OVERVIEW
Objective
¾
To explain the professional codes of ethics and conduct under which students and members of the ACCA operate.¾ Introduction
¾ Fundamental principles
¾ Conceptual framework – risks
¾ Conceptual framework – safeguards
¾ Ethical conflict resolution
ACCA CODE OF ETHICS AND
CONDUCT
INTEGRITY OBJECTIVITY & INDEPENDENCE
CONFLICTS OF INTEREST CONFIDENTIALITY
¾ Improper disclosure
¾ Improper use ¾ ¾ Two types Member v client
¾ Client v client
¾ Principles
¾ Fees and pricing
¾ Gifts and hospitality
¾ Financial interest
¾ Family and other personal relationship
¾ Loans and guarantees
¾ Overdue fees
¾ Provision of other services to assurance clients
¾ Long association with assurance clients
¾ Recent employment with an assurance client
¾ Future employment with an assurance client
¾ Close business relationships
¾ Actual or threatened litigation
¾ Serving on the board of an assurance client
¾ Second opinions
INDEPENDENCE IN OTHER ROLES
¾ Professional roles
1
CODE OF ETHICS AND CONDUCT
1.1
Introduction
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As a member of the IFAC, the ACCA’s Code of Ethics and Conduct, is based on the Code of Ethics of the IFAC and applies to all Students and Members of the Association (in practice, commerce, or any other environment, e.g. internal audit, education) in that they are required to observe proper standards of professional conduct and refrain from misconduct. Failure to observe standards may result in disciplinary proceedings.¾
The Code provides five fundamental principles (integrity, objectivity, professional competence and due care, confidentiality and professional behaviour) and a conceptual framework to assist ALL students and members in applying the principles, regardless of the areas of work undertaken.1.2
Fundamental Principles
1.2.1
Integrity
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In all professional, business, personal and financial relationships, members should be straightforward and honest. This implies honesty, fair dealing and truthfulness.¾
Members should not be associated with (eg sign off) reports, returns, communicationsor other information where they believe that the information: contains materially false or misleading statements;
contains statements or information furnished recklessly; or
omits or obscures information required to be included where such omission or obscurity would be misleading.
¾
For example: In the context of an audit under ISA, this means that if the financial statements contain a material error that the directors refuse to change, the auditor would qualify their opinion.
In the context of other work, e.g. preparing a cash flow forecast, if asked to verify data that is misleading, the member would refuse to accept the engagement or withdraw as soon as they become aware that the data is misleading and the client refuses to change.
1.2.2
Objectivity
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Members should not allow bias, conflicts of interest or undue influence of others to override their professional and business judgments.1.2.3
Professional competence and due care
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Members work and advice given must reflect current developments in practice, legislation, applications, techniques and professional standards.¾
Members must obtain and maintain the relevant knowledge and skill to ensure the provision of competent and professional service levels (e.g. through continuing professional development). This also requires the exercise of sound judgment in applying professional knowledge & skill and the need to act diligently in accordance with applicable technical and professional standards.¾
The requirements of each assignment must be fully understood such that the member and assignment staff will act carefully, thoroughly and on a timely basis – if unable to do so, the assignment should not be accepted. Thus members must also ensure that all others working under their authority have the appropriate training and supervision.¾
Where appropriate, clients, employers or other users of professional services, must be made aware of limitations inherent in the services to avoid the misinterpretation of an expression of opinion as an assertion of fact (eg in the engagement letter and/or report).1.2.4
Confidentiality (see also Section 3)
¾
Information acquired as a result of professional and business relationships is confidential and should not be disclosed to any third parties without proper and specific authority (e.g. from the client) or unless there is a legal, professional right, or duty to disclose.¾
Confidential information acquired as a result of professional and business relationships should not be used for any personal advantage of a member or any third party.1.2.5
Professional behaviour
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All relevant laws and regulations should be complied with and any action that brings discredit to the profession should be avoided. Members must show professional courtesy and consideration.¾
In marketing and promoting themselves and their work, members should not bring the profession in disrepute. Members should be honest and truthful and not: make exaggerated claims for the services they are able to offer (e.g. claim to be able to carry out statutory audits when they do not hold statutory recognition as an auditor) the qualifications they possess (e.g. claim to be qualified when still a student) or experience they have gained; or
make disparaging references or unsubstantiated comparisons to the work of others (e.g. “we are the best, better than all the rest”).
