Judgemental anc ethical decision-making frameworks associated professional standards ‘The overiding objective of this textbook is o buld a foundation with which io analyse cunrent professional ‘esues and adapt audit approaches to business and economic complexities. Though studying this chapter, you wil be able to | Aticuate @ general farmencrk for making high-quality pcfessional decisions and apply this remenert in selected auct setings Deserve why etfical behaviour by audios is requred to sy the pub's wust Deserve erica! theories hal canbe weed in adctessing obical probes. ‘Ariuiote @ Fatrewerk for mekeng high-qualty ethical decisions ard apply this femewark in sected saticgs, Explth how varous requremenis the CLERP 9 Act of 2004 and tha ASX Corporate Governance CGuicelnes infaied ip 2006 reflect previous eric! laces in erofessioral judgement on the past of Snarciel make pacipants ard sel the tone for proved etical cecision-making. Describe ard analy the independence mus of the Corporations Act 200% and of the APESE's APES 110.Code of Ethics for Professional Accounts. [Discuss the importance ot ndeperdenos tothe plc acoounting profession. [Dscuss the major tveats to independence ard approaches to riigale those treats, Discuss the auc commitee's responsbiltes related to the indepandence ofthe extemal aur. <> Loget taycHarsER 5» ‘A profession that exists to seive the public must assuro chat its services are performed at the highest devel of quay. and ‘This chapter intraduees a general framework depicting how to make high-quality professional Gecisions. In addition, the chapter imoduoes a more specific ethical decision-making famework, duswating considerations that professionals should weigh up as ‘hey sttempt to make challenging ethical judgements. We discuss the GLERP 9 Act, introduced in (Chapter 2, by Mustating how many ofits requirements seek io curb the potential for ethical lapses in professional judgement on the part of auditors, management and other parties invelved in corporate sgavemance, We also describe the APESB's Cade of Bthics for rofessianal Accountants. Finally, we ‘articulate the fundamental importance of auditor independence and, detail the rules, some of which liferentiate between listed and unlisted entities, concerning this issue for aucitors. In terms of te aut ‘opinion or review conclusion fommulation process, this chapter focuses on the fundemental building blocks regexding decision-making, professional conduct and ethics. Tne audio ofthe feled Witmot Forests group, Davis ‘Amnsvong, vito has vetied the company's accounts every yor since atleast 2006, has emerged as an investor and an Unsecured credtr af the group, rowing nto quasion nis independence as aucier. ussnassDay has lean al be Astong, whos rok resigned as Wilmot’ aude, isaleacing gue behind one of he | growergieurs thats tying to that moves by the Comment arcane St George Beri orertove Wits acmnistatr, the | suburban insolvency prectione: Tom Fereancez 1 On otobar 1 Mr Asmstrang wrote a four nage letter to ‘roars, who are owed donut $400 milo, ugg them 10 ‘copose ihe barks’ moves. Trelberis, owed mere than $120 miton, have gamered the suppor of the Ausvatan Secunties and vestments ‘As you ead this chapter, consider tis case and th ‘olowing questions: ‘wy is oning shares n one's cient considered inappropriate? ‘Why isitimpotert nat austors beindependentct hot cians? Inwhel croumstances can regalaryorproessionalbody ‘acton ke then fer aleged breaches of auctio ndopandencs? (Commission as they fro tne Feceral Court h Melbourne is meming seeking Mr Femande's remove “The banks clam Mr Fercendez, of Femandez Pare, a small aoccunting andinsovency fim in Mefoourre's eastern suburbs, dogs rot have the resources or experiance fo manage large and cemalicated insoWarcy such as Miimctt ‘The compary/s auditor, Mr Amstiong, Howes, has throne his suppor betind Wamot! Acton Group. wich wants Me Femarde2 retaned Inf lote of October 1, Mr Ametrarg det clr tal he wes wring to iow growers ‘tn my cansciy 3s an estar 2 Wilmott Forests Plantaon ard an unsecured creator of | Wilmot Forests Limited. He signed ho tier: Da Amistonig FCA WBA (Met), Aumsttong Parnes, Chater Acountanis, (Wilmot Forests LimtecAut ey. ‘Assume atthe grate on the etter | sn the cas di not ake cles eat it wes fom the company’s attr art {hen an anonymous tp 6 ASIC carne rom (one ofthe aut engagement team member. ‘What woukl be that nduicuals ethical dierrena. In terms of whistebiowang to ASIC about the sition?Part 13> vot ea a) peer ise cE i Research shows that companies with strong corporate governance, high-quality decision-making and high ethical standards generally perform better and have higher-quality financial information than those that are weak on these dimensions. Investigations into the world’s largest bankruptcies to date (HIH Led in Australia and WorldCom and Enron in the US) show that poor decision- making, inappropriate corporate cultures and ethical standards, and weak governance were ‘important factors in their collapse. Top management was overly concerned about meeting earnings expectations andl generating personal fortunes and took extreme measures to create the ilusion of companies that looked good on paper but were actually free-falling towards collapse. The corporate culture was one where employees knew about, or were concemed about, wrongdoing but were affaid to report it; the boards of directors were passive and ineffective; the extemal auditors arguably were preoccupied with keeping the clients! consulting business; and bankers ‘were so permissive they failed to uncover routine warning signs, Some of the partners of Authur Andersen, at one time the largest public accounting frm in the ‘world and the auditor of all sbove-named companies, were drawn into the delusion of sharing these fortunes and tured a blind eye to the financial reporting risstatements management was perpetrating. Barbara Ley ‘Toffler was partner-incharge of Andersen's Bthies & Responsible Business Practices consulting services, In her book Final Accounting — Ambition, Greed, ant the Fall of Arter Andersen, she chronicles how a culture of arrogance and greed infected her frm and led to crucial lapses in judgement among her peers.' ‘The firm, once regarded by many as the Dest public accounting firm in the world, changed its philosophy from 'we do it right’ to ‘keep the client happy’. Andersen was forced into bankruptey in the US after being in business for 88 yenrs ‘and it saon collapsed in Australia too, In this chapter, we first introduce a general framework for making professional decisions and then follow up with a more specific framework for making ethically difficult decisions. Throughout the textbook, we will ask you to return to these frameworks, applying them in the various sulting contexts that are the subject of subsequent chapters. Next, we discuss the APESB's principles and rules of professional conduct, which serve as guides in making professional decisions, both general ‘and those that are ethically charged, Finally, we discuss the notion of auclitor independence in tail, including an examination of why independence is fundamental to the aualting profession. We summarise relevant professional pronouncements at the end of the chapter. A FRAMEWORK FOR PROFESSIONAL DECISION-MAKING ‘Auditors add value to the financial markets by making high-quality decisions associated with thelr evaluation of client nancial zeports. High-quality decisions ate unbiased, meet the expectations of "rae rors Ly. Bil Arian = Abie, Grd, aud the Fal of Arr Andere (Nee Ye Bry Bos,JoDGEREATAL AND ETHICAL DECESLON-HAKING users, are in compliance with professional standards and are based on sufficient factual information to justity he decision that js rendered, For example, auditors have Lo make decisions about the types ‘of evidence to gather, how to evaluate that evidence, when to gather additional evidence, and what conclusions are appropriate given the knowledge that they have gained via the evidence, Ultimately, auditors have to decide whether te client's Mnancial report contains any departures from ‘accounting standards that would materially affect the judgement of users ofthe financial report ‘This type of decision-making situation is comunon among professionals. For example, consider a doctor trying to diagnose the illness of a patient, The doctor must decide what tests to orir, how to interpret the test results and when to order additional tests (how many and what type), and must ultimately diagnose any potential illness in the patient. In order to make complex, difficult and important decisions such as these, professionals ean benefit from a structured approach to their decision-making, as depicted in Exhibit 3.1, In Step 1, the auditor structures the problem, considering the relevant parties to involve in the decision process, \dentifying various feasible alternatives, considering how to evaluate the altertatives, identifying uncertainties or risks and determining how to structure the problem. To ilustzate these tasks, consider a cammon decision that auditors face ~ determining whether a clients inventory values are fairly stated in accordance with accounting standards. Auditors work within an ‘aval probiom | 1. Sieur the | [7 Saseoes 2 Assess | tisk ana ‘consequences o uncertainties of the ‘decison | aut problem %.Evaloate nformation/aust evidence. gathering atematves 5. Conduct 6. Gather sensi Infermation/audt | “araiyss ‘evsonce ecison about ‘aut problem | | | 7. Make | l cuaprer 59>Pawr 1 >> noens' organisational hierarchy with clearly defined roles about appropriate types of auditors that shoold participate in inventory testing (© less experienced auditors may conduct inventory test counts, but industry experts may consider the valuation of complex inventory items). In addition, auditors consider which individuals at the clint are most qualified to assess inventory values. Auditors also identify easible alternatives about the inventory balance. For example, iit falry stated, overstated, understated? Consideration will also be given to the evidence necessary to determine accurate inventory valuation (e.g. observing the inventory, referencing outside prices of the inventory and evaluating potential obsolescence). Auditors also have to evaluate the risk that the evidence they collect may not necessarily be diagnostic of the true, underlying value of the inventory. In other ‘words, there isa risk that despite the work that they perform, their conclusions may be incorrect. ‘The final stage of Step 1 includes structuring the problem, and professional guidance exists to assist In this process (see Chapter 11 on auditing standards concerning inventory valuation), In Step 2, the auditor assesses the consequences of the potential alternatives. Considerations at this stage include dotormining the dimensions on which to evaluate the alternatives and how to ‘weight those dimensions. Continuing the preceding example, the anditor wil have to consider the consequences of various inventory valuation alternatives and whether a particular valuation alternative is more or less appropriate than the other available alternatives. If the auditor deekles ‘thatthe inventory is fairly stated and that che valuation methodology is appropriate, and that isin fact the case, then there are no negative consequences to the decision. However, if the auditor reaches an incorrect conclusion, then stakeholders may be misled, exposing auditors to litigation and reputation damage. In Step 3, the auditor assesses the risks and uncertaintes in the situation. Those risks and uncertainties are related to (a) the risks the audit client faces, (b) the quality of evidence the auditor gathers and (c) the sufficiency of audit evidence gathered. In other words, there are risks related to a particular client and there are risks in gathering sufficient audit evidence. All of these risks need to be assessed in determining the appropriate information to gather. In Step 4, the auditor evaluates the various information/audit evidence-gathering altematives against an appropriate decision rule, For auditors, decision rules are often articulate in terms of accounting or auditing standards, In our example, inventory valuation rules under aecounting standards and generally accepled accounting principles may provide necessary guidance Lo assist in the decision-making process. Further, auditing standards articulate rules regarding appropriate cvidence-gathering strategies that must be folowed when auditing inventory values. In Step 5, the auditor considers the sensitivity of the conclusions reached in Steps 2, and 4 to Incorrect assumptions. It may be, given the results of the earlier steps, that the auditor can determine enough evidence has heen gathered to support (or not support), aba convincing level of certainty, that the audit problem being evaluated can be answered appropriately. Continuing the preceding example, it may be that the auctor’ initial evidence gathering and risk analysis enables ‘ definitive conclusion. tn that ease, the auditor can move on to Step 7. Hawever, there may sill be significant uncertainties to resolve, For example, in the case of inventory, there may be variation in avallable market values against which to compare the historical costs of inventory on the client's financial statements. As such, the true inventory value may fall within a range, so the client and auditor will have to use their professional judgement to determine a value that is most reflective of ‘economic reality, In such a situation, the auditor wil have to complete Step 6 of the process