P7 Lecture 4 Code of Ethics Conduct

ADVANCED AUDIT & ASSURANCE ENGAGEMENTS

ACCA – P7

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

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Lecture 4:ACCA’s Code of Ethics & Conduct

ACCA’s Code of Ethics & Conduct

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq3


Fundamental principals

Threats to independen

ce

Safeguards to

independence



Fundamental principals

Integrity Objectivity

independence

Confidentiality

Mandatory disclosure

Voluntary disclosure

Professional competence & due care

CPD

Professional behavior

ACCA’s Code of Ethics & Conduct:

Fundamental Principles


IntegrityDefinition:“Honesty & straightforward dealing”

Professional behavior Definition: “avoid situations or behavior that

could put yourself & the profession in disrepute”Professional competence & due care

Definition: “possess & maintain the necessary skills to carry out the work effectively and perform duties diligently” Responsibility to keep knowledge & skills up to date with

changing regulations, business practices etc is referred to as CPD (continuing professional development)


Fundamental Principles


Independence & objectivity: Independence - Definition: “to be free from personal

bias & from the influence of others” Objectivity: “maintain independence & thus carry out

duties & make decision objectively” Auditors must maintain independence of both “mind”

& independence of “appearance” Independence of mind refers to a maintaining a state

of mind which supports objective decision making Independence of appearance refers to avoiding

situations which may create doubt or suspicion in the minds of reasonable third parties regarding the integrity & objectivity of auditors



Confidentiality; requires auditors not to disclose confidential information without

authorization unless

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Exception #1: Mandatory disclosureClient suspected of:

Drug trafficking Money laundering Terrorism Acts of treason

Member served with court order to disclose

Regulatory body demands disclosure

Exception #2: Voluntary disclosureMember defending interests in

court of lawPublic interest is involved

(client polluting towns drinking water say) requires consideration of: Severity of issue Extent of financial damage Whether repetition is likely Whether society is affected Is the matter being hidden from

public knowledgeHowever before making

disclosure accountants should seek legal advice from an expert


Public Interest Entities


Before discussing threats to independence it is necessary to note discuss to issues, public interest entities & management responsibilities (discussed in next slide)

ACCA code separates companies for independence purposes into listed & non-listed entities. Listed entities include: Companies which are listed entities or Companies which are defined by regulation or legislation as public

interest entities or Companies which are required by regulation to conduct audits at the

same independence levels as the audit of listed entities Companies which are of significant importance to the public because of

their size

The distinction is drawn to ensure that auditors maintain a higher level of independence during audits of listed clients


Management Responsibilities


The ACCA code forbids audit staff from taking on management responsibilities at audit clients

This is because the law forbids directors, officers & employees from acting as company auditors

Management responsibilities include: Setting policies & procedures Developing strategies Making decisions as opposed to giving recommendations (which is

allowed) Taking responsibility for the preparation & fair presentation of

financial statements Taking responsibility for establishing & maintaining an effective

internal control system

Note that routine administrative duties are generally not considered to fall under the category of management responsibilities



Threats to independen

ce

Self-interest threat

Self-review threat

Familiarity threat

Advocacy threat

Intimidation threat



Self-interest threat:Auditors self-interests threaten their independence & objectivity

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Self-interest Threat


Financial interest: Situation in which the firm, its member or a family

member of a member has a financial interest in a client Example: the purchase of clients shares

Safeguards include: Disposing of the financial interest Removing the individual from the audit engagement Informing the clients audit committee of the situation &

safeguards being implemented Reviewing the work done can be done both:

Internally by other senior staff (partners) in the firm or Externally by requesting another firm to conduct the review



Close business relationship: Situation in which the firm, its member or a family member of a member has a

close business relationship with the client Example: audit partner of firm A & CEO of client B run third business C together Example: audit firm A & client B operate a joint venture C Example: audit firm A markets client B’s products &/or services for a fee or

commission

Safeguards include: Assess if the business investment is material/significant If insignificant the threat to independence is not severe & audit can be

provided However if there is a significant investment then identify whether the

investment is by: The firm in which case either the business relationship or audit should be discontinued The engagement partner then rotate the partner, however if it is a small firm then this may

not be possible & thus only option is to terminate business relationship An officer lower down the hierarchy in which case that individual should be removed from

the audit



Prospects of employment with an audit client: Situation in which firm staff are offered potential employment with an audit

client

Safeguards include: Removing the individual from the audit engagement

If partner rotate from audit engagement If officer remove from audit team

An additional complication arises when a staff member has left the firm & has taken up employment at an audit client