1.3
Conceptual framework
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The Conceptual Framework assists members (through guidance and illustrative examples) to identify, evaluate and respond to threats to compliance with theFundamental Principles, rather than merely following rules (which are unlikely to be appropriate for every situation and could thus be avoided).
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It allows members to consider the risks they face and to match those risks with the appropriate action. It is not a set of rules within a fixed framework as ACCA members need to be flexible within their operating environment in order to ensure theFundament Principles are not compromised.
¾
If identified threats are other than clearly insignificant, members must implement safeguards to eliminate the threats or reduce them to an acceptable level so that compliance with the Fundamental Principles is not compromised.¾
Whilst examples are used to illustrate the application of the framework, they do not cover all possibilities faced by members. The framework should be applied to the particular circumstances faced. Where a situation cannot be aligned with the examples given within the framework, the underlying concept is always “if in doubt, avoid, do not do”.1.4
Threats
¾
Compliance with the Fundamental Principles may potentially be threatened by a broad range of circumstances. Many threats fall into the following categories: self-interest; self-review; advocacy; familiarity; intimidation.
Remember that these apply to all members, not only those in practice but also those employed in industry, commerce etc.
1.4.1
Self-interest threat
¾
May occur as a result of the financial or other interests of members (including immediate or close family of the member) eg: loans or guarantees;
close personal or business relationships; financial interest in a client;
gifts and hospitality;
incentive compensation arrangements; concern over employment security;
commercial pressure from outside the employing organisation; interest in transactions with the company;
1.4.2
Self-review threat
¾
May arise when a previous judgment needs to be re-evaluated by individuals responsible for that judgment. The original judgment may have been made, for example, by the individual or by others within the individual’s organisation.¾
Circumstances which may give rise to self-review threats include, but are not limited to: providing a service to a client that will then be subject to review as part of the assurance engagement;
reporting on the operation of systems after being involved in their design or implementation;
the discovery of a significant error during a re-evaluation of the work being undertaken by the member;
a member of an engagement team who was previously employed by the client and was in a position to have had direct influence on the subject matter of the
engagement;
business decisions or data being subject to review and justification by the same person responsible for making those decisions or preparing those data;
an analyst, or member of a board, audit committee or audit firm being in a position to exert direct and significant influence over the financial reports.
1.4.3
Advocacy threat
¾
Occurs when members promote a position or opinion to the point that subsequent objectivity may be compromised (e.g. stating publicly a given opinion on a future position and then having to audit that position at a later date when it has changed and there is potential pressure to ignore the change).¾
It is natural for members to advocate their client’s/employer’s position and there is nothing improper in this provided it does not result in misleading information being given.¾
There could be circumstances, however, where this may not be acceptable and these include: commenting publicly on future events in particular circumstances, having made assertions without detailing the assumptions;
where information is incomplete or advocating an argument which is unlawful; promoting shares in a listed audit client or a client seeking to list;
acting as an advocate on behalf of an assurance client in litigation or disputes with third parties.
1.4.4
Familiarity threat
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There is a significant risk that professional scepticism will not be applied by the member. Examples of circumstances that may create familiarity threats include: a member in a position to influence business decisions, financial (or non-financial) reporting (e.g. the audit report) having an immediate or close family who is in a position to benefit from that influence (e.g. a director or shareholder);
over-familiarity with the management of the organisation such that professional judgement could be compromised;
long association with business contacts influencing business decisions;
acceptance of gifts or preferential treatment, unless the value is clearly insignificant; a former partner of the engagement firm being a director, officer or employee of a
client in a position to exert direct influence over the subject matter of the engagement.
1.4.5
Intimidation threat
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Will occur where members may be deterred from acting objectively by threats, actual or perceived, direct or indirect. Examples of circumstances that may create intimidation threats include: threat of dismissal or replacement of the member (as an employee or auditor) or a close or immediate family member, over a disagreement about the application of an accounting principle or the way in which financial and performance information is to be reported;
a dominant personality attempting to influence the decision-making process, for example with regard to the awarding of contracts or presentation of financial information, or controlling relations with auditors or other oversight bodies; being threatened with litigation;
coming under pressure to reduce necessary work to ensure a reduction in fees.