In Step 6, the auditor gathers information and audit evidence in an iterative process that affects considerations about the consequences of potential alternatives and the uncertainties associatedcarter 5 >> JUDGEMENTAL Aud ETHICAL DECESLON-RAKING FRAMEWORKS AND ASSOCIATED PROFESSIONAL. StANDAnDS ‘with those judgements. Importantly, the auditor considers the costs and benefits of information acquisition, Inowing that gathering additional evidence requires time, elfort and money. Given that a private sector audit is a for-profit enterprise, cost-benefit considerations in evidence gathering are particularly important. A good auditor knows ‘when lo say wher’ and decides to stop collecting evidence at the right time. In contrast, some auditors stop evidence collection too soon, therety -ylelding inadequate eviclence on which to make a decision. Stll others continue evidence collection even though the current evidence is adequate, thereby contributing to inefficiency and reduced profitability inthe audit ‘The auditor iterates Steps 1 through 6 repeatedly unt satisfied that a decision ean prudently bbe made, In Step 7, the auditor needs to make the difficult determination of whether the problem has been suliciently analysed and whether the risk of making an incorrect decision has been minimised to an acceptable level by collecting adequate, convincing evidence. Ultimately, the auditor must make and document the decision reached. Throughout the text and chapter problems, we will lustrate other applications ofthis decision analysis framework. Next, we turn to ‘2 more specific decision setting, one invalving the resolution of ethically charged issues. ACCEPTING A PUBLIC TRUST ‘The public accounting profession has worked hard to gain the public trust and benefits monetary from that trust as the sole legally acceptable provider of audit and review services over historical Financial information for companies and other organisations. For that trust and economic Loz advantage to be maintained, it is essential that: professional integrity be based on personal maral standards and reinforced by codes of conduct. Whenever a ‘scandal’ surfaces, the profession is | «diminished and often one oF more auditors are personally ruined. It is not dificult to find oneself in ethically compromising situations without realising it. During the course of an audit, for example, ‘an auditor may become aware of a client’ plans that will likely clouble the market value of its shares. Suppose the auctor has a roommate Irom college who would lke to know about the lnvestment opportunity. The roommate does not have a large investment portfolio, o sharing this knowledge would not affect the market. Should the auditor be allowed to share the information vith the roommate? Or, consider the case from the Professional Judgement in Contest scensrio described at the outset of the chapler. Imagine the ethical choice that a member of the auclt | ‘engzigement team would face in whistleblowing to the professional accounting bodies or to ASIG hhad the letter not been written, Whether to whistleblow and potentially damage a enreer or to jgnore the matter and possibly rationalise the aueltor's actions as inconsequential given the ‘minimal impact on the market, would create a real ethieal dilemma, Acoounting professionals are often faced with these types of dificult ethical choices, In such situations, a defined methodology is helpful in resolving the situation in a thoughtful, high-quality ‘manner. An ethical problem oceurs when an individual is morally or ethically required to take an action that may conflict with his or her immediate self-interest, An ethical dilemma eccurs when there are conflicting moral duties or obligations, such as paying a debt to one person when there is‘equal indebtedness to another person and sulicient funds do not exist to repay both. Coraplex ethical dilerimas do not lend themselves to simple ‘right’ or ‘wrong? decisions. ETHICAL THEORIES Bthical theories are helpful in assisting individuals in dealing with both ethical problems ancl ethical dilemmas. Two such theories ~ the utlitarian theory and the rights theory ~ provide references that have influenced the development of codes of conduct and can be used by professionals in dealing with ethically challenging situations. Uliltarian theory “Utititacian theory holds that what is ethical is the action that achieves the greatest good for the greatest nuraber of people. Actions that result in outcomes that fll short of the greatest good for the greatest number and those that represent inellicient means to accomplish such ends are less desirable, Utitarianism requires the following: ‘an identification of the potential problem ancl courses of action "an identification of the potential direct or indirect impact of actions on each affected party {ote referred to as stalholdexs) who may have a vested interest in the outcome of actions taken + an assessment of the desirability (gocdness) of each action » an overall assessment of the greatest goo! forthe greatest number: Uniiuarianism requires that individuals not advocate or choose alternatives that favour narrow interests or that serve the greatest good in an inefficient manner. There can be honest disagreements about the ikely impact of actions or the relative effcieney of different actions in ‘attaining desired ends, There are also potential problems in measuring what constitutes ‘the ‘greatest good’ in a particular circumstance. One problem with the wtiltarian theory isthe implicit assumption that the ‘ends achieved? justify the means. Unfortunately, such an approach can lead to disagirous courses of actions when those making the decisions fll adequately measure oF assess the potential costs and benefits. Thus, ethicists generally argue that uiltarian arguments shoukd be mitigated by some value-based approach. The rights theory approach presents sucha framework. Rights theory Rights theory focuses on evaluating actions based on the fundamental rights of the parties involved. But_not all rights are equal. In the hierarchy of rights, higher-onler rights take precedence over lower-order rights. The highesl-order rights include the right to lif, to autonomy and to human dignity, Second-order rights inchide rights granted by the government, such as cll rights, legal rights, rights to own property and licence privileges. Thirdorder rights are social rigits, such ag the right to higher education, to good health care and to earning a living, The towest-level, fourth-order rights are related to one's non-esseral inuerests or ones tastes, such a5 the right to get sch, to play golf or to be attractively dressed. Rights theory requires that the rights’ of affected parties should be examined as @ constraint on ethical decision-making, The rights approach is most eflectve in identiving outcomes that ought to be automatically eliminated, such asthe ‘Robin Hood approach’ of robbing from the rich to give to the poor, or in Wentiying situations in which the uttaian answer would be at odds with most societal valuescenaprer 32> JUDGENENTAL AND ETHICAL DECISLON-HAKING FRANEHORXS AND ASSOCIATED PROFESSIONAL STANDARDS AN ETHICAL FRAMEWORK ‘The following framework is derived from the utilitarianism and rights theories and defines an ppronch to addressing complex issues not addressed by the profession's cade or when elements of the code seem to be in conflict: 5 Identify the ethical issue(s). 1 Determine who are the affected partes and identify their rights. 1 Determine the most important rights Develop alternative courses of action Determine the likely consequences of each proposed course of action, _ Assess the possible consequences, including an estimation of the greatest good for the greatest number, Determine whether the rights framework would cause any course of action to be eliminated, * Decide on the appropriate course of action ‘The following case, similar to an actual situation, is presented to show how to apply this ‘ramework to auiting and other assurance situations. jpplying the ethical framework: Ideniy the ethical issue(s) The puble accounting frm providing suit services fo a client, Payroll Processors Ltd, believes Payroll Processors might go bankrupt. Several clients of the public accounting fm use the pay procesing snsces of Payroll Processors Should the other cents be provided with this confidential information prior to the information being publicly available through the avltor’s report? - Determine who are the alfected patties and identify their rights The relevant parties to the issue include the following: * Payroll Processors and its management * Payrol Processors’ current and prospective customers, ereitors snl investors =the public accounting frm and its other clients + the public accounting profession, Listing those potentially affected by the decision is easier than identifying their rights. The following, however, are some of the rights involved: ® Company management has the right to assume Uat conlidential information obtained by ite auditors will remain confidential unless disclosure is permitted by te company’ or is required by accounting or auditing stalards or the legal system. » Payroll Processors’ current and prospective customers, creditors and investors have a right to receive reliable information and not be denied information that others receive. The public accounting firm has the right to expect its professionals to follow the professional standards, However, some may feel pressure to protect thelr existing clients’ welfare ‘The public accounting profession has the right Lo expecta its members to uphold the Code of Ethies for Professional Accountants and to take actions that enhance the general reputation and perception of the Integrity of the profession. The ethics ruling on confidentiality was designed to assure a free flow of information between the client and the auditor. Such Information flow is considered necessary to the efficient and effective conduct of an audit engagement.Parr 1 >> Uunensrawotne aupiTon ResronsiasLiries Determine the most important tights Many auditors would assess that the most important rights are those of (1) Payroll Processors to not have confidential information isuproperly disclosed; (users to receive reliable information; and (3) the profession to retain its reputation for trust and assurance that effective audits will occur. Develop alternative courses of action ‘The possible courses of action are (1) share the confidential information with the other ellens of the public accounting frm prior to issuing an auditor’ opinion ‘on the elient’s financial report or (2) do not share that information prior to issuing an auditor's ‘opinion on the client's financial report. The public accounting frm was performing audit work, and i the professional standards require that the auditors disclose their reservations about: Payroll Processors remaining a going concern in their auditor's report, not in private information given to ' selected entities, Thus, that going-concern reservation would serve as a flag to anyone who reads ‘the annual report, A | Determine the likely consequences L_ Share the tnformation prior to issuing the auditor's opinion ~ Sharing this information with, | the other clients prior ta issuing an audit report with a going-concem reservation may cause q these other clients to take their business away ftom Payroll Processors, thus increasing the likelihood of bankruptey for Payroll Processors. It might also increase the possibilty of the public accounting firm being found in violation of the rules of conduct and being sued by Payroll Processors or others for inappropriately providing confidential information to selected parties outside of the public role that such publ accounting firms full i ‘The engagement team member may also have his or her registered company auditor licence suspended or revoked and perhaps be subject to the discipline of a professional body to which | the member belongs. Other Payroll Processors’ clients who co not receive the information because they are not the public accounting firm's clients will be pul at a competitive disadvantage, and they may sue te auditor because of discriminatory disclosure, 2 Do not share the information until the qutitor’s report has been issued ~ If the {formation is not sharec with the other clients, those clients might take their audit business elsewhere if they find out te auditors knew of this problem and did not share it with them. Other clients of Payroll Processors may suffer losses because of te financial problems of Payroll Processors. Assess the possible consequences and estimate the greatest good forte greatest number Sharing the information may help other ellents move their payroll processing business to other service providers in a mote orderly manner and more quickly than would happen if they had to wait until the auditor's opinion was issued. However, other Payroll Processors’ customers may be placed at-a dlisadvantage if Payroll Processors does go bankrupt and their payroll provessing is disrupted Payroll Processors’ employees will lose thelr Jobs more quickly andl its investors are likely to lose mote money more quickly. Its right to have confidential information remain confidential wil be violated, There may be less confidence in the profession because of discriminatory or unauthorised disclosure of information. Management of other firms may be reluctant to share other non-financial information with auditing firms. After assessing the relative benefils of disclosing vs. not disclosing the information prior to issuing the auelitor's opinion, it appears