Example: the audit manager resigns from the firm to work as the finance director at the client

The audit manager will be aware of the firms audit procedures & overall strategy

Therefore the firm should undertake the following measures Modifying the regular audit procedures & strategy usually implemented at that

client The objective is to create a degree of unpredictability The audit team should comprise of staff with sufficient experience



Temporary staff assignments: Situation in which firm staff are loaned out to clients for short

periods of time When staff are loaned out then it is important that client

management take responsibility for directing & supervising the activities of the loaned staff

This is because the ACCA code forbids auditors from taking on duties/responsibilities normally performed by management

Safeguards include: Not including loaned staff on audits of clients in which they have

worked in. or Not giving the loaned staff an area of the financial statements to

audit on which they have worked on Conducting an independent review of the work done by loaned

staff



Partner on client board: Situation in which firm partner or other staff

member is employed as a director of a clientThis situation may be allowed if the role is

purely administrative in nature

Safeguards include:The firm staff should be removed from the

audit engagement or The firm should decline to act as client

auditors



Family & personal relationships: Situation in which firm staff have a family or other personal

relationship with client staff The severity of the threat is based on 3 factors:

1. The audit staffs duties & position/seniority in the firm2. The client staffs duties & position in the company3. The closeness of the relationship

Example #1: if audit engagement partners wife is the finance director at the client then the threat is assessed as high

Safeguard would be to decline to act as auditors

Example #2: if audit trainees distant uncle works in the clients HR department then this threat is assessed as low

Safeguard would be to remove individual from audit team or Retain individual on team but have his work reviewed by senior officer



Compensation & evaluation policies: Situation in which audit staff are rewarded (i.e.

bonuses, salary increments, benefits, promotion etc) on the basis of getting non-audit work from audit clients

Safeguards include:The audit engagement partner’s performance

should not be evaluated on the basis of selling non-audit services to audit clients

Remove audit staff from audit teamReview work done by audit staff



Gifts and hospitality: Situation in which audit staff are given gifts or offered

hospitality by client Severity of threat depends upon:

Whether or not gift & hospitality is excessive Whether or not the giving of gifts & hospitality is routine

Example #1: gift is a cheap ball point or expensive fountain pen

Example #2: offered pizza or dinner at an expensive hotel Example #3: offered to customers, suppliers & auditors or

only offered to auditors

Safeguards include: If the gift or hospitality offered is excessive &/or non-routine

in nature then it should be declined



Overdue fees: Situation in which the client has yet to pay the auditors

previous year/s fees This can result in a number of threats:

Auditor turning a blind eye to material misstatements which overstate the financial position & performance of a client which is in financial difficulties. This is done to avoid the client collapsing & amount becoming a bad debt (self-interest threat)

Auditor being threatened by client management of non-payment or late payment (intimidation threat)

Auditor may appear to have a financial interest in a client in the form of a loan (self-interest threat)

Safeguards include: If the gift or hospitality offered is excessive &/or non-

routine in nature then it should be declined



Contingent fees: Situation in which the auditor is paid a fees based on results in the

clients financial statements or the auditors work done Note that auditors calculate fees on the basis of time spent by audit

staff involved in the audit (including out of pocket expenses) Example:

Partner: 15hrs @ Rs.5,500/- = 82,500/- Manager: 25hrs @ Rs.2,500/- = 62,500/- Audit team: 70hrs @ Rs.350/- = 24,500/- Total: = 169,500/- Out of pocket expenses = 23,000/- Grand total: = 192,500/-

Also note that auditors simply provide an estimate of fees & must clarify to clients that the final amount will depend upon the total time taken

Safeguards include: Firms are not permitted to agree payment on a contingent basis



High percentage of fees: Situation in which the audit firm derives a significant

proportion of total income from one particular clientExample: firm A derives 30% of total income from

client B

Safeguards include:Audit firm must reduce its dependency on client by:

Cutting back on non-audit services supplied to client Resigning from engagement Performing a review of audit work

Firms are advised that their income from public interest entities should not be more than 15% of total income earned over last 2 years



Lowballing: Situation where audit firm quotes a significantly low fee in order to secure an audit

engagement Often clients give non-audit services to their auditors. There are two main reasons for

this:1. Clients are reluctant to share their confidential data with more than one accountant2. Auditors gain an in-depth knowledge of the clients business & systems during the course of the audit

