimble & Co

14 The Grove

Kingston

KI4 6AP

 

25 November 20X4

 

To the Board of Directors of Murray Company.

 

This letter and the attached terms of business dated 25 November 20X4 set out the basis on which we are to provide services as auditors and your and our respective responsibilities.

 

The objective and scope of the audit: You have requested that we audit the financial statements of Murray Company, which comprise the statement of financial position as at December 31, and the statement of profit or loss, statement of changes in equity and statement of cash flows for the year then ended, and a summary of significant accounting policies and other explanatory information.

 

We are pleased to confirm our acceptance and our understanding of this audit engagement by means of this letter. Our audit will be conducted with the objective of our expressing an opinion on the financial statements.

 

The responsibilities of the auditor: We will conduct our audit in accordance with International Standards on Auditing (ISAs). Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

 

Because of the inherent limitations of an audit, together with the inherent limitations of internal control, there is an unavoidable risk that some material misstatements may not be detected, even though the audit is properly planned and performed in accordance with ISAs.

 

In making our risk assessments, we consider internal control relevant to Murray Company’s preparation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of Murray Company’s internal control. However, we will communicate to you in writing concerning any significant deficiencies in internal control relevant to the audit of the financial statements that we have identified during the audit.

 

The responsibilities of management: Our audit will be conducted on the basis that management acknowledge and understand that they have responsibility:

 

  • For the preparation and fair presentation of the financial statements in accordance with International Financial Reporting Standards.

 

  • For such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

 

  • To provide us with:

 

  • Access to all information of which management is aware that is relevant to the preparation of the financial statements such as records, documentation and other matters.

 

  • Additional information that we may request from management for the purpose of the audit.

 

  • Unrestricted access to persons within the entity from whom we determine it necessary to obtain audit evidence.

 

As part of our audit process, we will request from management written confirmation concerning representations made to us in connection with the audit.

 

We look forward to full cooperation from your staff during our audit.

 

Report: We will report to the members of Murray Company as a body, whether in our opinion the financial statements present fairly in all material respects, the financial position of Murray Company as at December 31, and its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards. The form and content of our report may need to be amended in the light of our audit findings.

 

Fees: Our fees, which will be billed as work progresses, are based on the time required by the individuals assigned to the engagement plus out-of-pocket expenses. Individual hourly rates vary according to the degree of responsibility involved and the experience and skill required.

 

Limitation of liability: To the fullest extent permitted by law, we will not be responsible for any losses, where you or others supply incorrect or incomplete information, or fail to supply any appropriate information or where you fail to act on our advice or respond promptly to communications from us.

 

Our work is not, unless there is a legal or regulatory requirement, to be made available to third parties without our written permission and we will accept no responsibility to third parties for any aspect of our professional services or work that is made available to them.

 

Confirmation of your agreement: Please sign and return the attached copy of this letter to indicate your acknowledgement of, and agreement with, the arrangements for our audit of the financial statements including our respective responsibilities.

 

If this letter and the attached terms of business are not in accordance with your understanding of our terms of appointment, please let us know.

 

Wimble & Co

 

Wimble & Co

 

Acknowledged and agreed on behalf of Murray Company by (signed)

 

 

…………………….

 

Name and Title

 

Date

 

Further explanation of engagement letter contents To the Board of Directors of Murray Company…

 

  • Although the auditor’s report is issued to the shareholders, the engagement letter is addressed to and signed by the directors of a company.

 

The responsibilities of the auditor… The responsibilities of management…

 

  • It is important to set out the directors’ and auditor’s responsibilities for clarity and to reduce any expectation gap.

 

  • The responsibilities of the auditor include the scope of the audit, i.e. the process by which the auditor will form their opinion. The same description of the scope of an audit is included in the auditor’s report.

 

We will report to the members of Murray Company as a body…

 

  • It is important to define who the intended users of the report are, i.e. who can place reliance on it.

 

Confirmation of your agreement…

 

  • Both the client and the auditor must sign and retain a copy of the engagement letter for reference and to support the contract agreed.

 

 

 

Test your understanding 2

 

Explain each of the FIVE fundamental principles of ACCA’s Code of Ethics and Conduct.