1.5
Safeguards
¾
The nature of the safeguards to be applied will vary depending on the circumstances (demonstrating the approach of the conceptual framework).¾
In exercising their judgement, members should consider what a reasonable and informed third party, having knowledge of all relevant information, including the significance of the threat and the safeguards applied, would conclude to be acceptable or unacceptable.¾
Safeguards that may eliminate or reduce to acceptable levels the threats faced by members fall into three broad categories: safeguards created by the profession, legislation or regulation; safeguards in the work environment;
1.5.1
Safeguards created by the profession, legislation or regulation
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Includes: Educational, training and experience requirements for entry into the profession. Continuing professional development/education (CPD/CPE) requirements. Corporate governance regulations.
Professional standards.
Professional or regulatory monitoring and disciplinary procedures.
External review by a legally empowered third party of the reports, returns, communications or information produced by a member.
1.5.2
Safeguards in the work environment
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Includes: The employing organisation’s systems of corporate oversight or other oversight structures, e.g. audit committee and “whistle blowing” rights.
The employing organisation’s ethics and conduct programmes including leadership that stresses the importance of ethical behaviour and the expectation that
employees will act in an ethical manner (e.g. ethical culture cascading down from top management).
Recruitment procedures in the employing organisation emphasising the importance of employing high-calibre, competent staff.
Strong internal controls.
Appropriate disciplinary processes.
Policies and procedures to implement and monitor the quality of employee performance.
Policies and procedures to implement and monitor the quality control of engagements.
Using different partners and engagement teams with separate reporting lines for the provision of non-assurance services to the client.
Policies and procedures to prohibit individuals who are not members of an engagement team from inappropriately influencing the outcome of the engagement.
Timely communication of the employing organisation’s policies and procedures, and any changes to them, to all employees.
The provision of appropriate training and education to employees.
Discussing ethical issues with those charged with governance of the client.
Policies and procedures to empower employees to communicate to senior levels (including governance) any ethical issues that concern them. This includes informing employees of the procedures open to them.
Consultation with another appropriate professional accountant.
1.5.3
Safeguards created by the individuals
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Includes: Complying with continuing professional development requirements. Keeping records of contentious issues and approach to decision-making.
Maintaining a broader perspective on how similar organisations function through establishing business relationships with other professionals.
Using an independent mentor.
Maintaining contact with legal advisors and professional bodies.
1.5.4
Other safeguards
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Certain safeguards may increase the likelihood of identifying or deterring unethical behaviour. Such safeguards, which may be created by the accounting profession, legislation, regulation or an employing organisation, include, but are not restricted to: effective, well-publicised complaints systems which enable colleagues and employers to draw attention to unprofessional or unethical behaviour; an explicitly stated duty to report breaches of ethical requirements.
1.6
Ethical conflict resolution
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In resolving ethical conflicts it is important to record the process and outcome, e.g.: relevant facts; the ethical issues involved;
the fundamental principles involved; established procedures followed; action followed and outcome;
alternative courses of action and their consequences; and
internal and external sources of consultation (e.g. ethics partner; audit committee).
¾
Where a significant conflict cannot be resolved, consideration should be given toconsulting legal advisors and/or the ACCA. Such consultation can be taken without breaching confidentiality (e.g. on a ‘no names’ basis). Care should be taken to ensure that those consulted are also bound by similar ethical rules.
¾
Members may determine that, in the circumstances, it is appropriate to withdraw from the engagement team or specific assignment, or to resign altogether from theengagement, the firm or the employing organisation.
2
INTEGRITY, OBJECTIVITY AND INDEPENDENCE
2.1
Principle
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The Fundamental Principles require that a member’s integrity and objectivity must be beyond question. This can only be assured if the member is, and is seen to be, as independent as possible.¾
Independence requires: Independence of mind - the state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgement, allowing an individual to act with integrity and exercise objectivity and professional scepticism.
Independence in appearance - the avoidance of facts and circumstances that are so significant that a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, would reasonably conclude a firm's, or a member of the assurance team's, integrity, objectivity or professional scepticism had been compromised.