& thus they do not need to go through this process again in order to provide non-audit services. This results in lower fees/costs for non-audit services for clients

Consequently auditors realize that if they can secure an audit client they will also benefit from the more lucrative non-audit assignments

Often lowballing is done during bidding However the problem is that this can exercise can compromise an auditors independence

of appearance Third party’s may ask how an auditor can provide a quality service at such a low fee Also because the firm is a profit making entity there is a possibility that it may cut

corners in order to reduce costs to earn profits from low fee audit assignments

Safeguards include: Audit firm must not engage in lowballing Audit firms must maintain time sheets as evidence of hours spent by staff on

assignments & to prove that audit was conducted in accordance with laws, standards & ethical guidelines



Recruitment: Situation where audit firm is requested by client to

recruit staff on behalf on client

Safeguards include:Audit firm must not perform management

responsibilities for clientsRather the firm should provide a shortlist of

potential candidates to client managementClient management can then make the final

decision

Self-interest Threat:Summary


1. Financial interest2. Close business relationship3. Prospective employment with client4. Temporary staff assignments5. Partner on client board6. Family or personal relationship7. Compensation & evaluation policies8. Gifts & hospitality9. Loans & guarantees10. Overdue fees11. Contingent fees12. High % of fees13. Lowballing 14. Recruitment



Self-review threat:Auditor is reviewing his own work and thus cannot act as an independent third party

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Self-review Threat


Management responsibility: As discussed earlier audit firms must not take on

management responsibilities in the firms they audit

Self-review Threat


Recent employment with an audit client: Situation where audit firm staff having recently been working as an employee for the

client Severity of threat will depend upon:

What the duties & seniority of the officer at the audit client What is the duty & seniority level of the officer at the audit firm The duration of time between the officer leaving the client & taking up employment at the audit

firm Example #1: Mr. X recently left company A in which he worked as finance director to

take up a job as audit manager in firm B. Firm B are the auditors of company A & Mr. X is overseeing the audit of company A. in this situation the severity of threat to independence is high because it is very likely that Mr. X will be reviewing his own work!

Example #2: Mr. X recently left company A in which he worked as IT manager to take up a job as IT manager in firm B. Firm B are the auditors of company A. In this situation the severity of threat to independence is Low as Mr. X had no accounting role in his previous position & is not involved in the audit of A

Safeguards include: Firms must allow for cooling off periods before appointing the new officer to be

involved in the audit of a former employer Review the work done by the staff member

Self-review Threat


Preparation of accounting records & financial statements: There is a high risk to independence if auditors prepare

accounting records & financial statements Practically however it is often the case that auditors assist

management in: Maintaining books of account Preparing financial statements Applying accounting & financial reporting standards

Safeguards include: Firms must use different staff or different departments (i.e. audit

department, consultancy o& tax department etc) for providing non-audit services

Review work done Inform client audit committee

Self-review Threat


Valuation services: This comprises of valuing assets & liabilities for clients Example #1: clients may ask auditors to value a fixed asset

or a pension. Because these assets & liabilities form part of the financial statements the auditors will be reviewing their own work. If the amounts involved are material (i.e. significant) then the threat is also significant

Safeguards include: Firms must use separate teams or departments Explaining to client the basis of valuation Ensuring client acknowledges responsibility for the valuation Reviewing work done Informing client audit committee

Self-review Threat


Taxation services: This includes:

Preparing tax returns: does not impact financial statements as is thus not a threat to independence

Calculating tax amounts to be included in the financial statements: this involves a self-review threat & should not be provided to public interest entities

Tax planning: may impact financial statements Timing of purchase of assets to minimize tax liability: no impact on financial

statements & is thus not a threat to independence Accounting treatment to adopt to minimize taxable profits: impacts financial

statements & is thus a threat to independence Representing clients in disputes with tax authorities: this creates an advocacy

threat (discussed later)

Safeguards include: Firms must use separate teams or departments Review work done Inform audit committee

Self-review Threat


Internal audit service: Companies have to choose between setting up an in-house internal

audit function or outsourcing it to an accountancy firm Firms may provide internal audit services but must be careful not to

take on work that is management responsibility Setting internal audit policies Supervising & directing clients internal audit staff Deciding on which recommendations to implement Taking responsibility for developing & implementing the internal control system