 

(5 marks)

 

 

 

 

Test your understanding 3

 

  • There are legal and professional arrangements for the appointment and removal of auditors.

 

  • State the circumstances in which a person is not eligible to act as an auditor.

 

(2 marks)

 

  • Describe the steps required to remove an auditor from an engagement.

 

(3 marks)

 

  • You are a manager in the audit department of Whilling and Abel. A potential new client, Truckers Co, a haulage company, has approached your firm to do the external audit in addition to some other non-audit services for the year-ended 30 September. Your audit firm was recommended to Truckers Co by an existing client, O&P, a shipping company who is also a major customer of Truckers Co.

 

You have been chosen to lead the engagement as you have experience of auditing haulage companies and you also manage the audit of O&P.

 

Whilst arranging the initial meeting with the directors of Truckers Co you discover that you studied accountancy with the finance director at university.

 

Truckers Co has not made a profit for the last 2 years. The directors explain that this is largely due to escalating costs in the industry including fuel price rises. They are confident they have now controlled their costs for the current year. They have also been approached to tender for a large profitable contract which would improve their financial performance going forward. They would like you to assist them with the preparation of this tender and present with them on the day.

 

The current year’s financial statements and audit are being finalised with another audit firm. The finance director tells you that the current auditors have identified material misstatements but the board of directors are refusing to make these adjustments. If adjusted, it would turn the break-even position into a loss.

 

The current auditors have replied to your professional clearance letter and have informed you that they are still owed fees relating to the prior year. This is under dispute with the client.

 

You calculate that the potential fees from Truckers Co would amount to approximately 14% of your firm’s total fee income.

 

Required:

 

Identify and explain the threats to independence if Whilling and Abel accept Truckers Co as a new audit client. For each threat, recommend how the threat can be managed.

 

(15 marks)

 

(Total: 20 marks)

 

Test your understanding 4

 

You are holding a training course for your firm’s new recruits covering the topic of ethics. The training will focus on the fundamental principles of ethical behaviour which accountants must follow. You have compiled the following quiz for the end of the session to test their understanding of the course content.

 

  • Which of these is NOT a fundamental ethical principle? A Integrity

 

B Independence C Objectivity

D  Professional competence and due care

 

  • Which of these statements provides the best explanation of integrity?

 

A Members should act diligently and in accordance with applicable technical and professional standards

 

B  Members should not bring the profession into disrepute

 

C Members should not use client information for personal advantage

 

D Members should be straightforward and honest in all professional and business relationships

 

  • A member was found guilty of ethical misconduct by failing to respond to the professional clearance requests from another audit firm. This is a breach of which fundamental principle?

 

A  Integrity

 

B  Independence

 

C  Professional behaviour

 

D  Professional competence and due care

 

  • Which of the following statements best describes the conceptual framework approach to ethics?

 

A  A set of rules which must be followed in all circumstances

 

B A set of principles which the auditor applies based on professional judgment

 

C  The conceptual framework is set out in company law

 

D  A set of principles which the auditor applies at their discretion

 

  • Why do auditors need to be independent?

 

A To ensure users of the auditor’s report can place reliance on it and have faith it is not biased

 

B  To ensure the financial statements give a true and fair view

 

C To provide more regulation for auditors to increase the perception of quality

 

D  The law requires it

 

 

Test your understanding 5

 

You are the audit manager responsible for the audit of Broome Co, a listed company. You have been informed by one of the audit juniors that the finance director has offered to take the audit team to a World Cup Final at the expense of the client as a thank you for an efficient audit with minimal disruption.

 

The finance director has requested that you attend a social event where the company will outline a new rights issue of ordinary shares to shareholders. The finance director believes that the presence of the external auditor will add credibility to the rights issue and increase the chance of raising the required finance.

 

  • Which of the following is NOT a threat to objectivity? A Independence

 

B Self-review C Advocacy D Intimidation

 

  • Which ethical threat would be created if the audit manager attends the social event where the client will outline a new rights issue to shareholders?

 

A Familiarity B Advocacy C Self-review D Self-interest

 

  • The offer of tickets to the World Cup Final creates which type of threat?

 

A Intimidation B Advocacy C Self-review D Self-interest

 

  • What is the restriction, if any, on the level of fee income that can be received from recurring work from Broome Co before a situation of dependency is presumed to exist?