¾
Members who provide assurance services must be independent of the assurance client (be they responsible for the subject information or the subject matter), regardless of the type of assignment, i.e. assertion or direct reporting.¾
As, in an assurance engagement, “members express a conclusion designed to enhancethe degree of confidence of the intended users other than the responsible party about
the outcome of the evaluation or measurement of a subject matter against criteria” it is logical that the assurance provider be independent of the assurance client.
¾
Members who provide other services (e.g. taxation services, compilation of accounts, corporate advisory services) to non-assurance clients, may none the less under specific circumstances, find their perceived objectivity under threat because of the nature their work and of their relationship with a client, e.g. a brother who is asked to prepare a company cash flow forecast by his sister who is a director of that company.¾
The following examples describe specific circumstances and relationships that may cause threats to independence. Whilst they mainly relate to members in practice (i.e. audit and assurance) they can equally apply to the provision of non-assurance services and members in industry, commerce etc.2.2
Fees and pricing
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A similar threat may also be created when the fees generated by the assurance client represent a large proportion of the revenue of an individual partner.¾
Every firm should consider its own circumstances to determine an appropriate level beyond which objectivity may be considered to be impaired. In addition, firms are obliged to consider the appropriateness of accepting an assurance engagement where fees would exceed a lower specified limit. Effectively, this lower level acts as a trigger point to consider appropriate safeguards.¾
To safeguard objectivity, the ACCA state that fee income for audit and other recurring work paid by one client (or a group of connected clients) should not exceed thefollowing % of gross practice income (and individual partner’s total fee income).
Initiate
review Extreme
Listed and other public interest companies 5% 10%
Other clients 10% 15%
Note that these are extreme levels – firms may set levels that are lower to reflect their particular circumstances.
Criterion does not initially apply to new practices. An initial period of time should be given to allow the practice to grow to a reasonable level.
The propriety of accepting or retaining clients should be reviewed against the lower % figures – and safeguards set up if engagement accepted/retained.
A company planning to seek a listing will be public interest in the period before it is listed (because publicity leading up to flotation will be “in the public eye”).
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Safeguards when initiating a fee level review include: taking steps to reduce dependency on the client, e.g. expansion of client base through organic or merger growth;
quality control review procedures, e.g. second independent partner review at the planning and completion stages where a fee breaches the lower review %.
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Fee income on non-recurring assignments, if taken together with recurring work, could give rise to dependency. This would particularly be the case if the non-recurring work, whilst of a different nature each year, effectively contributes a consistent base % of fee income from the client.2.3
Gifts and hospitality
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Unless the value is clearly insignificant, a firm or a member of the assurance team should not accept such gifts or hospitality as the threats to independence cannot be reduced to an acceptable level by the application of any safeguard.¾
A similar consideration will apply to gifts and hospitality made to the close family of a member of the assurance team, unless they receive the benefit in their own right and not because of their connection with the assurance team member.2.4
Financial interests
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Creates a potential self-interest threat.¾
In general, consider the nature of the financial interest, including the role of the individual holding the interest. This includes direct control over the interest, e.g. personal holding of shares, and an interest over which there is no control, an indirect interest, e.g. unit trust or pension fund.¾
Holders of a direct interest/material indirect interest (both being referred to as a relevant interest) are at risk and the threat should be assessed. Basically, partners cannot hold investments in assurance clients whilst other employees can. Such employees cannot be part of the engagement team.
¾
The engagement partner, other partners (regardless of discipline or involvement with the assurance engagement) and their immediate family cannot hold a relevant financial investment in any of the firm’s assurance clients.¾
The partner must dispose of the investment or the firm disengage from the assurance assignment or the client.¾
If a relevant interest is held by a member of the assurance team or their immediate family, then: require disposal of the holding by the employee or their immediate family member; or
remove the employee from the assignment (usually the action taken).
