P7 Lecture 4 Code of Ethics Conduct

Copyright myaccanotes.
com - Founder & CEO Muhammad Bilal Farooq
ADVANCED AUDIT & ASSURANCE ENGAGEMENTS

ACCA P7
1
Lecture 4: ACCAs Code of Ethics & Conduct
Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq
ACCAs Code of Ethics & Conduct

Fundamental principals
Threats to independence
Safeguards to independence

Fundamental principals
Integrity
Objectivity
Confidentiality
Professional competence & due care
Professional behavior
independence
Mandatory disclosure
Voluntary disclosure
CPD
ACCAs Code of Ethics & Conduct: Fundamental Principles

Integrity
Definition:Honesty & straightforward dealing
Professional behavior
Definition: avoid situations or behavior that could
put yourself & the profession in disrepute
Professional competence & due care

Definition: possess & maintain the necessary skills
to carry out the work effectively and perform duties diligently

Responsibility to keep knowledge & skills up to date with
changing regulations, business practices etc is referred to as CPD (continuing professional development)
ACCAs Code of Ethics & Conduct: Fundamental Principles

Independence & objectivity:
Independence - Definition: to be free from personal bias
& from the influence of others Objectivity: maintain independence & thus carry out duties & make decision objectively Auditors must maintain independence of both mind & independence of appearance Independence of mind refers to a maintaining a state of mind which supports objective decision making Independence of appearance refers to avoiding situations which may create doubt or suspicion in the minds of reasonable third parties regarding the integrity & objectivity of auditors
ACCAs Code of Ethics & Conduct:

Confidentiality; requires auditors not to disclose confidential information without authorization unless
Exception #1: Exception #2:
Mandatory disclosure
Client suspected of: Drug trafficking Money laundering Terrorism Acts of treason Member served with court
Voluntary disclosure
Member defending interests
in court of law Public interest is involved (client polluting towns drinking water say) requires consideration of:

order to disclose Regulatory body demands disclosure
Severity of issue Extent of financial damage Whether repetition is likely Whether society is affected Is the matter being hidden from public knowledge
However before making
disclosure accountants should seek legal advice from an expert

7 Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq
ACCAs Code of Ethics & Conduct: Public Interest Entities

Before discussing threats to independence it is necessary
to note discuss to issues, public interest entities & management responsibilities (discussed in next slide)
ACCA
code separates companies for independence purposes into listed & non-listed entities. Listed entities include:
Companies which are listed entities or Companies which are defined by regulation or legislation as public
interest entities or Companies which are required by regulation to conduct audits at the same independence levels as the audit of listed entities Companies which are of significant importance to the public because of their size
The distinction is drawn to ensure that auditors maintain a
higher level of independence during audits of listed clients

8
ACCAs Code of Ethics & Conduct: Management Responsibilities

The ACCA code forbids audit staff from taking on management
responsibilities at audit clients This is because the law forbids directors, officers & employees from acting as company auditors Management responsibilities include:
Setting policies & procedures Developing strategies Making decisions as opposed to giving recommendations (which is
allowed) Taking responsibility for the preparation & fair presentation of financial statements Taking responsibility for establishing & maintaining an effective internal control system
Note that routine administrative duties are generally not considered to
fall under the category of management responsibilities
Threats to independence
Self-interest threat
Self-review threat
Familiarity threat
Advocacy threat
Intimidation threat
10

