Learning Guide – Ethics and Corporate Governance – Part 1

FACULTY / COLLEGE College of Business and Economics

SCHOOL School of Accounting
DEPARTMENT Department of Accountancy
MODULE NAME Auditing 300 / Intermediate Auditing
MODULE CODE AUD 300 / S3BCTQ1

LEARNING GUIDE: ETHICS AND CORPORATE GOVERNANCE - PART 1

INSTRUCTIONS:
1. The information provided in this learning guide constitute the learning notes for the topic. It
should be used in combination with the online lectures (if relevant) and the contact sessions on
campus (if relevant), as well as any other learning material made available in class / online.
2. This learning guide provides you with clear instructions of what is expected of you to master the
topic well.
3. When required – complete the additional reading indicated in this learning guide.
4. When required – complete the questions in the Question Bank.

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TABLE OF CONTENTS

1. AN INTRODUCTION TO ETHICS AND GOVERNANCE .................................................... 3

2. THE BASICS OF ETHICS .................................................................................................. 5
3. WHY IS ETHICS IMPORTANT TO AN ACCOUNTANT? ................................................... 7
4. THE SAICA CODE OF PROFESSIONAL CONDUCT .......................................................10
5. THE AUDITING PROFESSIONS ACT NO 26 OF 2005 .....................................................13
6. THE GOVERNANCE ENVIRONMENT ..............................................................................14
7. QUESTION BANK .............................................................................................................16
8. CONCLUSION ...................................................................................................................16

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Learning Guide – Ethics and Corporate Governance – Part 1

1. AN INTRODUCTION TO ETHICS AND GOVERNANCE

Ethics and good governance is the foundation on which every business transaction is and should
be based. Ethics and specifically business ethics, should therefore be considered in everything
you will one day do as a responsible business leader. In fact, your personal ethics – will benefit
to evaluate whether certain thinking and consequent behaviour can be regarded as ethical.

Good governance on the other hand, is a mechanism instilled by an organization to ensure good
ethics and that all business activities are conducted in a way, to protect the public interest,
investors and all stakeholders of an organisation.

In this unit, you will obtain a better understanding of what business ethics is, as well as its
importance. To develop this understanding – we will build on your prior year knowledge developed
during your second year or other courses that included ethics and governance.

You will also learn about governance, as the foundation for all business activities within any
organisation. Hence, the overarching purpose of this unit is to provide you with an introduction
and solid foundation to business ethics to start your development as the future generation
responsible business leader and professional accountant, displaying sound qualities and skills
expected of an organizational ethical leader and custodian of good governance.

In AUD 300 / BCTA, we will start your ethics and governance journey by exploring the real
meaning of ethics and ethical behaviour, as well as good governance. We will explore why ethics
matter and determine if there is a difference between ethics and what is required in terms of
legislation i.e. can something be illegal but still ethical and vice versa?

Lastly, as a future Chartered Accountant (South Africa) / professional accountant / auditor and
custodian of trust, ethics and good governance, you will learn about the South African Institute of
Chartered Accountants (SAICA) Code of Professional Conduct (CPC), the King IV Report on
Corporate Governance and some statutory requirements applicable to the Companies Act No. 71
of 2008, that will “manage” the risks of unethical behaviour within the CA / professional accountant
and Audit profession.

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Your role as the custodian of trust, ethics and good governance will be demonstrated by
unpacking the Agency Theory and what your role is in protecting the public interest and the wealth
of your company’s shareholders and stakeholders. You will also learn about the Auditing
Profession Act No. 26 of 2005. This is crucial, as the Independent Regulatory Board for Auditors
(IRBA) regulate the audit profession in South Africa.