¾
Where assurance staff (or their immediate family) do hold investments in assurance clients, they must not be assigned to such clients.¾
A principal safeguard is the annual declaration by all partners and staff that they, and their immediate family, do not have a financial interest in any assurance clients. This is supplemented by informing partners and staff of new assurance clients (on a regular basis) and the requirement for partners and assurance staff to inform the compliance partner of any financial interest.2.5
Family and other personal relationships
¾
Personal or immediate family relationships between a member of the assurance team and a client’s directors, officers and other employees (with responsibilities that exert direct and significant influence over the assurance subject matter) will create self-interest, familiarity or intimidation threats.¾
The significance of the threats will depend on factors such as: the position held by the individual within the client; and the role of the member of the assurance team.¾
Safeguards include: removing the individual from the assurance team;
ensuring that the individual does not deal with the areas of responsibility of the client employee;
resigning from the assignment or client.
¾
The more senior the employee within the client and/or the more senior the member of the assurance team, the greater the need to apply the strongest safeguard, i.e. removal of the employee from the assurance team or resignation. For example: a junior’s uncle is a director of an assurance client will mean that the junior should not be a member of the assurance team;
a junior’s girlfriend who is the credit controller will mean that, if the junior remains on the team, they will not be involved in dealing with sales or receivables;
the senior’s girlfriend who is the credit controller will mean that they should not be involved with the assignment as they will be responsible for setting and reviewing the work of the team member who carries out work on the credit area;
a partner’s sister is a director of a company, means that the firm should not provide assurance services to the company. If requested to tender for the audit, the firm should decline. If the sister is recruited as a director by the company, which is already an audit client, the firm should resign the audit.
¾
Where other partners and employees have personal or immediate family relationships with assurance clients (for who they do not act) self-interest, familiarity or intimidation threats may still arise.¾
The safeguards put in place (including resignation from the assignment or the client) will depend on the closeness of the relationship and the respective positions within the client and firm.2.6
Loans and guarantees
¾
In respect of a general assurance client that is not a bank or similar institution, a firm (including partners) should not: make a loan accept a loan
guarantee borrowings
unless the loan/guarantee is immaterial to both the firm (and partners) and the
assurance client. There are no safeguards that would bring the threat to independence to an acceptable level.
¾
Where the client is a commercial financial institution (e.g. a bank) the firm, partners, employees of the firm (including engagement staff) and their immediate family may have deposits, overdraft facilities and standard loans (e.g. car, mortgage loans, credit card balances) provided the terms, arrangements and conditions are at arms length and generally available to all clients of the institution.¾
Where deposits made by the firm or loans to the firm by the client bank are material, safeguards should be put in place to bring the self-interest threat to an acceptable level. Such safeguards include review of the assurance assignment by an external,independent professional.
¾
Note that many firms specifically prohibit their partners (and the firm) from taking any form of material loan from financial institution clients. This is particularly the case for the engagement partners. Where a loan is material to an employee (which is likely to be the case), that employee would not be assigned to the audit of the bank concerned.2.7
Overdue fees
¾
Can be a self-interest threat where fees remain unpaid for a significant period of time, particularly where prior year fees have not been settled by the time of the current year’s report.¾
Safeguards include: requiring the payment of overdue fees before the issue of any further reports; discussing the level of outstanding fees with audit committees or those charged
with governance;
establishing on-account/standing order payments of fees over the year.
¾
Consideration must also be given to determine if the overdue fees are effectively a loan, and therefore if it is appropriate for the firm to continue to act for the client.2.8
Provision of other services to assurance clients
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However, in some jurisdictions (e.g. the USA under the Sarbanes-Oxley Act) auditors are specifically barred from providing additional assurance and non-assurance services to their listed company clients.¾
The following general safeguards are relevant when providing other services: policies and procedures to prohibit professional staff from making management decisions for the assurance client, or assuming responsibility for such decisions; making arrangements so that personnel providing the services do not participate in
the assurance engagement;
obtaining the assurance client’s acknowledgement of responsibility for the results of the work performed by the firm;
policies within the assurance client regarding the oversight responsibility for provision of non-assurance services by the firm (e.g. audit committee approval only if satisfied auditor’s independence will not be impaired);
involving an additional professional accountant outside of the firm to provide assurance on a discrete aspect of the engagement;
discussing independence issues related to the provision of the services with those charged with governance, such as the audit committee;
disclosing to those charged with governance, such as the audit committee, the nature and extent of fees charged.