thatthe greatest good is served by not sharing the information selectively with current audit clients, but to complete the audit and {ssue the aueit opinion in a timely mannercuaeten 5 >> LJUDOERENTAL AUD ETHICAL DECISION-RAKING FRAMENORKS AUD ASSOCIATED PROFESSIONAL. STANDARDS ne 0 the mary problems encountered inthe iM Led (Char woud never permit the auctor fo moet with audit © ergagemant wes thatthe CEO/Char of he board postion was committee members wihout his beg present ihe, ancineid by a dominating personelty, The CEO Decide on the appropriate course of action The suitor should not shate the information prior to Issuing the auditor’s opinion. The auelitor may encourage Payroll Processors to share its state of alfirs with its clients but cannot dictate thet it do so, ‘The need for equity and confidentiality of information dictates that the auditor's major course of communication is Ukrough formal auelit reports associated with the financial report, 1 i= ‘The financial scandals and associated market fallout inthe early 2000s were a dramatic illustration (os) ‘of the costs of inappropriate ethical decisions by vavious parties, weak corporate governance, poor auditor decision-making ancl insufficient auditor independence. The bankruptcies of HIH Ltd and One‘Tet in Australia and collapse of Andersen as a consequence of the collapses in the US of Enron ‘and WorldCom were such clramatic and large-scale events that the Federal Government felt [i compelled to respond, and it id so in the form of the CLERP 9 Act 2004 (refer also to Chapter 2). [et ‘This Act made amendments and additions to the Austratian Securities and Investments Commission Act 2001 (ASIG Act) ancl the Corporations Act 2001. Bxhibls 8.61 summarises the ‘major relevant provisions ofthe CLERP 9 Act. 4s is clear from reading Exhibit 3.E1, various sections of the CLERP 9 Act were written to respon to various abuses of the Onancial reporting process in the early 2000s, and many provisions affect auditors and the auditing profession directly. Auditor independence requirements ‘were enhanced through general and specific independence rules added to the Corporations Act 2001. For example, section 324DA of the Corporations Act introduced a requirement for aul partner rotation every five years. Section 24CH introduced ‘cooling off periods for ex-auitors before they are permitted to take up positions with former audi clients, Section 300(11) enhanced disclosures related to auditor-provided non-audit services ta include thelt dollar value by category with an explanation in the directors’ report of how the provision of these services did not compromise independence. Section 225(2) of the ASIC Act effectively removed self-regulation of the aueiting profession 4 ‘and replaced it with independent oversight by the Financial Reporting Council (PRC) and gave A legal backing to auditing standards in the way that accounting standards had been strengthenedre Paw 1 >> UWwoERsraKDING AUDITOR RESPOWSIOTLITIES 3 A Aree a {Go10) on ie testncn GUlcel Hite) clevennel decades earlier, ASIC hnd always had responsiblity for enforcement but ASIC's audit frm tnepection powers were strengthened in 2007 with passage of the Australian Securities ana lpmestments Commission Amendment (Audét Inspection) Act 2007 No. 1, 2007. Section '200(115, together with changes to the profession’ code of ete, rechuced the ability of accounting firms to provide some lypes of consulting services to audit clients In terms of financial reporting, fentaneed disclosures in the directors’ report in relation to directors’ other directorships and other Charactersties were mandated, Section 295A introduced a requirement for lsted companies that CEOs and CFOs must provide directors with a declaration in respect of the Mnancial vecords dnd the financial statements and notes. Part 94AAA Introduced protection for corporate Whistleblowers. Th terms of aspects more in the favour of auditors, «legal liability regime change that auditors had been requesting for many years, proportionate Tnbiity, wos enacted as part of CLERP 8. Basically, this change means that auditors (and other professionals) are ro longer lable for the hare of courl-dlrected directors’ or others’ damages if those parties are bankrupt, Finally, many Sections of the CLERP 9 Act significantly enhanced the penalties for criminal wrongdoing affecting the sveurities markets, individual shareholders and the general publi, including eriinal Habily for breaches of the continuous disclosure regime. The ASX Gororate Govenace eo ee ceccre When HIH Insurance Lid collapsed in 2001, Australia had no welkestablished or accepted fnaidetnes for eorporate governance. The Ramsay Report (2002) into the independence of nditors, commissioned by the Goverment upon the eallapse of HIH, wd recommended that the ‘ASX take on this responsibilty and iit did not, then the Government should through legsiation. In 2008, the recently formed ASX Corporate Governance Council resporkled withthe fist etion of iis Principles of Good Corporate Governance and Best Practice Recommendations, having in Moreh 2009 introduced a requirement that the top 600 companies establish auctt committees, ‘Aor a review in 2007 of the operation ofthis requiteent, it was amersied to Listing Rule 12.7 ‘vhieh requizes a company in the SAP All Ordinates Index atthe beginning fits financial yea" to have an audit commitiee during that year I the company’ was in the SSPIASK top 200 of that index at the beginning of its financial year, it must folow the Recommendations of the ASX Corporate Govemance Counell on the composition, operation and responsibly of the audit commitiee, Exhibit 262 summarises the 2010 version of the ASK Comporate Governance Principles and Recommendations. Since its inception, the ASX Corporate Governance Council har declined to take a ‘one size fits al! approach and so the recommendations remain just that ‘The only requirement is to disclose non-compliance and the reasons therefore If specific recommendations are not adopted,cuaeten 39> JUDGEMENTAL AND ETHICAL BECCSION-NAKING FRAMEVORKS AUD ASSOCIATED PROFESSIONAL. sranDARDS _Aueltors need to exhibit the highest standard of ethical principles in order to function. For example, if the public does not have confidence in the independence anc integrity of auditors, citizens will, not subseribe any value to auditors work. But not all public acountants serve the same audience or are memibers of professional accounting bodies. Additionally, there is a need for ethical behaviour across global entities. Thus auelitors should also be aware of the ethical standards issued by the International Federation of Accountants (IFAC) via the International Ethies Board for Accountants (IESBA). Austealia's Code of Bucs for Professional Accountants is based on IPAC's work. ‘The Accounting Professional Ethics Standards Board (APESB) was formed by CPA Australia ‘and the Institute of Chartered Accountants in Australia in 2006, with the then National Instizute of ‘Accountants joining later. Its formation was arguably a reaction by the profession to have its codes fof conduct in relation to professional practice removed to some extent from a sel/-regulatory approach to a more independent body, albell still funded by the profession. The APESB has continued to adopt and amend for Australian jurisdictional requirements the ethical standards issued by the IBSBA as well as updating or developing Australian-speeiic pronouncements on proctice-related matters. At the time of writing the APESB has issued the following pronouncements: = APES 110 Gode of Ethics for Professional Accountants APES 205 Conformity with Accounting Standards APES 210 Conformity with Auditing and Assurance Standards APES 215 Forensic Accounting Services APBS 220 Taxation Services APES 226 Valuation Services APES 205 Terms of Bngagement APES 815 Compilation of Financial Information APES 820 Quality Control for Pirms® APES 890 insolvency Services = APES 345 Reporting om Prospective Financial Information. INTERNATIONAL ETHICS STANDARDS BOARD FOR ACCOUNTANTS + "The International Bthics Standards Boord for Accountants (IBSBA) (and consequently Australia 2 {o0) has taken a broad approach to ethical conduct. It nas set out principles chat permeate all ofthe | ‘ther standards. The Code of Bthics requires accountants to adhere to ive urcamental principles: = Integrity - A professional accountant should be straightforward and honest in performing professional services. * Objectivity ~ A professional accountant should not allow bias, conflict of interest or undue Influence of others to override professional or business judgements, © Professional competence ancl de care ~ A professional accountant has a continuing duty to ‘maintain professional knowledge and skill ab the level required to assure that a client ot p85 300 Qual Conta for Fires ove alot lew eontnt othe AUASBs ASC 1 Quality Cntr far Firms that Pore susan Revie of Forel Reports aed Odor Pact! Infra, a Cor sure Engen ® . ot ASE In fee or tty ses a a whereas APIS 0 dos wotParr 1 > os 0 employer receives competent professional service based on current developments. A professional accountant should act diligently and in accordance with appliable technical and professional standards wlten providing professional services. © Confidentiality - A professional accountant 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. Confidential information acquired as a result of professional ‘and business relationships should not be used for the personal advantage of the professional ‘accountant or third parties, = Professional behaviour - A professional accountant should comply with relevant laws and regulations and should avoid any action that diseredits the profession.* ‘The IESBA focuses on fundamental principles that should guide auditor decision-making in every situation, For example, there Is a strong, focus on objectivity and integrity APES 110 PRINCIPLES FOR ACHIEVING INDEPENDENCE ‘The fundamental principles, presented above, provide a broad framework for professional conduct under APES 110 Code of Bthics for Professional Accountants and represent an authoritative gulce to professional behaviour, APES 110 develops the conceptual framework to be used by those in public practice and those working as professional accountants in industry or business, I develops guidance on specific applications of the conceptual framework in both these employment contexts, Professional aecountants covered by APES 110 (Le. members of CPAA, the CAA and the IPA) are to be guided not merely by the Lerins but also by the spit of the Code in its entirety ‘The conceptual framework recognises that absolute independence is not possible to achieve. Tt provides principles that members of assurance teams and firms should use to: (1) identify threats to independence; (2) evaluate the significance of those Unreats; and (3) eliminate the threats or reduce them to an acceptable level by the application of safeguards. Acceptable level is defined as a level at which a reasonable and informed third party would be likely to conclude, weighing all the specific facts and elreumstances available at that Lime, that compliance with the fundamental principles is not compromised. Five primary categories of teats to independence are conceptualised © Selfiinterest threats ~ the threat that a financial or other interest wil inappropriately influence Judgement or behaviour (APES 110.100.12a). 4 Selfreview threats — the threal that appropriate evaluation of the results of @ previous judgement made or service performed by the pracitioner, or by another individual within the practitioner's frm or employing organisation, on which the practitioner will ely when forming a Judgement as part of providing a current service (APES 110.100.12b) © “Advocacy sereais — the thveal that a practitioner will promote a client's or employer's position 1 the point that the practitioner's objectivity is compromised (APES 110. 