ACCA AAA

Advanced Audit and Assurance

Ethical threats
and safeguards
Kindly note that the content’s of this lecture support note is the summary of the past
ACCA exams. The purpose of this note is to provide my students with an insight to write
their examination properly and it is not meant for any kind of commercial purpose.

This is not a substitute for the complete textbook, so please use this note for the final
revision and practice revision kit of ACCA approved publishers for good results.

Alan Biju Palak

 ACCA AAA
Advice on accounting and management information systems

There are ethical threats relates to the Clients request for audit firm to provide advice on the new
accounting and management information systems to be implemented . If the advice were given, it
would constitute the provision of a non-assurance service to an audit client. The IESBA’s Code of
Ethics for Professional Accountants has detailed guidance in this area and specific requirements in
the case of a public interest entity, which is a listed entity.

The Code states that services related to IT systems including the design or implementation of
hardware or software systems may create a self-review threat. This is because when auditing the
financial statements the auditor would assess the systems which they had recommended, and an
objective assessment would be difficult to achieve. There is also a risk of assuming the
responsibility of management.

Lecture support notes by Alan Biju Palak

In the case of an audit client which is a public interest entity, the Code states that an audit firm shall
not provide services involving the design or implementation of IT systems which form a significant
part of the internal control over financial reporting or which generate information which is
significant to the client’s accounting records or financial statements on which the firm will express
an opinion.

Therefore the audit firm should decline offering the service to give advice on the accounting
systems.

Meeting with the bank (renegotiation of the Company’s lending facilities)

If the client has requested the audit engagement partner to attend a meeting with the bank, the
objective of the meeting being the renegotiation of the Company’s lending facilities. This is an
advocacy threat to objectivity, as the audit partner will be supporting the client in its renegotiation.

If the partner were to attend the meeting and confirm the strength of the company’s financial
position, or confirm any work performed on the cash flow forecast, there could be legal
implications. These actions would potentially expose the audit firm to liability, it could be perceived
that the audit firm is in some way guaranteeing the loan or guaranteeing that the client is in a
position to service the debt.

The partner should not attend the meeting or be seen to be supporting the client in its attempt to
raise further finance.

The matter should be discussed with those charged with governance of the client, with an
explanation provided as to why the audit firm cannot attend the meeting with the bank.

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Tax investigation- resolution of tax disputes

The ACCA’s Code of Ethics states that an advocacy or self-review threat may be created when the
firm represents an audit client in the resolution of a tax dispute, for example, before a tribunal or
court.

The advocacy threat arises because the audit firm will take a position to promote the client’s
interests at the tribunal, leading to a threat to objectivity. The self-review threat arises where the
matter which is the subject of the investigation and tribunal will have an impact on the financial
statements on which the audit firm will express an opinion.

The existence and significance of any threat will depend on a number of factors including:

• Whether the firm has provided the advice which is the subject of the tax dispute.

Lecture support notes by Alan Biju Palak

• The extent to which the outcome of the dispute will have a material effect on the financial
statements on which the firm will express an opinion.

The Code states that where the taxation services involve acting as an advocate for an audit client
before a public tribunal or court in the resolution of a tax matter and the amounts involved are
material to the financial statements on which the firm will express an opinion, the advocacy threat
created would be so significant that no safeguards could eliminate or reduce the threat to an
acceptable level.

Therefore, the firm shall not perform this type of service for an audit client and the this matter
should be discussed with those charged with governance of the client, with an explanation provided
as to why the audit firm cannot provide the requested service.

Audit committee asked whether one of firm’s audit partners can be appointed as a non-
executive director and serve on the audit committee.

This would seem inappropriate as one of the functions of the audit committee is to oversee the
external audit function, and it would not be possible for an audit partner of the firm to remain
objective when evaluating matters such as determining the audit fee.

The Code specifically states that if a partner or employee of the firm serves as a director or officer
of an audit client, the self-review and self-interest threats created would be so significant that no
safeguards could reduce the threats to an acceptable level. Accordingly, no partner or employee
shall serve as a director or officer of an audit client.

Hence, audit firm must explain to the client that unfortunately it will not be possible for an audit
partner to be appointed to serve as a non-executive director of the client.