¾
Where safeguards cannot eliminate, or reduce to an acceptable level, the threat to independence, the non-assurance engagement should be declined.¾
Under the ACCA Code, the following activities would generally create self-interest or self-review threats that are so significant that only avoidance of the activity or refusal to perform the assurance engagement would reduce the threats to an acceptable level: authorising, executing or completing a transaction, or otherwise exercising authority on behalf of the client, or having the authority to do so;
determining which recommendation of the firm should be implemented (i.e. making management decisions); and
reporting, in a management role, to those charged with governance. Specific examples of other services are detailed below.
2.8.1
Preparing accounting records and financial statements
¾
There is a danger that in preparing accounting records and financial statements, management decisions will be made, eg: determining or changing journal entries, or the classifications for accounts or transaction or other accounting records;
authorising or approving transactions; and
preparing source documents or making changes to such documents.
¾
The ACCA specifically bars members from preparing accounting records and financial statements (except to assist in emergency situations) for listed or public interest clients where they will also conduct the audit. To do so may impair (or appear to impair) the independence of the auditor.¾
In all other situations accounting, bookkeeping and financial statement preparation services may be provided, provided safeguards are in place, eg: Accounts preparation members are not part of the assurance engagement team; No managerial decisions made by the preparation team;
No authorising or approving transactions by the preparation team; Source data must be originated or changed only by the client; Underlying assumptions originated and approved by the client; Client acceptance of the responsibility for records as its own;
Client approval for any proposed journals, analysis or other changes impacting on the financial statements.
2.8.2
Internal audit
¾
Internal audit provide a broad range of services to their organisations (see Session 33). Many of these will not be related to the financial systems and may be undertaken without threat to independence by the external auditors.¾
However, the provision of internal audit services to an audit client relating to the internal controls (including business risk and financial controls) financial systems and financial statements will create a self-review threat.¾
The firm must consider the threats and proceed with caution before taking on internal audit services relating to internal control, financial systems and financial statements.¾
Safeguards include: ensuring the audit client recognises its responsibility for internal audit activities and acknowledges its responsibility for establishing, maintaining and monitoring the system of internal controls (e.g. in the engagement letter);
the audit client designates a competent employee, preferably within senior management, to be responsible for internal audit activities;
employees used by the audit firm and their internal reporting lines, should be different to those for the audit assignment;
the audit client is responsible for evaluating and determining which recommendations of the firm should be implemented;
the audit client evaluates the adequacy of the internal audit procedures performed and the findings resulting from the performance of those procedures by, among other things, obtaining and acting on reports from the firm; and
the findings and recommendations resulting from the internal audit activities are reported appropriately to the audit committee or supervisory body.
2.8.3
Valuation services
¾
A valuation comprises the making of assumptions with regard to future developments, the application of certain methodologies and techniques, and the combination of both in order to compute a certain value, or range of values, for an asset, a liability or for a business as a whole.¾
A self-review threat may be created when a firm performs a valuation for an audit client that is to be incorporated into the client’s financial statements to be audited by the firm.¾
Where the valuation is material to the financial statements and involves a significant degree of subjectivity (e.g. a pension fund actuarial valuation or fair value based on cash flows), the self-review threat created cannot be reduced to an acceptable level by the application of any safeguard.¾
Such valuation services should not therefore be provided. Alternatively, the firm could withdraw from the audit engagement.¾
Where the valuation is not material or does not involve subjectivity, the valuation may be undertaken provided the self-review threat can be reduced to an acceptable level.¾
Appropriate safeguards would include: involving an additional professional (who was not a member of the assurance team) to review the work done or otherwise advise as necessary;
confirming with the audit client their understanding of the underlying assumptions of the valuation and the methodology to be used and obtaining approval for their use;
obtaining the audit client's acknowledgement of responsibility for the results of the work performed by the firm; and
¾
In determining if the safeguards would be effective, the following matters should also be considered: the extent of the client's knowledge, experience and ability to evaluate the issues concerned, and the extent of their involvement in determining and approving significant matters of judgement;
the degree to which established methodologies and professional guidelines are applied when performing a particular valuation service;
for valuations involving standard or established methodologies, the degree of subjectivity inherent in the item concerned;
the reliability and extent of the underlying data;
the degree of dependence on future events of a nature which could create significant volatility inherent in the amounts involved; and
the extent and clarity of the disclosures in the financial statements.