The learning outcomes for this learning guide is as follows:

Learning Description of the Learning Outcome
Outcome
1 Discuss / explain your own personal moral compass used when evaluating ethical
thinking, behaviour and / or decision making.
2 Discuss / explain the difference between personal and business ethics.
3 Based on a practical scenario, discuss / explain / describe the ethics triangle and
conclude if the applicable identified thinking, behaviour and / or decision making
can be regarded as ethical.
4 Discuss / explain the myths applicable to ethics.
5 Discuss / explain the benefits of ethics to a business.
6 Discuss / explain the interaction of law and ethics.
7 Based on a practical scenario, discuss / explain / describe how the RIMS can be
used to solve an ethical / moral dilemma and provide suggested solutions to resolve
it.
8 Based on a practical scenario and with reference to the SAICA CPC, identify /
discuss / explain / describe the fundamental principles breached / potentially
breached.
9 Based on a practical scenario and with reference to the SAICA CPC, identify /
discuss / explain / describe the threats / possible threats to the fundamental
principles.
10 Based on a practical scenario and with reference to the SAICA CPC, suggest
safeguards applicable to learning outcome 8 and 9.
11 Discuss / explain / describe the independence concept and how it relates to
professional accountants.
12 Discuss / explain / describe the agency theory and its problem.

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13 Based on a practical scenario, discuss / explain / describe any concerns regarding

compliance with the Auditing Professions Act (APA).
14 Based on a practical scenario, identify and discuss / explain / describe a reportable
irregularity and the steps required by the auditor.
15 Discuss / explain / describe the governance concept
16 Based on a practical scenario, discuss / explain / describe the agency theory
implications and how it links to governance and ethics.
17 Based on a practical scenario and with reference to the King IV Report, discuss /
explain / describe any compliance and / or non-compliance.
18 Based on a practical scenario and with reference to the King IV Report, discuss /
explain / describe any recommendations to rectify non-compliance.
19 Based on a practical scenario, identify and discuss non-compliance with laws and
regulations (NOCLAR).

2. THE BASICS OF ETHICS

In Commerce, business people use various “jargon” that often do not have any meaning to the
“non-accountant”. As the future generation responsible business leader, it is important that you
“walk-the-talk”. In order to do so; you need to be familiar with the “jargon” used in business ethics.

When you hear the word “Ethics”, what are your first thoughts? What do you associate this word
with?

For me – I think of the following “words”, “Thoughts” and “Associations”:

Good and Bad Good vs Bad Right and Right vs Wrong Values
Wrong
Justice Norms Standards Integrity Objectivity
Independence Self-interest What is in it for Honesty Dishonest
me
Fairness Unfair Respect Disrespect Accountability
Non-reliant Transparency Laws Regulations Best practices
Policies For the greater Humanity Protecting Harmful
good others

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I want you to take a few minutes and think of the words that you associate the word
“Ethics” with.
These are all words that we are familiar with and sometimes use when we communicate in our
personal lives. Overall, these words, all in somehow relate to “Ethics”.

But what is the true meaning of Ethics?

Ethics is about what is good or right in human interaction. It revolves around three central
concepts:
 Self;
 Good; and
 Other.

Ethical thinking and its consequential behaviour results when one does not merely think / consider
what is good for oneself, but also think / consider what is good for others. In essence thinking and
behaving ethical is to not be selfish. Good is determined by society and general perceptions of
what constitute the meaning of “Good”.

It is crucial that each of the above thee central concepts be included in a definition of ethics.

Considering the good of “others” is always a good thing. However, thinking too much about
“Others” and neglecting “Yourself” might lead to you being unhappy and not making a decision
that is within the best interest of all parties involved. Consequently, this might negatively impact
on your consequent behaviour when it comes to ethics.

The “trick” is therefore, to find a “perfect” balance between the three crucial and central concepts
to evaluate whether you’re thinking, a decision and your consequent behaviour can be regarded
as ethical i.e. “Good”, “Self” and “Other”.

The “Ethics Triangle” gives us clear guidance to do exactly that i.e. considering “Good”, our “Self”
and “Others” when thinking about ethics and ethical behaviour. Note that the word “Ethics” is
central to the triangle i.e. finding that perfect balance between “Good”, “Self” and “Other” to make
an ethical decision that will lead to ethical behaviour.