100120). © Familiarity Wireats - the threat that due lo a long oF close relationship with a client or ‘employer, a rember will be too sympathetic to their interests or too accepting of their work (APRS 110.100120), Intimidation threats ~ the threat that a practitioner will be deterred from acting objectively because of actual or perceived pressures, including attempts to exercise undue inviuence over the practitioner (APES 110.100.126). suis IPA Tite ies Proouncrments of it rst ede ef Aas tt tt heen Dstt ary,Safeguards to eliminate threats or reduce them to an acceptable level fll into two broad areas: = Thove crested by the profession, legislation or regulation, eg, professional standards and a monitoring and disciplinary process. ‘Those existing within the work environment, eg. and those within the firm's own systems and procedures (APES 110,100.13) In the next sections, some of the most obvious threats ta independence and the Cerporntions Act 2001 and Professional Statement requirements in relation to those threats are discussed briefly; however, there is no substitute for reading APES 110 in its entirety. The end of chapter ‘questions require access to APES 110 (https/wwvapesb.org.au) since the document at over 140 pages cannot be done justice within this text, Specifically, it is Section 290 that deals with independence in relation to audit and review and engagements and Section 291 that deals with other assurance engagements, that are important to understand. The content of Section 290 is summarised briefly in Exhibit 82 in terms of application of the conceptual framework to independence. Before commencing the discussion it is important to define two terms newly introduced into the December 2010 version of APES 110: ie interest entities all iste entities » any entity defined by regulation or legislation as a public interest entity (PIE); © any entity for which the auditis required by regulation or legislation to be conducted in compliance ‘ith the same independence requirements that apply tothe audit of listed entities; and other entities may be treated as PIES entities because they have large nuruber and wide range of stakehokders, Factors to be considered incinde: the nature of the business, such as the aking of assets in a fiduciary capacity fora large ‘umber of stakehoklers (eg banks and insurance companies, and pension funds); sine; and © number of employees (APES 110.29026 and 26), key audit partner © The engagement partner, the individual responsible for the engagement qually control review, andl other audit partners, f any, on the engasement team who make key decisions or judgments on significant matters with respect to the audit of the Mnancial statements on which te fmm will express an opinion, Depending upon the circumstances and the role of the individuals on the audit, ‘other audit partners’ may include, for example, audit pariners responsible for significant subsidiaries or divisions (APES 1102. canter 5 >> ‘Financial interests ~ self interest threats (APES 110.290.102-117.1) 1 no dtotfrancllintret ox material nates rant ere the een or ‘memes of to dt team immer omy menioers of members ofthe act teem 6 parinote within the pul aocouning fm, patina and managerial persanel providing non ad srvces the public accountng fm providing the ae ree series + safeguards tobe apple fr aut eam members witha coos fry member zon to have a dec aca teres financial interest in the at ci,Paer 1 > 7 eiernivaion hy members oft au eam as to what entero tne ce eleguares need or any naa snanctintreets in ait cent hel by oterindiduals, including pares end profesional employees ofthe fn ote than those eee to Shove. oe tie imnpeciate family meets and maviulevah @ ose petsone]rationship with a meraer ofthe aut ean, vretvonent woke ate doomed otto compromise independence public aooounting fm has estebished policies and procedures that reve pomptndteaten ef any breads epprcpistnctions ae taken and the tm apples aber sears when necessary tore ay ‘ening treat to an acceptable level. owevet unless the won stil an inconsequential the fm shouk document and ses ‘nth those charged with governance ‘oars and Guarantees ~ self interest throats (APES 110.290.118-128) pans er guarantees om fara] nstution sk cent nd deposits or broketoge wth @ bank oF broker auton ade reer wel | oes teresa emai seine 2 mere ofthe aa eam |b acitteem mambo nmodate fam, and public accounting fms. Saloqutds need ft oar ram ancl nstaben under noma ending ‘audit cent and pubic nooouing fm recent oan loans o¢ gustan fem audit cents tata ‘meme ofan aud eam member ae only aoe ‘the pubic accountng fim, 2 tember ofthe aud am, € immedi fay member of suc team ember ane tiedlent vtges, rn and condltions to audit cent tat ere material © son-Snancla nations fom a pubic accounting fin, quit eam member, immediate amily abl ifinaateral 0 ‘Business Relationships ~ sei incorect or intimation threats (APES 110290.424-126) ty mmateial nance mtetess or nsgniicant bssnese eatonships (eg yt ventures, anangements to came one o mote series ot products ond detabutn or aeting arrangements) the puble accoutig ia, ra rember of he aut eam, ota mea emly {ember af uct team and othe cent rts managenen, are aoceptaDe he mcs the holding ofan interes se closey-held erty wen the aut cent ora eteta cafe ofthe cent or any group Meret ‘soo{tlde an niet in hat ent a long asthe Rn ntrest ous nt gi the aby to cartel the clone hed ent bya pubic acenating fir, of @ member of he cit Team, ra menibe of tative’ iment ary, talegunids to be pad fot business eatonshipe between immediate famly members ol an auc warm member end aud cle or ts | management Ties mogiitud creates a nee fr safeguards the parcheae af good an services fom an aut chentin the sonal couse of business a a ‘alg acoptable fo ‘public accounting fm 1 member of te a eam immer family member of aut team mess Family and Personal Relationships ~sel-nteres, familiarity or intimidation threats (APPS 110.290.127-198.1) tenn be an aut teary mernber when a7 mmeciatefamly members doctor or oficet ofthe aut cen, fan euoyoe m a postin cng any pend covered by the engagement othe fnancnsiarements to exo simaicant vec ever reparation of ett secon eco oF the nancial raters + salequatés eee wien member of uct tam has {an onmedive family member who an emnioyee ina position to exe sigan nfuence 0 evfrmanco oF oa Sows bb cose fay members vo ‘deter olin aft auc cont. Shemoloyee ing postion dunn any pened covered by the engagement othe financial sateen to exe lia ene ave propnation of eben accounting roars ote Franc sstemens «a dase celatonshuo wit «pero who snot an immediate or cose famuly member but who the chen’ nant pesto, fnancialcarrer 5 > JUDGEMENTAL AUD ETHICAL BECESTON-MAKING FRANEVORKS AND ASSOCIATED PROFESSIONAL STANDARDS RTT 8 eco: ocr of the aut chen _an employee in poston citing any pened ooveted by the engegeent cr the ancl tazaments to exat patation of ees eccounting cars rte nancial statements safeguards are needed when petsona ot fami rlatinships east boswoon a partner or amployo ofthe puble aeceunting fm who ie not a rember of he auait team: | a eetrecen or oie of te act cent: and an employee ina poston to exer significant intuence avr the preparation ofthe cents aecounting records or the fnanell statements, snadvrtat victors ae desned not to compromise independence i pubic accouting fm has established policies and prooedues that squire pomp notfeaion of any beaches. appropriate acons are taken end the fim apples other safeguards wien necessary to reduce ay remaining thet tan acoeptale lve, However, ules the Violation sila incansacvestial the ern shou acumen and sous it | sm tose charged wit governance. han ues eve ‘Employment with an Audit Client ~ familiarity or intimidation threats - differential PIE requirements (APES 110.290:134-141) * part om tho exoepton below, the folowing indvidusis join the ua ont asa crecar x oficr anda sigan connection remains betwen th fra and the individual, the public socounting frm cannot eran es suc: f fomer member af the auct team or partner ofthe fot » employe in a position te exert signcant inence ver preparation ofthe ellon's accounting vcore ox an exeeption othe above oocus wien 2 te ndvdal i not ented o any beneNts ox payment fem the pubic acoaunting fim unless made in accardance with Ke determined rangement bb any amcunt owed oth individuals ot matt the fmm; and {© thelnalidual doos ne: continu ts participate or appears nacpate nthe frm’a business preessonal acsvtee safeguards ere needes ere uch an above employment elstionship ens, but thee is no silat connection remalning between the public accountng fm and the individ * safeguards aro nended ven aonmor partner of the plc accunting fm has previously flnad an ent n uch a poiton as above and the nly subsequenty becomes an aut cent ofthe fin evaluation of te signifcance ofthe thea and enfaquas are needed when a member ofthe au eam paticipatesin the avait engogement | ‘whe lnowing thatthe meraber oft Avxt Team wil. o may, om the cent some tne in the fue 4 fim polis and procedures must ree ait tam members n auc station tora the frm when entedng employment negations ‘ath te cen. ancl atoments Is Requirements ‘parton the exception below, the pubic accounting frm cannot remain as auditor lion a key audit partner joins a PB awit ent sa: a iectoc role ot employes in a postion to exert significant nfuence verte preparation of te cles socounting rors othe fhancial sateen sn excepsion othe above oceus When | -siosequen othe partner casing to be a key suit pornes, the PIE had issued audited fancialstatements covering wo es than twelve | monte: |b thenacner ios nota member ofthe au team vith reqpactt the au of those facil statements | 6 the situation arises a5 rsut ofa business combinatin and the pasion hek by the former parner i discussed with those charged wath ‘governance, unless twelve months hve passed since the ndvidua hell te positon inthe pubic accounting fem othe station arose reall ofa boainess combination ane the postion held by te omer pare is discussed wath those charged with governance. | + tae pubic accountng fem eannot main a eur when an india who ae the pubic accounting cm’ enix of managing pane ciel | exacuive or equivain oie a PIE ana ion as | 2 enompiee ina poston to xe gions innen oer the rp L on of he entity's accnunting econ ors fnancil tstertens cr bb adduecicr or ofer ‘Temporary Staff Assignments -seif review threat (APES 110.290.142) * unt the exception ofthe services sted below and as kong a safeguards ae ape and te aut cents responsible or ecting and supervising the actives af to loaned staf the loading of staf by a public acounting fm oan auc cent may ace, bt only or host | povidone, ersonnel may nt be involved in | a providing non-assucence services that would not he permitted under this section; or > assuming management responses. teontinuesPart > Uwpensranping auprtor ResPousioiLiTsES ‘Recent Service with an Audit Cient~ self-interest, selt-review or familiarity Uhreate (APES 110.290.183-148) + the individual eoncemedl cannot ne assigned tothe aut team cng the ened overedby the aust reper, a member ofthe ud etn has reve seeved as feta ex oftoet ofthe suit cent: oF >> was an employee ina poston to eter significant infos over the preparation of the cen’saecounting records che financial statements + seloguars are noedod i belt the pero covered by the aust xara member of the ant tam bas recent served 0 8 lecea rotor ote aut eben; or vag an employee ina postion 0 exon significant fluence ove ihe preparation othe cents accounting records or the fnencial ttements Serving ae a Director or Officer of an Audit Client -solt-eviow and self-interest and advocacy (APES 110.290.146-149) +a publ aecounting frm mus refuse to perform, oto witadaw, fom he aut engegement a partner or empioyeo of tho pubic eooounting ‘im war 0 aocept a poston tos a5 1 an office including as 2 company secretary. or within management of an administatin} ce »acitecior ofan at cent © aean employee im a positon to exer deee: and slgmfoen nfuence over tho subject matt othe aud engagement + esfoming routine adminisuatve services to suppot a company secretarial function ox powcing advice in ren to company steal amunstasion mates doesnot general ceateUueats 1 ndopondence song escent management ales al eleent decisions, ‘Long association of senior personnel (including partner rotation) with sp Audit Client ~femilanty and self-interest thrests— siforentiat PIS requirements (APES 110.200.150-185) * sefeguars are neada when the sme sein: pereonnel are used onan out eacagortens over along peo of tne, IE Requirements ‘fy aude panes required to rtate ata sven yeas wth time-out pened oto years ‘sma cases due to unlreseen creunszances utsceof Ue fm's conto, may be permite to stay cn te engagement if conta special impertent to suet un. + rotation not resuied wen {independent eulatr has provided en exemption em partner rotation where firm has ony few people with necessary knuedge and cl to srve as hoy aa pantnor, and independent regulator has provided stenawe sfequards ‘Provision of Non-assurance Services to Audit Clients ~selt-review, sel interest and advocacy threats -diferential PIE requirements (APES 110.290.156.219) Management Puncions + public accoming fm cennot pera management ending al decing an enty, nchiding meking sgneant eckson rogers the ‘aoqulslien, deployment end contol of human, fnencal, physical and intargibe resources) futons for en aut cent + hen providing non-aseuancesotvices management is essonsble or making the sgniicant decisons and judgements: and »souepang responsi for the actions tobe taken othe result the sevice Accounsg ae Bookkeeping Serics * ua fm can provide services reid to the preparation of accountng records and hancial stsements services are ofa routine ot mechanical nature ‘PIE Requirements © cont m emergency tuations, audios ate not permitted 1 provide aecounting and bookkeoping services, including puyol services, cto prepare Anencin stterienis onan hfonnaion wah forme the bale ol the nance starements Vatstion Services | + fm connc provide valuation eros tha: ae materia ad involve sgiicant subjectivity (when results ofthe vluationpefonmed by {to ot more partes not key tobe materiality dren. DIE Requirements * ant fm cannot prod vaiuanon sericea iit wuld have a mater elfec, sopaatly into agqogate on the financial statementsJUDGEHENTAL AND CIWICAL DECHSION-HAKING FRANEUORARS AND ASSOCIATED PROFESSIOWAL, STANDARDS LRT Taxation Services ‘as Rettn reparation + oonaiete once nonnaly cca thcass to independence proces managerent aes Yeapanstliy fr the tums, motutngsny sgnicant hudgements made ‘Tax Caleulnions «+ seleguads tobe epplles when preparing calculstons of curent and defer tx bits forthe purpose ofthe preparsen ofthe aesourting PIE Requirements + exoet in emergency stations, cannot prepare ex calculations if those ae fr the purpose of prepaving accounting ens that are natal to ‘Oe nancial statements, “Tox Planning and Other Advsny Serews + safaguadssequite if ait fam provides * audit fon not pert to provide whore 1 effectvenss of tx advice depends on aparticlsraocouning weatment or presentation: end by seasoable doubt emsts as to aperopiatenes afte ested accounting eaten x Frsentain; a ¢ ouleame of ax acvice wl have a