Self-interest threat:
Auditors self-interests threaten their independence & objectivity
11
Self-interest Threat
Financial interest:
Situation in which the firm, its member or a family
member of a member has a financial interest in a client Example: the purchase of clients shares
Safeguards include:
Disposing of the financial interest Removing the individual from the audit engagement Informing the clients audit committee of the situation &
safeguards being implemented Reviewing the work done can be done both:
Internally by other senior staff (partners) in the firm or Externally by requesting another firm to conduct the review
12
Close business relationship:
Situation in which the firm, its member or a family member of a member has a
close business relationship with the client Example: audit partner of firm A & CEO of client B run third business C together Example: audit firm A & client B operate a joint venture C Example: audit firm A markets client Bs products &/or services for a fee or commission
Safeguards include:
Assess if the business investment is material/significant If insignificant the threat to independence is not severe & audit can be provided However if there is a significant investment then identify whether the investment is
by:
The firm in which case either the business relationship or audit should be discontinued The engagement partner then rotate the partner, however if it is a small firm then this may not be
possible & thus only option is to terminate business relationship An officer lower down the hierarchy in which case that individual should be removed from the audit
13
Prospects of employment with an audit client:
Situation in which firm staff are offered potential employment with an audit client
Safeguards include:
Removing the individual from the audit engagement If partner rotate from audit engagement If officer remove from audit team
An additional complication arises when a staff member has left the firm & has
taken up employment at an audit client Example: the audit manager resigns from the firm to work as the finance director at the client The audit manager will be aware of the firms audit procedures & overall strategy Therefore the firm should undertake the following measures
Modifying the regular audit procedures & strategy usually implemented at that
client The objective is to create a degree of unpredictability The audit team should comprise of staff with sufficient experience
14
Temporary staff assignments:
Situation in which firm staff are loaned out to clients for short
periods of time When staff are loaned out then it is important that client management take responsibility for directing & supervising the activities of the loaned staff This is because the ACCA code forbids auditors from taking on duties/responsibilities normally performed by management
Safeguards include:
Not including loaned staff on audits of clients in which they
have worked in. or Not giving the loaned staff an area of the financial statements to audit on which they have worked on Conducting an independent review of the work done by loaned staff
15
Partner on client board:
Situation in which firm partner or other staff member
is employed as a director of a client This situation may be allowed if the role is purely administrative in nature
Safeguards include:
The firm staff should be removed from the audit
engagement or The firm should decline to act as client auditors

16
Family & personal relationships:
Situation in which firm staff have a family or other personal
relationship with client staff The severity of the threat is based on 3 factors:
1. 2. 3.
The audit staffs duties & position/seniority in the firm The client staffs duties & position in the company The closeness of the relationship
Example #1: if audit engagement partners wife is the finance director at
the client then the threat is assessed as high Safeguard would be to decline to act as auditors
Example #2: if audit trainees distant uncle works in the clients HR
department then this threat is assessed as low Safeguard would be to remove individual from audit team or Retain individual on team but have his work reviewed by senior officer
17
Compensation & evaluation policies:
Situation in which audit staff are rewarded (i.e.
bonuses, salary increments, benefits, promotion etc) on the basis of getting non-audit work from audit clients
Safeguards include:
audit engagement partners performance should not be evaluated on the basis of selling nonaudit services to audit clients Remove audit staff from audit team Review work done by audit staff
The
18
Gifts and hospitality:
Situation in which audit staff are given gifts or offered
hospitality by client Severity of threat depends upon:

Whether or not gift & hospitality is excessive Whether or not the giving of gifts & hospitality is routine
Example #1: gift is a cheap ball point or expensive fountain
pen Example #2: offered pizza or dinner at an expensive hotel Example #3: offered to customers, suppliers & auditors or only offered to auditors
Safeguards include:
If the gift or hospitality offered is excessive &/or non-routine in
nature then it should be declined
19
Overdue fees:
Situation in which the client has yet to pay the auditors
previous year/s fees This can result in a number of threats:

Auditor turning a blind eye to material misstatements which
overstate the financial position & performance of a client which is in financial difficulties. This is done to avoid the client collapsing & amount becoming a bad debt (self-interest threat) Auditor being threatened by client management of nonpayment or late payment (intimidation threat) Auditor may appear to have a financial interest in a client in the form of a loan (self-interest threat)
Safeguards include:
If the gift or hospitality offered is excessive &/or non-
routine in nature then it should be declined

20
Contingent fees:
Situation in which the auditor is paid a fees based on results in the
clients financial statements or the auditors work done Note that auditors calculate fees on the basis of time spent by audit staff involved in the audit (including out of pocket expenses) Example:

Partner: 15hrs @ Rs.5,500/= 82,500/Manager: 25hrs @ Rs.2,500/= 62,500/Audit team: 70hrs @ Rs.350/= 24,500/Total: = 169,500/Out of pocket expenses = 23,000/Grand total: = 192,500/-
Also note that auditors simply provide an estimate of fees & must
clarify to clients that the final amount will depend upon the total time taken
Safeguards include:
Firms are not permitted to agree payment on a contingent basis
21
High percentage of fees:
Situation in which the audit firm derives a significant
proportion of total income from one particular client Example: firm A derives 30% of total income from client B
Safeguards include:
Audit firm must reduce its dependency on client by: Cutting back on non-audit services supplied to client Resigning from engagement Performing a review of audit work Firms are advised that their income from public interest
entities should not be more than 15% of total income earned over last 2 years
22
Lowballing:
Situation where audit firm quotes a significantly low fee in order to secure an audit
engagement Often clients give non-audit services to their auditors. There are two main reasons for this:
1. 2.
Clients are reluctant to share their confidential data with more than one accountant Auditors gain an in-depth knowledge of the clients business & systems during the course of the audit & thus they do not need to go through this process again in order to provide non-audit services. This results in lower fees/costs for non-audit services for clients
Consequently auditors realize that if they can secure an audit client they will also benefit from
the more lucrative non-audit assignments Often lowballing is done during bidding However the problem is that this can exercise can compromise an auditors independence of appearance Third partys may ask how an auditor can provide a quality service at such a low fee Also because the firm is a profit making entity there is a possibility that it may cut corners in order to reduce costs to earn profits from low fee audit assignments
Safeguards include:
Audit firm must not engage in lowballing Audit firms must maintain time sheets as evidence of hours spent by staff on assignments &
to prove that audit was conducted in accordance with laws, standards & ethical guidelines
23
Recruitment:
Situation where audit firm is requested by client to recruit
staff on behalf on client

Safeguards include:
Audit firm must not perform management responsibilities
for clients Rather the firm should provide a shortlist of potential candidates to client management Client management can then make the final decision
24
Self-interest Threat: Summary

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14.
25
Financial interest Close business relationship Prospective employment with client Temporary staff assignments Partner on client board Family or personal relationship Compensation & evaluation policies Gifts & hospitality Loans & guarantees Overdue fees Contingent fees High % of fees Lowballing Recruitment

Self-review threat:
Auditor is reviewing his own work and thus cannot act as an independent third party
26
Self-review Threat
Management responsibility:
As discussed earlier audit firms must not take on
management responsibilities in the firms they audit
27
Self-review Threat
Recent employment with an audit client:

Situation where audit firm staff having recently been working as an employee for the client Severity of threat will depend upon: What the duties & seniority of the officer at the audit client What is the duty & seniority level of the officer at the audit firm The duration of time between the officer leaving the client & taking up employment at the audit firm Example #1: Mr. X recently left company A in which he worked as finance director to take up a
job as audit manager in firm B. Firm B are the auditors of company A & Mr. X is overseeing the audit of company A. in this situation the severity of threat to independence is high because it is very likely that Mr. X will be reviewing his own work! Example #2: Mr. X recently left company A in which he worked as IT manager to take up a job as IT manager in firm B. Firm B are the auditors of company A. In this situation the severity of threat to independence is Low as Mr. X had no accounting role in his previous position & is not involved in the audit of A
Safeguards include:
Firms must allow for cooling off periods before appointing the new officer to be involved in the
audit of a former employer Review the work done by the staff member
28
Self-review Threat
Preparation
of
accounting
records
&
financial
statements:
There is a high risk to independence if auditors prepare
accounting records & financial statements Practically however it is often the case that auditors assist management in:
Maintaining books of account Preparing financial statements Applying accounting & financial reporting standards
Safeguards include:
Firms must use different staff or different departments (i.e. audit
department, consultancy o& tax department etc) for providing non-audit services Review work done Inform client audit committee
29
Self-review Threat
Valuation services:
This comprises of valuing assets & liabilities for clients Example #1: clients may ask auditors to value a fixed asset or a
pension. Because these assets & liabilities form part of the financial statements the auditors will be reviewing their own work. If the amounts involved are material (i.e. significant) then the threat is also significant
Safeguards include:

30
Firms must use separate teams or departments Explaining to client the basis of valuation Ensuring client acknowledges responsibility for the valuation Reviewing work done Informing client audit committee
Self-review Threat
Taxation services:
This includes: Preparing tax returns: does not impact financial statements as is thus not a threat to independence Calculating tax amounts to be included in the financial statements: this involves a self-review threat & should not be provided to public interest entities Tax planning: may impact financial statements Timing of purchase of assets to minimize tax liability: no impact on financial statements & is thus not a threat to independence Accounting treatment to adopt to minimize taxable profits: impacts financial statements & is thus a threat to independence Representing clients in disputes with tax authorities: this creates an advocacy threat (discussed later)
Safeguards include:
Firms must use separate teams or departments Review work done Inform audit committee
31
Self-review Threat
Internal audit service: Companies have to choose between setting up an in-house internal audit
function or outsourcing it to an accountancy firm Firms may provide internal audit services but must be careful not to take on work that is management responsibility

Setting internal audit policies Supervising & directing clients internal audit staff Deciding on which recommendations to implement Taking responsibility for developing & implementing the internal control system (this is the responsibility of client management)
Firms are prohibited from providing internal audit services on a recurring
basis to public interest entities

Safeguards include:
Firms should use separate teams or departments Review audit work done Inform the clients audit committee of situation & safeguards introduced
32
Self-review Threat
Corporate finance:
Provision of consultancy on financing strategy, sourcing of
funds, cost of capital etc are acceptable If corporate finance impacts the financial statements then it will create a threat to independence Audit firms however are not allowed to:
Promote audit client shares Deal in audit client shares Underwrite client shares
Safeguards include:
Firms must use employ separate teams or departments Review of audit work done Inform client audit committee of situation & safeguards
introduced
33
Self-review Threat
IS & IT consultancy:
Provision
of consultancy on developing the clients information system (including accounting system) whether manual or automated (i.e. IT based) will create a selfreview threat
Safeguards include:
Firms must use employ separate teams or departments
Review of audit work done

Inform client audit committee
34
Self-review Threat: Summary

1. 2. 3. 4.
5.
6. 7.
8.
Management responsibility Recent employment with an audit client Preparing books of account & financial statements Valuation services Taxation services Internal audit services Corporate finance IS & IT services
35
Self-review Threat
IS & IT consultancy:
Provision
of consultancy on developing the clients information system (including accounting system) whether manual or automated (i.e. IT based) will create a selfreview threat
Safeguards include:
Firms must use employ separate teams or departments
Review of audit work done