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ETHICS

But how do we determine what is good and what is bad within the workplace?

We know that our association of what is good vs. bad can be formed by our upbringing, our set
of values, morals and believes, our religion, etc. However, in the workplace we all need to have
a streamlined understanding of what is good and bad. Hence, being ethical within the workplace,
leads to ethical behaviour and consequently to make ethical decisions.

Good vs bad is streamline in business by means of codes of conduct, company policies, ethical
leadership, the tone-at-the-top, etc. The codes and policies also take into account the “Self” and
“Other”. Hence, as the future generation Chartered Accountant (CA), it is important that you know
what is expected from a CA in the workplace to display good ethics and ethical behaviour.
Remember that the SAICA Code of Professional Conduct is applicable to CAs in public and
private practice i.e. CAs in business. Codes of conduct and policies, etc. also indirectly define
what is regarded as “Good”.

3. WHY IS ETHICS IMPORTANT TO AN ACCOUNTANT?

In order to complete your degree at the 3rd year level, you have subjects such as financial
accounting and reporting, taxation, management accounting and finance, as well as audit and
assurance. In order to be a well-rounded accountant, you must have a broad spectrum of
knowledge applicable to each of the above subjects. This is because, a business is based on the
fundamental principles embedded in each of these disciplines. As such, ethics is not just
applicable to auditing and assurance. It is ingrained in each discipline in the boarder field of
accountancy.

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Think about it – what is the purpose of financial accounting and reporting?

In a simplified manner – it is firstly to track, analyze and report your business income and
expenditure. The reports generated are then used, for example to examine resource usage, cash
flow, business performance and the financial health of the business. As such, this assists you and
possible investors to make informed decisions about how your business is managed.

In theory, well managed businesses should be performing well, increase possibility for company
survival and limiting the chance of company distress. As such, your business will attract investors
to invest in your company. Consequently, the cash generated from investors can be utilized to
further grow and develop the business.

Considering the above, financial accounting and reporting will assist you to draft financial
statements that are of a high standard, technically correct, transparent and representing a
reasonable correct and fair presentation of the financial performance and position of the company.
As such, your financial accounting and reporting knowledge benefit possible investors and other
stakeholders to rely on the financial statements and data to make informed decisions. Hence, you
are a custodian for the integrity of the financial statements and all of its variables.

But how does this relate to ethics?

The International Financial Reporting Standards (IFRS) are basically a large set of “rules” when
drafting financial statements. It commences with the Framework and IAS 1 – Presentation of
Financial Statements. Thereafter, many ISAs, IFRSs and IFRICs, etc. are used to explain and
guide the accountant to calculate, measure, disclose, etc. specific transactions. At the end of the
day – all these transactions are presented in the annual financial statements.

As such, the “rules” contained in IFRS is a mechanism to ensure that financial statements (and
all of its content) is reliable and non-fictitious. Hence, users of the financial statements can rely
on the information provided to make informed decisions. IFRS can therefore be seen as a
mechanism to prevent unethical accounting.

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Think about fair value accounting. Why do you think you learn about the recognition,
measurement and disclosure for financial instruments? It is because – fair value accounting
requires a level of judgment. Without any “rules” - fair value create the opportunity for
management to manipulate the financial statements to their own benefit (i.e. Self) and not that of
the stakeholders (i.e. others).

The same argument holds for all of your other core subjects. Can you perhaps think of how the
Income Tax Act 58 of 1962, is an example of a mechanism to prevent unethical conduct? Also
take into accountant, that something might be legal but unethical and vice versa.

From the above, you will realize that ethics is a fundamental part of a business and how it is and
should be conducted. If you are not familiar with the ethics triangle and / or any of its content,
please revisit your second year notes on the topic.

In business, you will often encounter different views regarding ethics i.e. you might think
something is unethical, but your colleague might view it to be ethical. What do you then do? Do
you look the other way and hope that the problem resolves itself? Or do you react?