material impact on the nasal statements Assitsace mn Feslution of Tex Dipes + salaguatds tobe applied when aut fin represents audit cient in resolation ola tax ste onc tax authonties have jected en's sgumont and are elouing tho matter for detemnation in a formal proeeding fim nox peed to provide if the sori mvolve acting as an advocate fr ana ent heforea pute tribunal x eoartnthe ressiton of tax mater andthe amounts are maternal tothe nana statements Irvrnal Act Services * only prove intemal acl sericea i aut fm sats tha management takes espansbilty othe seces PIE Requirement * auc fim, cannot provide internal aut sence that rate to sigicant par ofthe ntmalcontols ovr fnancalrepatin, » finanial accounting estams that generate inomnaticn thats, separately orn the sogregate, mate othe fhancial statements moun of ecoeutea that te separately orn the aggregate. motor othe ancl eters Internation Technalogy Services * saloguads tobe apple for aut fim provision of design an implementation services PIE Requirement + au fm cannot ponde design or mplemencaton sorvicos. “Allentitios * installation of pre-packaged sotware K acepeabe provided required customisation is nsignfcant | tatsation Support Services | = ust sem cannot provide ceri involving estimation of damages if msters are mareral and involve asiieant degree of ance | PIE Requirement | + tua rm cannot provide services inslving esumation of damages mater ate mater egal Serves + eefequads noe wo be apolld for aud fim provision of aga! corvicos the suppor an audit contin executing & wansacion fog. contact ‘ppor, loge, agave elgonce and rete ud firm cannot ating in an advocacy ele for an await ent in resting a dispute ltigaton when the amounssnvclved are mate tothe Financial statemens + safeguards woe applied when the aut frm see to acm an sevocny roe fox an aut ent resalving acute or getion wen the ‘mounts involved ae not mate to the Manca statements arte oan employee ofthe uct fom cannot act 3s general coun rth legal alas of an auc ent eonsParr 1 >> Uunensraupine AUDITOR ReseonsiaILITIES Recraning Services + salaqurds tobe apoted when auct firm provides coring vewioes wo aut het, PIE Requirement rut fm eaot provide to an audit cen he flog selec with eepec to adrator &ofeso sent mangement na postion to exe: ‘gaiean influence ver the preparatlon ofthe accounting recads or nancial atements fa seach or ox sek ont cancats ' uncertae wlrence checks of pospectve candidates Compra Panes Saneces + saloguarcs tobe apled when aut fen provides compra nance services o aut cent, pardon 2 tht willbe eported in the nancial sateen ‘ud fs nt permite to provide corporate nance services o aut cents a2 etuaton 1 whet te effectvenes of copocte nance acvioe dapencs ona particular accounsng weatment or presentation nthe fxancilsaterests ar the aut eam has eegonabe dows as othe spprepiteness of the rested accounting teamnent or presentation unr the relat fmaneil paring framework an + the outcome of consequences ote enpocate fiance adie wil have maton effec on the natal statements > involving promoting, dating i, orunderwsting an aut cents shes. oe tha wil doc atlect amounts "Fees owed to the audit fim self interest or intimidation test ~ differentia sents (APES 110.290 220-222) {safeguards tobe applied when ttl fees tom an au ent represent @alorge propain ofthe total oe fe a t,o } alatge proportion ote revens from an nde] pares’ ints oa lrgepropation ofthe revenue of ividua oie fe pubic sezounting fir | rea IE Requirements + Tf es ftom 35 edt cent exceed 15% of total eo of tho fim fortwo consecuve years 1 teclge to those charged wih govemance, | have a pre.ssuonge of post seuace review peslonned by prolesionl eccnuntant who nota membo ofthe fm ‘Overdue Fees — self interest threat (APES 110,290.229) «+ seloguards tobe applied it ees ce fom a aut lle emain unpaid cr a long tine, expec ita sgnicant part 8 not pl before te ese the aut report fr tho fllowng yar. ‘Contingent Fees ~ self interest Unreat (APES 110200.224-227) + publ aocounig fms cannot charge a ceatiagent fee In espe of en aut engagement or @nor-assuance service in # eteumsaance where 2 te non-audzsendces fei chargod by the autor and the fee is matertal or expected tobe maven that auc fm the non-aucls serves fei charged y a notwrk fem tha pasiipates in a sigascant par ol the a andthe foes materi er expected to be mati to hat aut fir, ot «© te outcome ofthe non-ssutence service, an theteore the amount o the non auc fee, 1s dependent on a future ce contemporary Judgement relates to the aul of « mater amount inthe nancial statements 4. seleguards er to apie for etter contingent fe anangomonts chetged by afm fr # non-esewence serves to an put cet ‘Compensation and Evaleation~ self intorest threat (APES 110290 228-229) + oy uel partners are not be evluated on ar compensate based on te parine's suocessin sling non-ssuance eves to thet a cents + seloguards need tobe apple when other nem ol he aut team are avauated on of compensate! based on socess in soling non Cites and Hospitality + ules the vale is vin and inconcoqueial, gs or hasty of interest and familiarity threats (APBS 140.290:230) | nat accepted om an audit cent “Acwal or Threatened Litigation ~ self interest and intimidation threats [APES 110.290.231) | + saleguards to edie treats to an acoupale eve need vo be appli’ whon ligation teks place, or appears Hey. between the uct fm ata | rembot ofthe ad eam andthe audit eet o ke the auc shoud withdraw fom. ot desing he aud engegerent a- cnarren 39> JUDGEMENTAL IO ETHICAL DECISION-MAKING FRAMEWORKS AUD ASSOCIAIED PROFESSIOUNL STANDARDS Enforcement of APES 110 Coniplionce with APES 110 depends primarily on the voluntary cooperation of CPAA, IAA and IPA members and secondarily on public opinion, reinforcement by peers and, ultimately, on ciscipinary proceedings by the professional bodies and the Companies Aucitors and Liguidators Disciplinary Board (CALDB) under ASIC, However, ASA 102 Compliance with Behtcal Requirements when Performing Audits, Reviews and Other Assurance Engagements, which has legal force for audits conducted pursuant to the Corporations Act 2001, makes it clear that [XPES 110 mus: be complied with and hence extends the application of APES 110 to practitioners ‘who are not members ofthe professional bodies, when those practitioners conduct statutory audits or reviews. The professional accounting bodies nave power to fine, suspend and cancel retnbership, but if a member chooses to resign prior to the disciplinary action i is dificult 1o penalise @ prior member. The CALDB has the power to suspend or cancel registration &s a company auditor, effectively withdrawing the licence to practise as an auditor. Although we discussed various principles and rules regarding auditor independence in the previous section, we return in defail to this topic because independence is the cornerstone of the auditing profession. Without it, the profession would not have the necessary credibllly to add value to i corporate governance, Auditors must be independent in fact and in appearance. ‘To be a Independent én fact, auditors mnust be objective and unbiased in their actions and evaluations and not be influenced by management. Auditors must be professionally sceptical as they gather evidence. They should not accept management's explanations without corroborating evidence. ‘To meet the objective of independence i appearance, the auditor must be perceived by knowledgeable users of financial reports as independent. An auditor could be independent in fact but not appear to be independent, For example, an auditor may have an immaterial investment in . = ‘an audit client and remain independent in fact. However, a financial report user who knows af that, investment may perceive that the auditor's judgement is impaired by a desire to inerease the market value of that stock, MAJOR THREATS TO INDEPENDENCE, Independence isa state of mind shat can be impatred by several potential threats, Ib starts with basic objectivity. The auditor and the audit firm must manage these threats to objectivity. We deserve those threats and approaches to mitigate those threats next, Compensation schemes Partners’ compensation in many public accounting firras has historically been based in large part on attracting an retaining clients. This creates a temptation to accede to client wishes in order to keep the client happy. The wish to retain profitable clients can impair independence, The profession has responded! in two ways: (a) structuring partner compensation schemes to focusPaer 1 >> Unoenstenotne aupcran wesre! more on quality of services rendered and training of stall personnel, (b) relying more on audit committees to enhance auditor independence and (c) greater understanding that keeping a bad client is not good business, And a client who wants the auditor to potentially snerifice Independence is not a good client. Who is the client? Under the Conporations Act 2001 shareholders are the ultimate client Although the audit client is the shareholders, the auditor is getting paid by the company and interacts with management on a daily basis, 90 there is a potential threat to auditor independence based on monetary incentives and personal fanuiarity. Although the fee is paid by the company, all the important decisions related to the audit are made by the board or audit committee where one exists, bath of which are charged to actin the best interests of the shareholders For non-statutory audits, the ellent Is whoever has the authority to engage the auctor, That may be the owners, management, the boar! of directors o, if it has one, the audit committee. The key point is that no matter who the client is, the auditor must make an objective, unbiased judgement about the faimess (truth and fairness) of the nancial report and should not favour the interests of one party over another. An audit firm, therefore, mist find ways to reinforce to its ‘auditors that maintaining the public trust is more important than retaining a client where it might appear that its independence could be compromised Familiarity with the client Auditors serving a client for several years may develop relationships and ftiendships that cause them to become less sceplical than they would have been otherwise. The CLERP 9 Act requires, that the lead and review partners rotate off listed company audits at least every five years. The Auditing in Practice: Partner Rotation Rules box notes the difficulty that smaller audit firms may have in complying with the partner rotation rules ‘Some argue that public companies should periodically change audit fms and not merely partners to help assure an objective and fresh approach to the audit. Studies, however, on the costs of mandatory audit frm rotation conclude that they are high and that other safeguards ean bee builinto the process. Time pressures Pate accounting fams often compete for clients through tenders. The low bidder soften likey to get the nomination and the engagement. But, i order to make @ slficient retum an the ait, there wil be time pressures to get the audit done as quickly as possible Those in charge af aus are evant not only on the quality of thelr work but sso on the ecieney with which the aut is Conducted. This may create an environment in which the audors do not look as deeply nto potential problem areas as they should For smal ct rms, thee may simoly not be enough parners _legsars, views rotation as important, aut ems that carnot to rotate cn and aflisted cient engagements. However, since propatyrlale pariners shouldnt perfam Isted company ineenancence fs fundamental and he publ, through is aul‘charrer 5 >> JUDGENEWTAL AND ETHICAL DECISION-HAKING FRAMEWORKS AND ASSOCIATED PROFESSEONAL STANDARDS ‘aditionally, auditors facing time pressure may choose to ‘at! time and not recor all of the ime that chey spent working on the audit engagement, Katine time allows for the auditor to make ii appear as if the tasks were completed within the budgeted time period. However, such an approach makes it dificult forthe audit team to properly prepare a time budget for future years, inereby continulng the possible negative consequences of time pressure. Beluviour such as eating time is typically formally protibived by auelt firms, but anecdotal reports by practising aueltors indicate that the practice stil sometimes occurs. »nalising behaviour ‘when potential misstatements are detected, it takes time to investigate and determine if they ‘could be material. To save time, the auditor may rationalise tat the misstatement, is not likely to ‘be material, when in fact it could be. Research has shown that auditors often rationalise potential inisslatements away by assuming tat a misstatement that occurred in a small sample of transactions was a ‘unique’ occurrence and therefore does not require further investigation. ‘Auditors need to be aware of the Iman tendency to rationalise away unpleasant or unwanted issues and be on guard against having that tendency affect their professional judgement, Providing non-audit services Public accountants may help organisations improve their Information systems, suggest anc help the cllent implement ‘best practices’ do the client's bookkeeping, identify potential candidates for management positions and perform other non-auclt tasks. However, when public accounting rms provide these types of non-audit services to audit clients, they may find temsolves in the position of aucliting their own work or some of their own decisions. Indepencience is likely to be compromised if auditors are put into the position of auditing their own work ar if auclitors identity too closely with the