Inform client audit committee
36
Self-interest Threat: Summary

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14.
37
Financial interest Close business relationship Prospective employment with client Temporary staff assignments Partner on client board Family or personal relationship Compensation & evaluation policies Gifts & hospitality Loans & guarantees Overdue fees Contingent fees High % of fees Lowballing Recruitment
ACCAs Code of Ethics & Conduct Advocacy, familiarity & intimidation threats
38
Advocacy Threat
Auditor independence (of appearance) is affected
in situations in which he is defending or promoting the position of his audit client Examples:
Providing a positive analysis on the clients financial
position & performance to client banks or prospective investors providing a positive analysis to prospective buyers of a clients business Evaluating the clients business line (e.g. a division or plant) for sale Defending or representing the client in litigation
Familiarity Threat
Auditors independence is threatened due to a
familiarity with the client staff or systems This occurs when the audit firm has been auditing the client over a number of successive years For public interest entities the recommendation is a maximum of 7 years after which there is a compulsory requirement to rotate the engagement partner The engagement partner must not be involved in the clients audit for at least 2 years
Intimidation Threat
This occurs when an audit client threatens the auditors in
some way Threats may be open as in threatening to sue the auditors for negligence or The threats may be more subtle as when management delay payment of audit fees to an audit firm facing financial difficulty or Seeking a second opinion
Safeguards:
Immediately disclose to the audit committee of the client
managements threats Removing audit staff from audit team who may be the cause of friction with client management Reviewing work done
Conflicts of Interest
Conflicts of interest involving auditors & audit
clients:
An auditor may have an investment in a second
business Z which competes directly with an audit client The auditor may be tempted to supply client confidential data to Z Also auditor may be tempted to provide incorrect advice in order to weaken the competitive position of Z
Safeguards include: removing individual from audit team Informing client audit committee of situations in safeguards implemented Ultimately if the threat cannot be mitigated then resign as auditors
42
Conflicts of interest between two different clients:
An auditor may have two clients are in direct competition with
one another Clients may fear that confidential data may be leaked by auditors to competitors ACCA does not restrict auditors from providing assurance services to competing clients This is because firms often specialize in particular industries (i.e. financial sector or textile say) & clients benefit from the experience of specialists
Safeguards include: Informing the management & audit committees of both clients of the situation & the safeguards introduced Using different teams on clients & ensuring there is no communication between these teams (i.e. Chinese walls) Ultimately if the threat cannot be mitigated then resign as auditors
43
Conflicts of interest between two different clients:
An auditor may have two clients are in direct competition with
one another Clients may fear that confidential data may be leaked by auditors to competitors ACCA does not restrict auditors from providing assurance services to competing clients This is because firms often specialize in particular industries (i.e. financial sector or textile say) & clients benefit from the experience of specialists
Safeguards include: Informing the management & audit committees of both clients of the situation & the safeguards introduced Using different teams on clients & ensuring there is no communication between these teams (i.e. Chinese walls) Ultimately if the threat cannot be mitigated then resign as auditors
44
3 Levels of Safeguards
National level: created by government & regulatory bodies
Legislation Companies Act 2006 (who is eligible, rights & duties, appointment
removal remuneration etc) Corporate governance requirements (audit committees) Profession: ACCA (education, training, monitoring & investigation of members & disciplinary action)
Firm level: created by firm leadership

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

Continuing professional development Getting advice from a mentor Maintaining a record of situations in which independence was threatened & how it
was subsequently resolved

45

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Copyright myaccanotes.

com - Founder & CEO Muhammad Bilal Farooq

ADVANCED AUDIT & ASSURANCE ENGAGEMENTS

Lecture 4: ACCAs Code of Ethics & Conduct

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

ACCAs Code of Ethics & Conduct

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

ACCAs Code of Ethics & Conduct

Professional competence & due care

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

ACCAs Code of Ethics & Conduct: Fundamental Principles

put yourself & the profession in disrepute

Professional competence & due care

to carry out the work effectively and perform duties diligently

ACCAs Code of Ethics & Conduct: Fundamental Principles

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

ACCAs Code of Ethics & Conduct:

order to disclose Regulatory body demands disclosure

However before making

disclosure accountants should seek legal advice from an expert

ACCAs Code of Ethics & Conduct: Public Interest Entities

The distinction is drawn to ensure that auditors maintain a

higher level of independence during audits of listed clients

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

ACCAs Code of Ethics & Conduct: Management Responsibilities

fall under the category of management responsibilities

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

ACCAs Code of Ethics & Conduct

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

ACCAs Code of Ethics & Conduct

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

engagement or The firm should decline to act as client auditors

Example #1: if audit engagement partners wife is the finance director at

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

hospitality by client Severity of threat depends upon:

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

nature then it should be declined

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

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

routine in nature then it should be declined

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

staff on behalf on client

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Self-interest Threat: Summary

ACCAs Code of Ethics & Conduct

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

management responsibilities in the firms they audit

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Recent employment with an audit client:

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Firms are prohibited from providing internal audit services on a recurring

basis to public interest entities

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq

Copyright myaccanotes.com - Founder & CEO Muhammad Bilal Farooq