As an accountant, you will have a fundamental role to play in protecting the public interest. We
will visit this principle later when we look at governance i.e. how does the Agency Theory give
rise to the need for good company governance. Hence, when confronted with unethical thinking
and behaviour – you cannot look the other way.

If you look at any corporate scandal – you will find that it narrows down to ethics. Why? Because
in most of the corporate scandals – someone acted in his / her own best interest (Self), regarding
something that is not regarded as good (Good) by general standards, and to the detriment of
others (Others).

Chances are that in corporate scandals, the entire board of directors (governing body) did not
agree with the planned / unplanned unethical thinking and behaviour i.e. there were
disagreements. As such, there is a high probability that some directors were not in agreement
with what certain directors wanted to plan and / or execute. However, these directors perhaps
looked the other way and probably “hoped” that the issue resolves itself. Can you see that this
presents a possible moral and ethical dilemma?

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As an accountant, you will often experience the scenario describe above i.e. facing moral and
ethical dilemmas. How can you respond to this?

In your second year – you learned about Rational Interaction for Moral Sensitivity (RIMS). This is
a powerful strategy that one can use in attempting to resolve moral and ethical dilemmas. To
apply the strategy, communication is key. You also need to consider moral dissensus and use
the stepped approach to the strategy. However, as with all things in life – the RIMS strategy has
certain limitations and using it to resolve moral and ethical dilemmas is based on specific
assumptions.

If you are unsure about any of the RIMS strategy details – you need to revisit your second year
study notes.

4. THE SAICA CODE OF PROFESSIONAL CONDUCT

As mentioned before, the SAICA Code of Professional Conduct (CPC) is a mechanism to identify
and respond to potential and factual unethical thinking and behaviour. It indirectly sets the scope
for what is considered “Good”. As such, it is crucial that you fully understand the content of the
CPC. Throughout your career as a CA / professional accountant, you will be obliged to comply
with the SAICA CPC in all of your business dealings / encounters.

It is important to note that all professional bodies Codes of Professional Conduct are similar in
some way or another. The principles contained in Codes of Conduct identify certain fundamental
principles on which ethics is based, as well as certain threats that could negatively impact on the
fundamental principles.

For the SAICA CPC, the fundamental principles are (i) integrity, (ii) objectivity, (iii) professional
competence and due care, (iv) confidentiality and (v) professional behaviour. Together these five
fundamental principles will result in ethical thinking and behaviour.

You can now watch the first lecture on the CPC available on Blackboard.

A threat is defined as “a person or thing likely to cause damage or danger”. As such, the CPC
“labeled” five categories of threats that could cause damage or danger to comply with the

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fundamental principles for good ethics. These are (i) self-interest threat, (ii) self-review threat, (iii)
advocacy threat, (iv) familiarity threat and (v) intimidation threat.

Please revisit your second year notes to familiarize yourself with the definitions for the
fundamental principles and the threats. You should also read Chapter 3 of Dynamic Auditing (14th
Edition) pages 3-1 to 3-61.

You can now watch the second lecture on the CPC available on Blackboard.

The CPC includes many “rules” that could negatively impact on the fundamental principles such
as conflict of interest, gifts, professional appointments, second opinions, fees and other types of
remuneration, inducements, hospitality, custody of client assets and responding to non-
compliance with laws and regulations.

Remember that the fundamental principles and threats are applicable to all CAs. As such, the
SAICA CPC provides guidance for professional accountants in business and in public practice. A
professional accountant in public practice, in most cases refers to an external auditor.

In summary, the SAICA CPC combines the fundamental principles and threats applicable to
professional accountants in business and public practice in order to design what is meant by
“Good”. Consequently, the identified threats guide professional accountants to practice business
that is good for both “Self” and “Other”.

What do you think is the auditor’s objective when conducting an audit?