 

A 5% B 10% C 15%

 

D  No restriction

 

  • For clients where the level of fees must be monitored, what safeguard can the firm apply to reduce the threat to an acceptable level?

 

  • Rotation of audit team members on an annual basis.

 

  • Discussion of the matter with the audit committee.

 

  • Assign an engagement quality control review partner.

 

  • (i) and (ii) only

 

  • (i) and (iii) only

 

  • (ii) and (iii) only

 

  • (i), (ii) and (iii)

 

8         summary

Test your understanding 1

 

  • Conflict of interest

 

Wimble & Co must inform both clients of the conflict and obtain their consent to act.

 

Separate teams and engagement partners must be used for each audit.

 

Procedures should be in place to prevent access to information e.g. using teams from different offices.

 

The audit teams should sign confidentiality agreements.

 

An independent review partner should be assigned to ensure the safeguards have been effective.

 

  • Threats and safeguards

 

Threat Managing the threat
Financial interest The audit manager must
The audit manager owns shares in dispose of the shares
immediately or another
Murray Co.
audit manager should be
This creates a self-interest threat:
appointed to the
the audit manager may be reluctant engagement team instead.
to identify misstatements or modify
the audit opinion for fear of
damaging the value of their
shareholding.
Previous employment with the The audit manager should
client not be assigned to the audit
The audit manager used to work for of Murray Co if they would
Murray Co. be audited accounting
This creates a self-review threat. records they had prepared
whilst employed at the
client.

 

If employment with the client was
recent, the audit manager may be
auditing work for which they were
responsible when working for Murray
Co. They may not identify errors in
their own work, or if they are
identified, they may not be brought to
the client’s attention.
In addition, a familiarity threat may
arise as the audit manager is likely to
have friendships with previous
colleagues which could result in the
audit manager not applying sufficient
professional scepticism and trusting
the client too much.
Gifts and hospitality The firm should evaluate
Murray Co has offered free the gift offered and unless
trivial and inconsequential,
equipment to the auditor.
the audit team must not
Accepting gifts or hospitality from an
accept the equipment.
audit client may create self-interest
and familiarity threats.
The auditor may feel indebted to the
client or the offer may be seen to be
a bribe from the client for a clean
audit opinion.
Long association • Rotate the senior
The engagement partner for Barker personnel.
Co has been in place for twelve • Independent review of
years. the senior personnel’s
Familiarity and self-interest threats work.
are created by using the same senior • Independent quality
personnel on an assurance control reviews of the
engagement for a long period of engagement.
time. The audit partner may be too
trusting of the client and may lack
professional scepticism.

 

Personal relationship Tim Andrews should not be
The audit senior’s sister is the on the audit team for
Murray Co.
financial controller at Murray Co and
is therefore in a position to exert
significant influence over the
financial statements.
Family and personal relationships
between a member of an assurance
team and a director of the client, or
an employee of the client in a
position to exert significant influence
over the subject matter, may create
familiarity, self-interest or
intimidation threats.
The audit senior may be too trusting
of his sister and not apply sufficient
professional scepticism.
Representing the client Firms must not represent
Murray Co would like the audit firm to audit clients in such
represent the company in a dispute disputes. The request
should be politely declined.
with the taxation authorities.
This would create advocacy and
self-review threats as the audit firm
would be seen to be taking sides
with their client.
Overdue fees Do not perform any more
The fee for last year’s audit of Barker work for the client until the
Co has not yet been paid. outstanding have been
paid, or arrangements for
Overdue fees create a self-interest
payment have been agreed
threat where they remain unpaid for with the client.
some time. The auditor may be
reluctant to raise issues with the
client in case they refuse to pay.
In addition, overdue fees could be
perceived to be a loan. An audit firm
must not enter into any loan
arrangement with a client.

 

Provision of other services • The firm must only
Murray Co would like the audit firm to perform work of a
routine or mechanical
prepare the financial statements.
nature.
Preparing the financial statements
• Use staff who are not
and then auditing them creates a
part of the audit team
significant self-review threat. If the
to prepare the
auditor reviews work they were
financial statements.
responsible for, they may not identify
errors they have made. • If performed by a
member of the audit
team, arrange an
independent partner
or senior staff member
to review the work
performed.
Tutorial note: If an audit
client is a listed or other
public interest entity, the
firm must not provide any
accounting or bookkeeping
services.
Test your understanding 2
Fundamental principles

 

Integrity. A professional accountant should be honest and straightforward in performing professional services.