(this is the responsibility of client management) Firms are prohibited from providing internal audit services on a

recurring basis to public interest entities

Safeguards include: Firms should use separate teams or departments Review audit work done Inform the clients audit committee of situation & safeguards

introduced

Self-review Threat


Corporate finance: Provision of consultancy on financing strategy, sourcing of

funds, cost of capital etc are acceptable If corporate finance impacts the financial statements then it

will create a threat to independence Audit firms however are not allowed to:

Promote audit client shares Deal in audit client shares Underwrite client shares

Safeguards include: Firms must use employ separate teams or departments Review of audit work done Inform client audit committee of situation & safeguards

introduced

Self-review Threat


IS & IT consultancy: Provision of consultancy on developing the clients

information system (including accounting system) whether manual or automated (i.e. IT based) will create a self-review threat

Safeguards include:Firms must use employ separate teams or

departments Review of audit work doneInform client audit committee

Self-review Threat:Summary


1. Management responsibility2. Recent employment with an audit client3. Preparing books of account & financial

statements4. Valuation services5. Taxation services6. Internal audit services7. Corporate finance8. IS & IT services

Self-review Threat


IS & IT consultancy: Provision of consultancy on developing the clients

information system (including accounting system) whether manual or automated (i.e. IT based) will create a self-review threat

Safeguards include:Firms must use employ separate teams or

departments Review of audit work doneInform client audit committee

Self-interest Threat:Summary


1. Financial interest2. Close business relationship3. Prospective employment with client4. Temporary staff assignments5. Partner on client board6. Family or personal relationship7. Compensation & evaluation policies8. Gifts & hospitality9. Loans & guarantees10. Overdue fees11. Contingent fees12. High % of fees13. Lowballing 14. Recruitment



Advocacy, familiarity & intimidation threats

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Advocacy Threat

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Auditor independence (of appearance) is affected in situations in which he is defending or promoting the position of his audit client

Examples:Providing a positive analysis on the clients

financial position & performance to client banks or prospective investors

providing a positive analysis to prospective buyers of a clients business

Evaluating the clients business line (e.g. a division or plant) for sale

Defending or representing the client in litigation


Familiarity Threat

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Auditors independence is threatened due to a familiarity with the client staff or systems

This occurs when the audit firm has been auditing the client over a number of successive years

For public interest entities the recommendation is a maximum of 7 years after which there is a compulsory requirement to rotate the engagement partner

The engagement partner must not be involved in the clients audit for at least 2 years


Intimidation Threat

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This occurs when an audit client threatens the auditors in some way

Threats may be open as in threatening to sue the auditors for negligence or

The threats may be more subtle as when management delay payment of audit fees to an audit firm facing financial difficulty or

Seeking a second opinion

Safeguards: Immediately disclose to the audit committee of the client

managements threats Removing audit staff from audit team who may be the cause of

friction with client management Reviewing work done

Conflicts of Interest


Conflicts of interest involving auditors & audit clients: An auditor may have an investment in a second

business Z which competes directly with an audit client The auditor may be tempted to supply client

confidential data to Z Also auditor may be tempted to provide incorrect advice

in order to weaken the competitive position of Z

Safeguards include: removing individual from audit team Informing client audit committee of situations in safeguards

implemented Ultimately if the threat cannot be mitigated then resign as

auditors



Conflicts of interest between two different clients: An auditor may have two clients are in direct competition with

one another Clients may fear that confidential data may be leaked by

auditors to competitors ACCA does not restrict auditors from providing assurance

services to competing clients This is because firms often specialize in particular industries

(i.e. financial sector or textile say) & clients benefit from the experience of specialists

Safeguards include: Informing the management & audit committees of both clients of the

situation & the safeguards introduced Using different teams on clients & ensuring there is no communication

between these teams (i.e. Chinese walls) Ultimately if the threat cannot be mitigated then resign as auditors

3 – Levels of Safeguards


National level: created by government & regulatory bodies Legislation – Companies Act 2006 (who is eligible, rights & duties,

appointment removal remuneration etc) Corporate governance requirements – (audit committees) Profession: ACCA (education, training, monitoring & investigation of

members & disciplinary action)

Firm level: created by firm leadership Creating a culture of integrity & honesty (via leadership) Recruitment of qualified staff Training & development Performance appraisal Disciplinary action

Individual level: created by individuals Continuing professional development Getting advice from a mentor Maintaining a record of situations in which independence was threatened &

how it was subsequently resolved

P7 Lecture 4 Code of Ethics Conduct

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