It is for the auditor to obtain reasonable assurance about whether the financial statements as a
whole are free from material misstatement, whether due to fraud or error, thereby enabling the
auditor to express an opinion on whether the financial statements are prepared, in all material
respects, in accordance with the applicable financial reporting framework (IFRS) and to report on
the financial statements, and communicate as required by the International Audit Standards
(ISAs), in accordance with the auditor findings (ISA 200.11). As such, an audit results in an audit
opinion and report (ISA 700).

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Remember that providing an audit service should be independent. Why? Because independence
result in an unbiased view of the financial statements, that avoid conflict of interest and ensures
the integrity of the information audited. Can you see that independence could easily be an issue
for an auditor? It is therefore imperative that an auditor eliminate any risks to his / her
independence to conduct the audit and express and audit opinion over the financial statements
or when conducting a review of financial statements.

Part 4A in the SAICA CPC provides specific guidance applicable to the independence for audit
and review engagements. It is crucial that you read this in Dynamic Auditing (14th Edition) page
3-53 to 3-61. Part 4A provides many examples of “threats” that could impact on the auditor’s
independence when conducting an audit or a review of financial statements.

Remember, when conducting an audit – independence is fundamental. It comprises of

independence of mind i.e. the state of mind that permits the provision of an opinion without being
affected by influences that compromise professional judgements, allowing an individual (the
auditor) to act with integrity, and exercise objectivity and professional skepticism. It also
comprises of independence in appearance. That is, to avoid any facts and circumstances that are
so significant, that an informed third party having knowledge of all relevant information, including
any safeguards applied – would reasonably conclude a firm, or a member of the audit team’s
integrity, objectivity or professional skepticism had been compromised.

Also remember that both professional accountants in business and public practices have a
responsibility regarding non-compliance with laws and regulations.

You can find the SAICA CPC and an additional summary of the important parts under “Resources”
on Blackboard.

The SAICA CPC provides guidance to professional accountants to evaluate if “something” is

ethical and if not: to employ safeguards to protect the fundamental principles or, if not practicable
– walk away and keep your hand clean.

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5. THE AUDITING PROFESSIONS ACT NO 26 OF 2005

In the previous section – you learned about the objective of an auditor when conducting an audit
of financial statements and that independence of the auditor is key. As such, only a Registered
Auditor (RA) may conduct an audit of financial statements to express an opinion in his / her
auditor’s report.

In order to build an audit profession that is independent, the IRBA is the South African regulator
for RAs.

The Auditing Professions Act No 26 of 2005 (APA) is enacted by parliament to provide the
establishment of the IRBA for auditors. As such, the main role of the IRBA is to provide for the
education, training and professional development of RAs and registered candidate auditors and
to regulate their conduct. Hence, all auditors must comply with the APA. This is applicable to
individuals that practice as RAs and audit firms. From an AUD 300 / BCTA perspective it is crucial
that you master the content of the APA well.

One of the most important sections in the APA is Section 45 that deals with the auditor’s duty to
report on irregularities. Firstly, it is important that you know what is meant by a reportable
irregularity. This is defined in Section 1 of the APA. Remember that a reportable irregularity will
have an impact on the auditor’s opinion and report. This you will learn more about when we look
at audit reporting later in the year. For now – it is crucial that you can identify a reportable
irregularity by applying information from a case study to the definition in Section 1 of the APA.

You are now required to read Chapter 1 of Dynamic Auditing (14th Edition) – The Audit Profession
in South Africa.

You can also find the APA on Blackboard in the “Resources” folder.

You can now watch the lecture applicable to the APA. You will find the video in the “Video and
Slides” folder on Blackboard.

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6. THE GOVERNANCE ENVIRONMENT

So far we have looked at the basics of ethics, as well as how the SAICA CPC can be used to
manage ethics i.e. a mechanism. The SAICA CPC is also very specific about the fundamental
principles that all professional accountants in business and public practice must comply with. It
also refers to independence of professional accountants in business and public practice.