company. Providing non-aualit services to audit clients can also result in the public accounting frm having an inereased economic dependence on the client. The fees received from non-audit services can be much Jarger than the fees received from the audit services. In those situations, independence in the audit may be compromised, as the aucitors may choose to go easy’ on te client in the audit so that the frm can retain the client and fees from both audit and non-aueit services. MANAGING THREATS TO INDEPENDENCE Recognising that there are threats to auditor independence is the fist step In managing independence. Fortunately, audit firms have developed effective approaches to managing the threats to independence, including the following © establishing ancl monitoring corporate codes of concluct within public accounting firms developing appropriate compensation schemes implementing high-level reviews of decisions to accept or retain eients separating consulting activities from audit activities performing within-frrm reviews of audit work and audit documentation performing reviews and inspections within Uke profession, Public accounting firm codes of conduct Establishing a strong code of conduct isa first step. However, the code must be accompanied by an inderstaneling that the aueit firm ‘ives’ the code and that any deviation from the code will nat bebunensranoine aunivon REsPoussBr4r THES tolerated. The tone is established at the top and is reflected in compensation schemes that reiterate the importance of the code, Its reinforced through training and constant evaluation, ‘Appropriate compensation schemes ‘Most firms have modified their compensation schemes to recognise that walking away from a ‘bac! client is inthe firm's best interest, that taking hard stances on the acceptability of accounting is ‘dood business, and that the quality of audit documentation is key to demonstrating high-quality audit decisions. jews of client accaptance or retention decisions Many aut firms have a high-level committee that evaluates decisions on accepting andl retaining ‘uit clients, Most of these decisions are based on risk models; that Is, does the nature of the operations or the quality of management present a risk to the audit frm? The review of these decisions recognises that simply increasing fes isnot the sole objective of the firm. The firm must rnnise the risk caused by being associated with an unscrupulous client. Separation of consulting activities Most ofthe Big 4 firms sold off their consulting businesses aru 2002 because of the peresived independence conflict and associated polities pressures. However, since that ime, all of the lage invermational firms have developed non-audi, services that are provided vo audit (vith some resirctons) and non-audit clients, The fees from these services continue to grow and will ikely approach te size of audit fees again inthe future. These services inchude business risk consulting, computer security evaluations, internal audit outsoureing, tax planning and relate services \Within-firm reviews of audit work Knowing that your work will be reviewed during, prior to completion and after completion of the engagement reinforces the need for high-quality decision-making. All public accounting firms have audit partners and managers who review the work of staff auditors. Further, many auclit engagements are reviewed by an audit partner who is not connected with the audit client to provide a somewhat independent review of the engagement prior to the issuance of an audit opinion. In addition, most large firms have internal quality review programs whereby independent groups of partners and managers perform a review of the audit work and documentation of selected audits that have been completed to determine that (a) the work meets professional standards and (b) the work was eartied out objectively. Reviews and inspections within the profession Imaddition to ASIC inspections, the professional accounting bodies onganise voluntary peer reviews ‘of auclit engagements. These reviews are conducted by practitioners employed by the Institute of Chartered Accountants and CPA Australia as a quality control mechanism and annual reports are Issued on findings from the reviews, though individual practitioners reviewed are not named. ‘nana repots of ised eniies, and other audit sngagernents wher itis deemed necessary that ne alts repats notJUOGENENTAL AND ETHICAL DECESION-HAEING FRANENORKS AUD ASSOCIATED PROFESSIONAL lah the engagement pares review ofthe nancial reports and audltor's reports appropri, ‘The eagagement quality contiel reviower is required to consider: the engagement team’s evaluation of the firm's indepenclence in relation to the aut ‘engagement ‘whether appropriate consultation has taken plage on matters involving diferences of opinion or ‘other difficult or contentious matters, and the conclusions arising from those consultations ‘whether audit documentation selected for review reflects the work performed in relation to the sigoificant judgements made and supports the conclusions reached. I differences of opinion arise within the engagement team, with those consulted or, where applicable, between the engagement partner and Uhe engagement quality control reviewer, the ‘engagement team is required to follow the public accounting imn's policies and procedures for dealing with and resolving differences of opinion, IMPORTANT ROLE OF AUDIT COMMITTEES ‘The audit committee or in ts absence, the board of directors, is responsible for the oversight of the financal reporting for the entity, including selection of the nominated auditor to be voted on by shareholders at a general meeting. This responsibility includes board or audit committee oversight carter 5 >> ‘dated unit completon ofan engagement quality control the proposed aust’ reper: review of selctad auc! {eview. Tis review is designed to prove an objective documentation relating to the siilcent dgerrents the ‘evasion othe significant judgements the engagernent team engagement team mado and the conclisione teaches nd ‘made and the conclusions reached in fonalaing the aucila's evakaton of he corcusions reached in aruda the report. Tis evaluation rwokes discussion of sniicant matters auditor's report anc cansidertion of whether the proposed Lo regarding auditor independence. The CLERP 9 Act requires the board to declare in the annual report, on advice from the audit committee where one exists, that any non-audic services ‘purchased during the reporting period have not impaired auditor inclependence, Additionally, the ual frm is requited to communicate certain information related to the firm's independence to the client and to provide a declaration for inclusion in the annual report in relation to the firm's independence from this client. Specitically, tte CLERP 9 amendment to the Corporations Act 2001 requires that, for each Snancial and half-year report, the Jead engagement partner must provide a written declaration to the directors of the company, registered scheme or disclosing eniity in the form of one of the following: that, to the best of the knowledge and belief of the lead engagement partner there have been. no contraventions of the independence requirements of the Corporations Act in relation to the auditor review; and 1b any applicable code of professional conduct in relation to the autor review oR = that, to the best of the lead engagement partner's knowledge and belief, the only contraventions of (a) and (b) above have been set out in the declarationUunenstanaine AupTTon aesPousimiLcTaES ‘These rules highlight the important role that the auclt committee, or in its absence the board, plays in helping assure auditor inclepenclence, Aueit comrnittees should consider all factors that right alleet the independence of the aueltor and should nol advise the board to sign off on non audit services that the aucit committee members believe might impair independence. Summary Public accountants ean serve the public only if they safeguard their reputation for high-quality decisian-making, ethics and independence, For most of the past century, the professional accounting bodies had the primary responsibility to provide auidanee to the profession on pervasive ethies and independence concepts, All members of Australia’s three professional bodies are expected to follow the basic principles of APES 110 Code of ttics for Professional Accountants. However, ‘nereased regulation over ethies, especially the maintenarice of auditor independence, arrived with the CLERP 9 Act in ‘response to peveeived failures by the profession to cliseipline members who hal acted unethtealy. ‘The decision-making framework that we introduced in this chapter can be used by auditors to analyse many professional audit judgements, When those judgements involve ethically charged issues, an ethical framework, such as the fone outlined in this chapter, can help resolve an ethical dilemma in a thoughtful manner. Such a framework is useful in situations for wiich specif ethies and independence rules have not been developed. SELECTED REFERENCES TO UF PROFESSIONAL PROWGUNCENENTS AMD GUIDANCE Reference International Equivalent Description” 8001 soc ‘ust Contra Fes tht Perm Aus and Rove of Fanci Reports and Oe anc! lnterato and Other Assurance Engagements sa 102 CComptance with hia! bgurements when Fermin Aus Ravews aa Otter Camptarce an Enea! Recukamant when Poor Audis, Rov and Oe gages sa 200 isa200 Cura Ciectives ofthe serene Aura ihe Conc fan Aut n Acca wih Aastelen Busing Stanaese pear A Z20 (cust Contato an Aust ef nance Repert and Other Heitor Franc tvomaton presto ESA Caio sf Pessoal Accountants nS 205, CContamiy with Acceaning Sarairs aes 210 Contemiy wah auctng ana Asswence Stands aresais Foren Accouning Seraces pesca Taration Snices s0es.205 Vetaton SevceseS 8 Tems of Engagarent 2985315 Correaten ef Frere tromaton pers 220 att Conor tr Fs pesto Irschency Sores ESS Feo on Pesce Franc iomston | nee ta Sa on usa a ot et oe AS, tit As fo Rn Piss eres a nur AS an eg Ss ae, AD — Sudan i Cag rete, APESS cna essa Ena Sara ts APRA a> ings Ao, ASA Asta ana on i, AE tn See ad srs Cres, ; 295tsurar Sicots amp ASE- San oe spe ARSE = Att Aa res ‘Sure Bow 60S0= arene Spey Cg, FED eat eutigSaes Boed 15, C~ rare Fa Cas ASB ner are Sos a, SS nee Ay ‘Stren Ont SC norte Sorts Come. FAC Pama Fen txt FS = _ ‘esa nel ay Sarees, Gk~ brat Sore on Ai, AE Mant Sr en ‘ree PED = Pe Company Snag One Bee, SED Sete an cere Coenen) Review questions ote: More questions, including multiple choice questions, are available one 2-1 (402) How is ethical behaviour related to organisational success? 2 (LO) Why is ethical behaviour by auditors required to justly the publics trust in the profession? 3 (106) Why is independence considered the most important characteristic of an auditor? 4 (10) Whavare the major threats to auditor independence? Explain why each Wem represents a treat to auditor : independence. 3-5 (LO) What cana public accounting frm do to manage the threats to autitor independence? Explain why each approach you lst should be effective and ow it woul be implemented. 3-6 (LO 7) What ve the major principles that have guiced the regulotors'actions on autor independence? 3-7 (107) Whatave the services that a public accounting frm carznot provide for an auktt client under APES 1102 : 3:8 (L06) Describe che priniples that form the basis of APES 110. 3 3-9 (L06,7) Whar vole do hoards of directors and/or aut committees play in approving audlitor-provided! non-audie services? Explain 3-10 (L065, 6, 7) Why might a listed company be more circumspect than a nor-isted eompany about the types of non- aut services it purchases from its audit ir? 8-11 (10 6,7) What does APBS 110 state with regard to providing data processing and consulting services for an aut client? 3-12 (108) Whatis meant by independence (a in fuk and (b) in appearance? Give an example of an auditor being independent in faet but notin appearance 3-13 (LO6) Describe the diference between a direct financial interest and an indirect financial interest in an aut cient, 3-44 (102, 5) The CLERP 9 Act contains various requirements thet reflect responses to ethical lapses in professional judgement on te part of varios financial market participants. Refer to Exhibit 3.E1 online onthePast 1 218 textbook website for an averview of the Act an identify wot ethical lapses may have occurred to result in these new requirements, Discuss how these new requirements help to justify the publi’s trust in the auditor. (LO 6) Would independence be impaired, according to APES 110, if professional accountant: ‘a. Obtained a home mortgage with a bank that later became an audit elient while the mortgage was stil in effect? bb, Hadl been the audit client's controller duting the fst six months of the period covered by the audited financial repor!? ¢. Obtained a home mortgage while the lending institution was an audit cient? (L0 7, 10) What role does the audit committee have in making judgements about auctor independence? {LO 6) Under what elreumsiances is it appropriate fora professional accountant to disclose confidential information about a client? {LO 6) Woule a professional accountant violate APES 110 if he or she served a client bot as ts auditor and lawyer? Bxplain your answer 3-19 (106) In considering APES 110, under what circumstances is it appropriate for a CPA to: 1. Provide services on a contingent fee basis? b, Accept a commission for referriug a product or service to the client? c. Pay a referral fee to another professional accountant? (106) How is APES 110 enforced”? (103) Briefly deseribe the concepts and approaches imderlying the wtitarian theory and the rights heory (LO 1) Explain the decision process used to encourage high-quality decision-making in an auditing context Discus how the concepts of audit evclence, uncertainty and risk affect the approach to developing sufficient Information to support high-quality decisions. 