 

Objectivity. A professional accountant should be fair and not allow personal bias, conflict of interest or influence of others to override objectivity.

 

Professional competence and due care. When performing professional services, a professional accountant should show competence and due care by acting diligently when performing their work and keeping up-to-date with developments in practice, legislation and techniques.

 

Confidentiality. A professional accountant should respect the confidentiality of information acquired during the course of providing professional services and should not use or disclose such information without obtaining client permission.

 

Professional behaviour. A professional accountant should act in a manner consistent with the good reputation of the profession and refrain from any conduct which might discredit the profession.

 

Test your understanding 3

 

  • (i) A person is not eligible to act as an auditor in the following circumstances:

 

– They are not a member of an RSB (recognised supervisory body) or not allowed to practise under the rules of an RSB.

 

–  They are an officer or employee of the company.

 

– They are a business partner or employee of such a person.

 

  • Steps required to remove an auditor from an engagement

 

– A decision must be made by the shareholders at a general meeting usually with a majority vote being required.

 

– Advance notice must be given to the company and the auditors prior to any general meeting.

 

–  Auditors have the right to attend and speak at the general meeting or have representations read out on their behalf.

 

  • Threats and independence

 

Threat Managing the threat
Audit manager knows one of the A different audit manager
directors socially. This creates a should be assigned to the
familiarity threat. The auditor may audit of Truckers Co.
be too trusting of the client or too
sympathetic to the client’s needs.
You are the audit manager of one A different audit manager
of Trucker Co’s major customers. should be assigned to the
This creates a conflict of interest audit of Truckers Co.
and a risk that confidential Different teams should be
information may be passed
used for the audit of Truckers
between the clients.
Co and O&P.
The audit manager has been The auditor should politely
asked to present at the tender for a decline the invitation to
contract. This would give rise to an present at the tender
advocacy threat as the audit firm explaining their reasons.
would be promoting the client.

 

 
There are outstanding fees still Discuss reasons for non-
owed to the previous auditors. This payment with the client and
situation could arise again for the consider whether you should
new auditor leading to a accept the assignment.
self-interest threat where the
auditor may not wish to identify
misstatements or modify the audit
opinion for fear of not receiving the
outstanding fees.
The audit firm will provide non- The audit firm should ensure
audit services in addition to the separate teams work on each
external audit. This represents a engagement.
self-review threat. The audit firm An independent partner
may ignore or overlook their own
review of the files for each
errors when auditing the financial
engagement should be
statements.
arranged.
Total fees received from Trucker Whilling & Abel should
Co will represent 14% of the audit consider declining additional
firm’s total income. Fee non-audit services from
dependence creates a self-interest Trucker Co to reduce fee
threat. The firm may not wish to dependence.
raise issues with the client for fear An independent partner
of losing them.
review of the audit work
should be arranged.
Tutorial note: If the client is
a listed company, fee
dependency is presumed
when fees exceed 15% for
two consecutive years.

 

Test your understanding 4

 

(1) B Whilst independence is an important characteristic for
an auditor it is not one of the fundamental principles.
(2) D Integrity means straightforward and honest.
(3) C Professional behaviour incorporates professional
courtesy e.g. responding promptly to requests from
other auditors.
(4) B The conceptual framework approach requires the
auditor to assess each situation individually and act in
a manner that would be seen as appropriate for a
professional accountant. Principles rather than rules
are used as principles can apply across national
boundaries. The Code of ethics is professional
guidance but not a legal requirement.
(5) A Independence means freedom from bias and influence.
Test your understanding 5
(1) A Independence.
(2) B The audit manager may be seen to be promoting the
company and encouraging the shareholders to
subscribe to the rights issue.
(3) D Self-interest. The auditor may feel they owe the client
something in return if they accept such an expensive
gift.
(4) C 15%.
(5) C Independence matters should be discussed with the
audit committee and an engagement quality review
partner should be assigned. Rotation of the audit team
would not provide a safeguard for this self-interest
threat.
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