A very important mechanism to create a sound ethical environment and to protect the public
interest and the interests of the stakeholders and stakeholders of an organization, is good
governance.

But what does governance mean?

Different definitions exist for the governance concept. However, the overarching purpose of
governance is to facilitate effective, entrepreneurial and prudent management that can deliver the
long-term success of a company. It is the “system by which a company is directed and controlled”.

Governance does not only determine how the objectives of a company are set and achieved, but
also focusses on how the risk level in a company is assessed and how the performance is
optimized to create shareholder wealth.

The governance concept originated from the Agency Theory in an attempt to identify and address
the agency problem. The separation between ownership and control give rise to the so-called
agency problem. This problem occurs when shareholders shift their responsibility to control the
day-to-day and strategic decision making activities of a company, to appointed managers. In this
regard, executives (directors / those charged with governance) can possibly abuse their position
for their own benefit (rent extraction) rather than focusing on the wealth maximization of
shareholders and the company as a whole.

Can you see how the ethics triangle can play an important role?

Governance is the “exercise of ethical and effective leadership by the governing body (board of
directors) towards the achievement of the following governance outcomes: ethical culture, good
performance, effective control and legitimacy” and relates to the way that companies are
governed rather than to the way they are managed.

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From the above, can you see that governance is central to conducting business in an
ethical way?

A specific area in company governance is corporate governance. Within the South African
context, the King IV Report on Corporate Governance provides suggestions and guidelines to
instill good corporate governance within a business. Hence, following the guidelines and
principles contained in the King IV Report will, in theory, create a sound corporate governance
environment / governance environment.

It is very important to remember that the application of the King IV Report is not compulsory for
privately owned companies. However, it is for companies listed on the Johannesburg Securities
Exchange Limited (JSE). This is because the JSE listing requirements include compliance for
listed companies to the King IV Report. The King IV Report does however recommend and
strongly encourage all companies / organizations to apply and incorporate the principles in the
Report.

If you are not familiar with the Principles contained in the King IV Report – please revisit your
second year notes.

You can watch the revision video on the King IV Report. The video is available in the “Videos and
Slides” folder on Blackboard. The King IV Report on Corporate Governance is available in the
“Resources” folder, as well as a summary of the important Principles.

You are now required to read Chapter 2 of Dynamic Auditing (14th Edition) pages 2-1 to 2-24
(section 5.4.5). You are not required to read Section 6 (Internal Control). We will visit internal
control later in the year.

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7. QUESTION BANK
Once you have worked through the theory in this learning guide, please do the questions from
the Question Bank.

8. CONCLUSION
In part 1 of Ethics and Corporate Governance we looked at the basic of ethics. We also explored
the governance concept.

With regards to ethics – we linked the concept to the SAICA CPC as a mechanism to established
good ethical thinking and behaviour for professional accountants in business and public practice.
Furthermore, we specifically looked at the term independence and how this is relevant to
professional accountants in business and public practice. We further explored ethics with regards
to the IRBA APA, a set of legislation that is applicable to RAs and audit firms. We also noted that
RAs have a responsibility to report any reportable irregularities in terms of Section 45 of the APA.

Remember that both professional accountants in business and public practice, as well as RAs
have a responsibility to act on any non-compliance with relevant laws and regulations.

We also looked at the King IV Report on Corporate Governances as a mechanism and suggested
practice to create a sound governance environment that should result in an ethical business
environment.

Remember that ethics and governance is also regulated by law i.e. the Companies Act No. 71 of
2008. The broad spectrum of governance compliance, includes non-compliance with laws and
regulations. As such, in the next part of ethics and governance (Ethics and Governance – Part 2)
we will investigate and unpack the sections of the Companies Act that are relevant to ethics and
governance. We will also unpack how ethics and governance (including the Companies Act)
impact on the audit of financial statements and the remainder of the units covered in the year.
This will create the “bigger picture” for your 3rd year studies and emphasize that ethics and
governance should not be viewed in isolation, but rather considered throughout the entire audit
process.

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