2-23 (LO6,7) What ave the major differences in the content on auditor independence as put forth by API Corporations Aet 2001? S 110 and the \ Discussion and research questions A (Applying APES 110, LO 7) Which of the following would not be eonsicered a violation of the underiying indepenclence principles of APES 110 or auditing standards? Assume the situation involves a listed client ‘@ Virchow John (VJ), public accountants, has a separate division that performs personal financial planning {Gvealth management) for high-income ndividunls,I-is a separate profit centre and is evaluated on is resus. fos performs this service for a select number of senior management, at customary fees and at the client's request, i {or some aut clients | b, Virehow John, public accountants, is engaged by a vote of shareholders ata general meeting, but its fees are paid by the client, €. Virehow John, public aecountants, has a separate unit that performs temporary accounting services. One of the clients lost. a divisional controller ofa unit that represents 7% of its revenue, VJ uses its temporary accounting services to provide the controllership activity for 45 clays while the client searches fora new controller 4. Virchow John, public accountants, recommends that the company improve its controls and accepts a 90-day ‘engagement to train the eompany on how it should go about implementing better controls (APRS 110, LO 6) Many professions have developed cades of conduct, Phe public accounting profession, through the Accounting Professional Bthical Sianclards Board, has developed dotailed guidanes in its Code of Ethics for Professional Accountants (APES 110).REQUIRED. _ 1a, What isthe major purpose of te Code of Bthles enacted by the APESB? bb. What are the potential sanctions if professional accountant is found to have violated the Coxle of Ethics? 2 (Pests to Independence, LO 8) Scene 1 ~ You are the senior in charge of the aust of NOB Compary. The OFO is pressuring you to complete the audit in two weeks. Some of the auclt team members are new staff and have required a significant amount of traning to bring them up to speed for the auelit. As a result, your audit is behind schedule, However, you know that even with extended avertime, your audit team cannot complete all of the planned audit work in two weeks. REQUIRED = 1a, What should you coin this situation? 'b. What could have been done to prevent this situation? Scene 2 ~ Partners in the public accounting frm of Noble, Wishman & Kant earn compensation points for (1) obiaining new clients, 2) retaining cients and (8) selling additional services to existing clnts. Depending on the ‘number of points, each partner's compensation can be increased by up to 150% oftheir base salary. REQUIRED. ees ‘a. Explain why this arrangement can be a threat to independence. bb. What could be done to eliminate this threat but yet encourage the aualit frm to seek out sufficient profitability to attract and retain qualified auditors? 2-27 (Audit Committee Responsibilities, LO 5, 10) The CLERP 9 Act mandates thatthe board of directors, on advice from the audit comunittee if one exists, must declare that all non-audit services performed by the auditing frm do not create a breach of auditor inclependence. REQUIRED. 4a. Discuss the rationale for this mandate as opposed to letting the shareholders, CFO or CEO have these responsibilities b. What factors should the board/audit committee consider in evaluating the independence of the external auditor? 3-28 (Independence Principles, LO 7) REQUIRED ___ a. What are the guiding principles for auditor indepenilence? b. Are the principles applicable only to auditors of listed companies, or do they apply to auditors of smaller, privately held companies as well? ce. The following are five situations in which auditors may find themselves. For each of the situations, indicate ‘whether it appears to violate the independence principles set out in APES 110. Explain your answer (@ Spencer is the partner in charge of the audit of Fip Ltd. He has half interest in a joint venture with Flip's ‘CFO, but the joint venture is audited by a separate independent public accounting frm, @) Vitoria is the senior-in-charge of the auelit of Holder Ltd. During the past year, she filed in for the chief accountant, who had emergency suegery and was out for six weeks,Poet t 3:29 3-30 3-31 REQUIRED_ er iii) Brandon has been asked by an audit client to represent the client in negotiations with the management of another company’ that the ellent wants to acquit. (dv) Sanders isthe partner-in-chorge of the audit of Marshall Ply Ltd. The CEO and CFO have asked Sanders to prepate their personal income tax returns as well as the tax reluns for the company” (W) Marianne Keulu is an audit partner anda member of Blackhawk Country Club. She is alow-andieap ‘golfer and plays ina regular foursome every Saturday morning that includes Shelly Pati, the CFO of one aucit client, and Nancy Sprague, the CBO of another audit client (APES 110 Code of Ethics, LO 6) For each of the following separate situations, indicate whether it isa violation of APES 110 and explain your answer: ‘a, Bames isa partner in a public accounting fir and the firm performs an audit of Ovats Ltd, (Barnes practises inthe same office as the lead engagement partner for the Ovats Lud auc but does not ‘work on the audit. Barnes owns a few shares in Ovats Lid, (i) Bames practises inthe same office as the lead engagement partner for the Ovats Ltd audit but does not work on the audit. Barnes's wife owns stock in Ovats Ltd. », Putts isa new staff person and works on the audit of Tale Lid. Putts owns a few shares in Tate Ltd. . Netsis an audit senior and participates in the audit of Varsity Ltd. His non-lependent mother owns shares in Varsity that are material to her net worth and of which Nels has knowledge. 4. Kart is an audit senior in the same office that does the audit of Looney Lt but doos not participate in te au ‘of Looney La, Kard owns 6% of Laoney's shares, (dndependence Principles, LO 7) Consider the principles regarding indepenclence. Discuss and reach a conclusion as to whether any of the following four situations, representing services performed by a public aecountant for an audit client, violate audit independence principles. Ifyou believe that the services can be performed if safeguards are in place, state the safeguards: a A public accounting frm prepares the clients tax return, b. Foran audit client, a public accounting firm performs business risk analysis with a focus on economic and ‘business risk rather than accounting risks. The intent isto help the company better identify and manage its risks, Management makes all decisions about risk priorities and approaches to mitigating the risk, ‘¢. A public accounting firm perforins marketing research, but only for nor-aulit clients. However, it does have a significant number of audit ellents who are in the same industry for which it performs marketing research for sts non-audit clients, 4. Actient board member performs consulting work: for the consulting division of the public accounting fim, However, the board member has no relationship with the auditors except that of being a board member. (Mitigating Threats to Independence, LO 9) Public accounting firms have taken many’ positive steps to assure the independence of thelr firms in conducting audit. 1a Identify five ways in which a public aecounting frm can take positive actions to improve the firm’s independence in condueting an audit b, Identity a small public accounting firm nearby. Visi ce finm’s website and deteumine the scope ofthe firm's services, Are independence issues different for small firms that audit only privately Held companies than for ‘Arms that audit mostly listee| companies? Explain and be prepared wo describe the breadth of services performed by the frm and the independence issues you believe it must manage ‘e. Identity three unique chellenges that smaller public accounting firms face in maintaining audit independence.‘cunprer 5 > 4d. What are the requirements for indepenclence and objectivity if an audit frm perfoums consulting services for an audit elient? Explain the rationale forthe requirements. 2 (Aualtor Independence, LO 6, 8) independence is often hailed as the ‘eomerstone of auditing’ and recognised as the most important characteristic of an auditor. REQUIRED ae ‘&. What is meant by independence as applied to the public practitioner? b, Compare the independence of an auctor with tat ofa ® Judge (@®) Lawyer . Describe the difference between the independence of an external and an internal auditor 4. Por each ofthe following situations, indicate whether the auditor is in vielation ofthe Code of Etc for Professional Accountants, Explain your answers. ‘The auditor's father works for an auelit client as: (a) A custodial engineer, (b) The treasurer. (Qi) The auditor’ thd cousin twice removed is treasurer of an auelit ellen. Gil) The auditor of a charitable organisation is also its treasurer. 5-33 (Code of Ethies, LO 6) The following are a number of seenarios tat might constitute a violation of the Code of Bthics for Professional Accountants. REQUIRED, For each of the six situations, identify whether it involves a violation of the ethical standards of the profession and Indicate which principle or rule would be violated. a Tom Hart, public accountant, does the bookkeeping, prepares the tax veturns and performs vatious management services for Sanders Ltd, but does not do the avait, One management service involved the assessment of the computer needs and the identification of equipment to meet those needs, Hart ‘recommended a product sold by Computer Co., which has agreed lo pay Hart 10% commission I Sanders Dbuys its product. >. Tema Stone, public accountant, was scheduled to be extremely busy for the next few months, When a prospective client asked if Stone would do its next year's aut, she deelined but referred them tn Joe Rock, GPAICA. Rock paid Stone $2000 for the referral, e. Naney Heck, CPAICA, has agreed to perform an inventory control study and recoramend a new inventory control system for Bites Lid, a new client, Currently, Butes engages another publie accounting firm to auc its financial repo. The financial arrangement is that Ettes Lid will pay Heck 60% of the savings in inventory costs over the two-year period following the implementation of the nev system, 4. Brad Gage, CPA/CA, has served HitDee Co. as auditor for several years, In sdlditan, Gage has performed other services for the company. This year, the financial controler has asked Gage to perform a major computer system evaluation, ‘e. Due to the death ofits controller, an aut client had its extemal auditor, Gail Klate, OPA/OA, perform the ‘contraller’s ob for a month unt a replacement was found Chis Holt, CPA, conducted an audit and issued a report on the 2012 financial report of Tree Lid, ‘Tree has not ‘vel paid the audit fees or the audit prior to Issuing the audit report on the 2012 financial statements, 3:24 (Cote of Bthies and Bthical Dilemmas, LO 4, 6) The requirement for confidentiality recognises a fundamental public trust between the client and the auditor and reflects the manner in which all professionals conduct. themselves. However in certain instances the auditor may be required vo conununicate confidential information,Part 1 REQUIRED ____ — ‘a. Briefly explain the purpose of the confidentiality rule. Why is it important to assure the client ofthe confidentiality of information? '. Under what circumstances isthe public accountant allowed to communicate confidential information, and who are the partes to which the information can be communicated? Assume that an auditor i the partner-in-charge of two separate engagements, but during the conduct of the ‘audit of Client A, the auctor learns of information that will materially affeet the audit of Client B. Client B is not aware of the information (the inability of Client A to pay its debts). What alternative courses of action are available to the auelitor? Would comunication ofthe information to Client B be considered a violation of ‘confidentiality? What guidance might the auditor seek in developing an answer to this ethical dilemma? 4. Is the auditor’ report considered a confidential communication? Explain 3-35 (Code of Ethics, LO 6) Robert, CPA/CA, has a large one-office firm ina growing city, but his practice is shrinking. Several other firms recently opened offices in the city and Robert lost several key clients to his new competitors, Because ofthe changed competitive climate, Robert decided his firm needed to offer wider array of services ancl seek clients in industries in which the frm had not previously ventured, For example, Robert tendered on aneary community college's annual audit, even though his firm hal never before audited a college. The college receives 8 significant amount of Federal financial assistance, The tencier was successful, and Robert's firma conducted and ‘completed what he thought was an appropriate aut, Shortly after its conclusion, however, Robert was informed by the ethics commitzee of one ofthe professional aecounting bodies to which he belonged that an investigation was ‘being considered to determine ithe had violated any ofthe clauses ofthe Code of Conductor related interpretations, REQUIRED. ‘a, What principles and guidance would the ethics committee mos likely refer to for this investigation? b. How might Robert have avoided violation of those principles and guidance? 