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Reviewing the internal controls of an audit client

Reviewing the internal controls of an audit client which are relevant to the financial reporting
system would create a self-review threat as the auditor would consequently assess the effectiveness
of the control system during the external audit.
The design, implementation and maintenance of internal controls are also
management responsibilities. If the auditor were to assist in this process, it may be considered that
they were assuming these management responsibilities. This creates potential self-review, self-
interest and familiarity threat. The latter arises because the audit firm could be considered to be
aligning their views and interests to those of management.

The Code states that the threats caused by adopting management responsibilities are so significant
that there are no safeguards which could reduce the threats to an acceptable level.

Lecture support notes by Alan Biju Palak

The only effective measures which could be adopted would be those which ensured the audit firm
did not adopt a management responsibility, such as ensuring that the client has assigned competent
personnel to be responsible at all times for reviewing internal control review reports and for
determining which of the recommendations from the report are to be implemented.
Furthermore, if the client is listed and also an audit client, then the
audit firm should not provide internal audit services which relate to a significant part of the internal
controls relevant to financial reporting. Given that this is the main expertise of the audit firm, it is
likely that they will be required to perform some work in this area and this service would therefore
not be appropriate.

If client would like the firm to perform a review of internal controls not related to the financial
reporting system, firm would need to consider whether they have the professional competencies to
complete the engagement to the necessary standard of quality.

Auditing multiple entities in a competent market

There is nothing ethically inappropriate having clients in the same industry; this is actually normal
practice and allows firms of accountants to develop industry specialisms which allow them to offer
high quality, expert services. It is therefore likely that firms will have clients which compete in the
same industry.

Acting for two competing companies may give rise to ethical threats though. It may be perceived
that the auditor cannot offer objective services and advice to a company where it also audits a
competitor. The clients may also be concerned that commercially sensitive information may be
inadvertently, or intentionally, passed on to the competitor via the auditor.

The main safeguard available is to disclose the potential conflict to all parties involved. If both
client accept the situation, it is appropriate for firm to continue in its capacity as auditor to both

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as long as appropriate safeguards are put in place. These include:

• Separate engagement teams (with different engagement partners and team members).
• Procedures to prevent access to information
• Signed confidentiality agreements by the engagement team members.
• Regular review of the application of safeguards by an independent person of appropriate
seniority.
• Advise the clients to seek independent advice.

If either of the client do not give their consent, then auditor must resign as the auditor of one of the

Lecture support notes by Alan Biju Palak

companies. If this is the case, a number of ethical and commercial considerations should be made
before deciding which client should be rejected. Firm will need to consider the risk profile of both
clients and should conduct appropriate acceptance/ continuance procedures for both clients prior to
making any final decision. From a commercial perspective, firm, may also consider which of the
two clients provides the highest audit revenue.The Firm should also consider if any non-audit
services are currently offered to the clients and whether additional services could be offered to
either of them in the future.

Guarantee in respect of bank loan

The provision of such a guarantee represents a financial interest in an audit client, and creates a
self-interest threat because the audit firm has an interest in the financial position of the client. The
audit firm may be reluctant to request adjustments to the financial statements that would result in the
firm having to honour the guarantee.
If an audit firm guarantees a loan to an audit client, the self-interest threat created
would be so significant that no safeguards could reduce the threat to an acceptable level unless the
loan or guarantee is immaterial to both the audit firm and the client.

The matter should be discussed with those charged with governance of the client, with an
explanation provided as to why the audit firm cannot provide the guarantee.

Audit manager joining client

Familiarity or intimidation threats may be created by employment with an audit client. The
familiarity threat is caused by the relationship that audit manager will have with the audit team,
having worked at the firm. This may cause the audit team to fail to challenge him sufficiently and
lose professional scepticism.

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The more junior members of the audit team may also feel intimidated by him as his previous
position was as audit manager. He will also be aware of the firm’s audit methodology and
procedures, making it easier for him to circumvent procedures. If a former member of the audit
team or partner of the firm has joined the audit client in a position that can influence the preparation
of the financial statements, and a significant connection remains between the firm and the
individual, the threat would be so significant that no safeguards could reduce the threat to an
acceptable level.
It is crucial that audit firm ensures that no significant connection between
the audit firm and audit manager remains, for example, by ensuring that he does not continue to
participate or appear to participate in the firm’s business or professional activities, and by making
sure that he is not owed any material sum of money from the audit firm. If a significant connection
were to remain, then the threat to objectivity would be unacceptably high, and firm would have to
consider resigning as auditors.