2.8.4
IT systems services
¾
The provision of services to an audit client that involve the design and implementation of financial information technology systems that are used to generate information forming part of that client’s financial statements, may create a self-review threat.¾
Appropriate safeguards include: acknowledgement by the audit client of its responsibility for establishing and monitoring a system of internal controls;
the audit client designates a competent employee, preferably within senior management, with the responsibility to make all management decisions with respect to the design and implementation of the hardware or software system;
the audit client makes all management decisions with respect to the design and implementation process;
the audit client evaluates the adequacy and results of the design and implementation of the system;
the audit client is responsible for the operation of the system (hardware or software) and the data used or generated by the system; and
employees used by the audit firm and their internal reporting lines, are different to those for the audit assignment.
2.8.5
Provision of temporary staff to a client
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The lending of staff by a firm to an audit client may create a self-review threat when the individuals are in a position to influence the preparation of a client’s accounts orfinancial statements.
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In practice, such assistance may be given (particularly in emergency situations) but only on the understanding that the personnel will not be involved in: making management decisions;
approving or signing agreements or other similar documents; or exercising discretionary authority to commit the client
¾
In addition such staff will not be involved in the audit of those areas and activities undertaken whilst on the temporary assignment to the client.¾
It is important that the audit client acknowledges its responsibility for directing and supervising the firm’s staff whilst on temporary assignment.2.8.6
Recruitment of senior management
¾
The recruitment of senior management for an assurance client, such as those in a position to affect the subject matter information of the assurance engagement, may create current or future self-interest, familiarity and intimidation threats.¾
Care must be taken to ensure that no managerial decisions are taken by the firm during the recruitment process. For example, services provided could cover reviewing the professional qualifications of a number of applicants and providing advice on their suitability for the post.¾
In addition, the firm could generally produce a short-list of candidates for interview, provided it has been drawn up using criteria specified by the assurance client. In no circumstances should the firm rank or identify the most suitable candidate.2.9
Long association of senior personnel with assurance clients
¾
Creates a familiarity risk where senior members of the assurance team are assigned to one particular assignment for a significant period of time.¾
The significance of the threat should be evaluated and safeguards applied, e.g. rotating the senior personnel off the team;
involving an experienced member independent of the assignment to review the work of the senior team members; or
¾
For a listed entity or a significant public interest entity , the risk is significant and specific rotation procedures must be applied: Five year maximum rotation of engagement partner (who cannot return to the engagement within five years).
Seven year maximum rotation of other “key audit partners” (who cannot return within two years or as the engagement partner, within five years). Also applies to the individual responsible for the engagement quality control review.
When an audit client becomes listed, it may be possible that the engagement partner/key audit partner will have already exceeded their rotation period or will have less than two years to run. In both circumstances, they are allowed to remain with the client for a maximum of two more years and must then be rotated.
2.10 Recent employment with an assurance client
¾
May create a self-interest, self-review and/or familiarity risk. Especially high risk where the member of the assurance team has to, for example, report on subject matter that they were responsible for whilst with the assurance client.¾
Any partner, manager or employee cannot be part of the assurance team during the period for which a report is to be made, or at any time in the prior two years (i.e. three years in total), if they were an officer or employee of the client, or they were seconded to the client from the practice, and had direct and significant influence over the subject matter of the assurance assignment.¾
For similar situations prior to the two year period, where the subject matter is currently being reported on, the significance of any threat must be assessed and appropriate safeguards applied, e.g. specific independent review of the work carried out by the team member.¾
In addition, in some jurisdictions, legislation may prohibit an officer/employee of a company from accepting appointment as auditor of that company (e.g. UK Companies Act 2006).2.11 Future employment with an assurance client
¾
May create self-interest, familiarity and/or intimidation threats, especially where significant connections remain between the individual and their former firm.¾
Because of the significance of the threats, a key audit partner of an audit client cannot accept a key management position with that client until at least two years have elapsed from the conclusion of the audit.¾
For other partners and staff of any assurance client (whether or not an audit is conducted), the threat must be assessed taking into account: the position the individual has taken at the assurance client;
the length of time that has passed since the individual was a member of the assurance team or firm; and
the former position of the individual within the assurance team or firm.