3-36 (Application of Ethical Framework, LO 4) As the auditor for XYZ Company, you discover that a materia sale {8500 00 sale, cost of goods of $800000) was made to a customer this year. Due to poor intemal accounting controls, the sele was never recorder, Your elient makes a management decision not to bill the customer because such a long time has passed since the shipment was made, You determine, to te best of your ability, that the sale was not fraudulent. REQUIRED. ‘a. Do accounting standards require disclosure of this situation? Cite specific applicable standards, Regardless of your answer to part (a), utilise the ethical framework developed in the chapter to determine whether the auditor should require elther a recording or disclosure of the transaction. If you conclude that the tansaction should be disclosed or recorded, indicate the nature of disclosure and your rationale for it 3-37 (Application of Ethical Framework and the Code of Bthics, LO 4, 6) Your aualt elent, Germane Industies, as Aoveloped a new finaneial instrument, the major purpase of which is to boost earnings and to keep a significant amount of debt off the balance sheet, Its investment banker tells the firm that the instrument is structured. explicitly to keep it off the balance sheet and that she has discussed the treatment with three other Big firms that have indicated some support for the clients position. The transaction is not covered by any current, authoritative pronouncement. Your intial reaction i thatthe iter, when viewed in its substance as opposed to its form, is debt, The client reacts that accounting standards do not prohibit the treatment of the tem it advocates and that the financialcunpter 5 > repor is that of management. The client notes further, and you corroborate, that some other firms would account, {or the item in the manner suggested by management, although its not clear that a majority of other firms would accept such accounting. REQUIRED a, Whats the ethical derama? b, Does competition lead toa lower ethical standard in the profesion? € What safeguards are built into the profession's standards and Code of Ethics for Professional Accountants thar would mutigate the potential effect of competition on te quality ofthe profession's work? (3-38 (Application of Ethical Framework, LO 4) "Radacion wn bnasgrer se on wrap orseciienmsete nin @) an example of an ethical dilerama. , Analyse the dilemma following the ethical amework presented in this chapter. Your analysis should be concise and should include all of the components of the framework included in this chapter. 339 (Bthies in Practice, LO 2, 3, 4) In her book Bxtraordinary Circumstances;* Cynthia Cooper, ex-WorldCom {internal auditor, describes her lfe as going from an internal auditor to a whistleblower. In the book, she staves that she never believed she was a whistleblower, rather she believed she was ust doing her jo REQUIRED — 1 a, What isthe difference between an ‘ethical dilemma’ and just doing one's job"? Respond in relationship to bot Internal and external auditing. 3 b, Bxternal auditors are not thought of as ‘whistleblowers’. However, the extemal auditor may find situations in ‘which he or she concludes that the company’ hos fraudulently violated accounting standards. Management 4 clisagrees and refuses to change the financial report. To wham does the auditor report the ndings? ‘e. Assume an external auditor finds that an internal employee has perpetrated a fraud against the company. ‘The : amounts are material tothe individual, but not co the company. Does this constitute an ethical dilemme or an ethical problem? How should the auditor decide the appropriate course of action to take? Suggest and defend! your suggested action, 3-40 (Professional Decision-Making Framework, LO 1) This chapter lays out a framework for high-quality decision= ‘making that has been applied across « number of different professions, including che medical profession, The {framework has been adapted in this textbook to fit audit Lerminology. REQUIRED, ‘a. What is meant by the term high-quality decision-making? How is that term operationalised in an audit situation? ’b, How are both (I) the risk of making an incorrect decision and (i) the risk thal errors exist in the accounting records implemented in the decision-making model? ‘¢. What does the decision-moking model infer about the sulficiency and persuasiveness of information needed to rmake high-quality decisions? What is meant by the term sensitivity analysis? 4d. What isthe major decision auditors have to make regarding audits of a company’s financial report? For ‘example, assume that the reports only ‘alittle bit wrong’. What are the consequences for the auditor? What it the statements are significantly in error? What are the consequences for te auditor? ager inti. Beinn Cantu: (ew Yak Wi 08 -Cases 3-41 (Public Trust, LO 2) Ina 1988 article, Arthur Wyatt, a former member of the US Financial Accounting Standards Board (FASB), stated: Practicing professionals should place the public interest above the interests of ellen, particularly when participating in a process designed to develop standards expected to achieve fair presentation... Granted that the inereasingly detailed nature of FASB stanclards encourages efforts to find loopholes, a professional aught to strive to apply standards in a manner that will best achieve the objectives sought by the standards. Unfortunately, the auditor today is ten a participant in aggressively seeking loopholes. “The public, on the ather hand, views auditors as their protection against aggressive standard application ® [Bmphasis acd, REQUIRED Sees ————————— ‘a, What does it mean to find Joopholes’ in accounting standards? How would finling loopholes be potentially valned by the management ofa client? How would finding loopholes affect the public's trust in the auditor's work? >. Explain how auditors could be participants in ‘aggressively seeking loopholes’ when statute and the auditing standards require the pursuit of faimess (or truth and fairness) in financial presentation ‘e. How is professionalism related to the concept of fairness (or truth and faitess) in financial reporting? Explain, 4d. What features of the CLERP 9 Act may have led to improved management and auditor performance on these 3-42 (Application of Ethical Framework and Code of Bthies, LO 4, 6) The auditor had completed the aucit of Company 1 with no problems encountered and issted an unqualified opinion. Shorly thereafter, essentially the same audit team began she audit of Company 2. While conducting that auclt, the auditors realised that there was. significant contvaet between Company 2 and Company 1. The auditors continued with the auelt and were surprised to find that Company’ 2 Tad not dealt fanly with Company 1 by selling them property that was signifiantly overpriced Now the auditors were caught ina dilemma: They could (ell Company’; alternatively, they could refrain from telling Company 1 andl hope that Company 1 would never find cut, BEQUIRED. — a, Discuss what course of action you would recommend the auditors take and potential results ofthat action, . How could this situation have been avoided? c. Discuss how this case differs from the Wilmott Forests Ltd ease described in the chapter in terms of disclosing confidential information 3-43 (Application of Ethical Framework, LO 4) You have been engaged to examine the balance sheet of Hi-Sail Ltd ‘which provides services to finanelal institutions. Its revenue source comes from fees for performing these services, [ts primary expenses are related to selling and general and administrative costs. The company has assets and linbties of approximately $1 million. Operating losses in rocent years have resulted in a retained earnings deficit and shareholder's eqully close to zero. The assets consist primarily of restricted cash ancl accounts receivable. Its liabties consist of accounts payable, accrued expenses and reserves for potential losses on services previously fh provided. o) ‘Your preliminary audit work indicated thatthe company generates a high volume of transactions. The internal A ‘control system surrounding these transactions is weak, I is alsa apparent that management is involved only ‘moderately in day-to-day activities andl spends most of is time dealing with non-routine transactions and events‘cnarien » ‘You expencled « significant amount of time and money to complete your examination of the balance sheet ‘The cllont understood the extended offorts and stated a willingness to pay whatever It east to complete this ‘engagement, However, monthly progress billings have not been paid. ‘On completion of the audit Neldwork, you reviewed a draf.of the balanee sheet and related notes with the company’s CEO and CFO. ‘Witt minor wording modification, they agroed with the draft. They requested that you issue this report as soon as possible. You committed tothe issuance of your opinion, subject to a review of the draft with the company’s chair of the board. Alter the chairperson reviewed the draf, she requested a special meeting outsice the compang’s office, At the subsequent meeting, she stated that the deatted balance sheet and notes were severely in ervr. Included in her comments are the following: The previous year's tax returns have not been fled and the company has extensive potential tax Labilitles, ‘The company has guaranteed! significant amounts of debt related to joint ventures. These ventures have fale! ‘and the company’s oint venture partners are insolvent. Significant notes payable to the chair of the board have not been recorded, Amounts payable tothe chair ancl other officers related (o reimbursement of monies expended by these individuals personally for travel, entertainment and related expenses on the company’s behalf have also not been recorded. ‘The chair surmised that the CEO and the OFO did not disclose these items because oftheir detrimental impact fon the company. She believed that those officers were trying to slage a shareholder dispute Lo unseat her ‘You continued to have separate meetings with these individuals. 1 became clear that the parties were in dispute and you found it increasingly dificult to understand what was factual and what was not. The two officers, ln particular, requested an urgent conclusion of the audit and delivery of your opinion. They claimed the chai’s position was self-serving ancl not representative ofthe company’s nancial postion. ‘You discovered the reason the two officers were anxious for the opinion an balance sheet was that they were attempting to sell the company. You also learned that another af your clients was interested in purchasing the ‘company. This second client has asked you why you have not yet issued your report on HiSail Lid. DISCUSSION ISSUES. 348 ‘a. Write a report using the ethical framework in the chapter to deseribe what course of aetion you would take concerning the audit and how you decided on that course of aetion, ‘The report should inelude all components of the framework presented in this chapter b, Indicate what you would do in response to the second clien’s inquiry andl why. (Application of Bthical Framework, LO 4) The following case requires you to read published academle papers that discuss ethis in auditing andl accounting, ancl that will provide you with insight on opinions regarding how ethics training can be accomplished. Read the following two published research papers: a. ‘Hollow men and women atthe helm... Hollow accounting ethics? by Sanclra Waddock, Issues in Accounting Education 2006 (Vol. 20, No.2), pp. 145-60. . ‘Danish evidence of auditors’ level of moral reasoning and predisposition to provide fair judgements’, by Bent ‘Worming-Rasmussen and Carolyn A, Windsor, Journal of Business Buhics 2008 (Vol. 47), pp. 77-87 Based on your reading of the two articles, answer the following four questions. What are the major arguments made inthe first paper? Do you agree with them? What are the strengths of Professor Waddock’s analysis? What are the wealnesses? What does the fact that there were frauds and ‘unethical behaviour long before the advent of formal business sehool education imply regarding Professor Waddock’s views?‘What was the average level of moral reasoning for the auditors surveyed in the secondl paper? What does this imply for potential audit judgements made by those aualitors and the extent to which they may be influenced by client preferences? Discuss whether you believe that ethics interventions during your tertiary edueation will be helpful in assuring that your ethical framework will be appropriate for the duties you will be expected to perform as a professional accountant "Nearly all of the students with you in your class willbe entering the professional workplace during the next ‘year of s0. Tt important that you consciously consicer how you might react if you encounter an ethical dilemma. Most importantly, you need to recognise that you are encountering an ethical dilerama and to think very carefully about the nature of that dilemma, how you might handle the situation itself and how you might anticipate the outcomes ofthat situation, Towards that end, you are to ‘imagine’ an ethical dilemma that you ‘may eneounter in your new professonal fe @ Deseribe the nature ofthe dilemma, Gi) Describe how you plan to handle the situation, (Gi) Describe potential outcomes of your reaction to the situation,