Lecture support notes by Alan Biju Palak

In the event of audit manager accepting the position and no significant connection between him
and the firm remaining, the existence and significance of familiarity and intimidation threats would
need to be considered and appropriate safeguards, such as modifying the audit plan and changing
the composition of the audit team, put in place.

There may have been a self-interest threat if manager knew he was going to
apply for the role at the same time as performing work for the client. Manager may have avoided
any conflict which would have affected his chances of getting the job.

Any work that the audit manager may have recently performed on client Co should be subject to
review to ensure his objectivity has not been impaired. However, as audit planning has yet to
commence, this may not be an important issue.

The firm should have in place policies and procedures which require members of an audit team to
notify the audit firm when entering employment negotiations with the client. The firm’s policies and
procedures should be reviewed to ensure they are adequate and they may need to be communicated
again to members of staff.

Contingent fee

As to the comment regarding whether the audit can be conducted on a contingent fee basis, this is
not allowed according to ACCA’s Code of Ethics. Contingent fee arrangements in respect of audit
engagements create self-interest threats to the auditor’s objectivity and independence that are so
significant that they cannot be eliminated or reduced to an acceptable level by the application of any
safeguards.

If the fee is contingent on the company’s performance the audit firm may not request management
to make adjustments to the financial statements which would result in lower profit as this would

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reduce the audit fee income. The audit fee must not depend on contingencies such as whether the
auditor’s report on the financial statements is modified or unmodified.

The matter should be discussed with those charged with governance of the client and the basis for
the calculation of the audit fee should be agreed with the audited entity before significant audit
work is undertaken.

Overdue fees

The overdue fees create a self-interest threat. A self-interest threat may be created if fees due from
an audit client remain unpaid for a long time, especially if not paid before the issue of the auditor’s
report for the following year.

Lecture support notes by Alan Biju Palak

The audit firm should determine the amount of fee which is unpaid, and whether it could be
perceived to be a loan made to the client. It may be a relatively insignificant amount, and it may not
be long overdue, in which case the threat to objectivity is not significant.

If the self-interest threat is significant, then no audit work should be performed until the fees are
paid. This decision, and the reason for it, should be communicated to management or their audit
committee, if possible.

Intimidation Threat

Client stated that they wanted guarantees that this year’s audit will be more efficient, less intrusive
and cheaper, otherwise he will seek an alternative auditor. This may give rise to an intimidation
threat.

The audit manager or partner should arrange a meeting with the senior management and the audit
committee, if one exists, and they should explain how the audit has to be performed and how the fee
is calculated.
They should take care to explain the professional standards which
they have to comply with and the terms of the engagement which the client agreed to, specifically
that management should provide all necessary documents and explanations deemed necessary by
the auditor to collect sufficient appropriate evidence. It should be explained that due to the need to
comply with these standards, they cannot guarantee to reduce either the volume of procedures or
the audit fee.

Firm should also consider the integrity of the client. If the audit firm considers any threat created
too significant, then they may wish to resign from the engagement. If not, it may be necessary to use
more senior, experienced staff on the assignment who are less likely to be intimidated by client
while performing audit fieldwork.

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If the audit proceeds, it should be ensured that the planning is

performed by an appropriately experienced member of the audit team. This should be reviewed
thoroughly by the audit manager and the partner to ensure that the procedures recommended are
appropriate to the risk assessment performed. In this way firm can ensure that any unnecessary, and
potential time wasting, procedures are avoided.

The audit manager should then make sure that the client is given adequate notice of the timing of
the audit and provide him with a list of documentation which will be required during the course of
the audit so that he may prepare for the visit by the audit team. The manager could also recommend
that client should make specific time available to meet with the audit team and then request that the
audit team use that time to ask all the necessary enquiries of the client. This should minimise any
disruption experienced by the client during fieldwork.

Lecture support notes by Alan Biju Palak

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