¾
If the threat is more than insignificant, appropriate safeguards should be applied, eg: modifying the assurance plan; assigning a sufficiently experienced team; quality control review.
¾
In all cases: the individual concerned is not entitled to any benefits or payments from the firm (after they have left) unless these are made in accordance with fixed
pre-determined arrangements (e.g. partnership agreement);
any amount that is owed to the individual should not be of such significance to threaten the firm’s independence (e.g. akin to a loan); and
the individual does not continue to participate or appear to participate in the firm’s business or professional activities.
¾
Similar threats will also apply when an employee of the firm participates in anassurance engagement knowing that they will, or may be employed by the client (e.g. having interviews).
2.12 Close business relationships
¾
A close business relationship between a firm or a member of the assurance team and the assurance client or its management, will involve a commercial or common financial interest and may create self-interest and intimidation threats. Examples include: joint ventures with the client, directors, officers or employees who perform managerial functions;
marketing arrangements between the firm and a client for a joint product or the other’s products and services.
¾
In such circumstances, no safeguards would be able to reduce the risk to an acceptable level, therefore: terminate such business relationships already established; refuse to enter into any such business relationships offered; or refuse to perform assurance assignments for the client.
2.13 Actual or threatened litigation
¾
When litigation takes place, or appears likely, between the firm or a member of the assurance team and the assurance client, a self-interest or intimidation threat may be created.¾
The firm and client may be placed in adversarial positions, therefore the auditor may be unable to report impartially: and/or the client may be unwilling to disclose relevant information.
¾
The significance of the threat will depend on: the materiality of the litigation;
the nature of the assurance engagement; and
whether the litigation relates to a prior assurance engagement.
¾
Safeguards that may be applied include: disclosing to the audit committee, or others charged with governance, the extent and nature of the litigation;
if the litigation involves a member of the assurance team, removing that individual from the assurance team; and
independent review of the work that was carried out and is subject to the litigation.
2.14 Serving on the board of an assurance client
¾
Serving on the board of an assurance client creates significant review and self-interest threats.¾
The firm and client may be placed in adversarial positions, therefore the auditor may be unable to report impartially: and/or the client may be unwilling to disclose relevant information.
¾
Partners and employees of a firm cannot serve on the board of any of their firm’s assurance clients.Example 1
Required:
Comment and conclude on the following four situations.
Comment –
Conclusion –
(2) Paine & Co has been requested by a long standing client to do a special investigation into a foreign group of companies. The target group is based in Turkey where the firm has no representation. The client is very keen to use the firm and are prepared to pay not only for the cost of the investigation but also the additional costs of the firm having to use temporary staff to service other existing clients. The firm’s gross practice income is normally $7,500,000, the audit fee for this client is normally $800,000. The extra service is expected to cost the client $1,600,000
Comment –
Conclusions –
Comment –
Conclusion –
(4) Sean & Co are the auditors of Starck a.s. During the current year, Starck has expanded rapidly, taken over three other companies and is currently preparing to float a proportion of its shares on a recognised stock exchange. As a result of several special assignments connected with these events, total fees from Starck amount to 19% of the total fee income of Sean & Co for the year.
In addition, Sean & Co’s senior tax manager owns a small number of shares in Starck, acquired several years ago when the company issued shares under a business expansion scheme
Comment –
2.15 Second opinions
¾
Occurs when an entity approaches an accounting firm who is not its auditor, for an opinion on the application of accounting, auditing, reporting or other standards or principles. Sometimes referred to as “opinion shopping” by the client.¾
Providing a second opinion to a company or an entity that is not an existing client, may give rise to threats to compliance with the fundamental principles, unless the advice sort is clearly insignificant.¾
For example, there may be a threat to professional competence and due care incircumstances where the second opinion is not based on the same set of facts that were made available to the existing accountant, or is based on inadequate evidence.
2.15.1
Risks
¾
The firm may express an opinion which is not based on the facts as known to the auditor.¾
The second opinion may create undue pressure on the judgement and objectivity of the appointed auditor, thus threatening their independence.2.15.2
Safeguards
¾
The person or firm asked for a second opinion must: seek the client’s permission to contact the current accountant and/or auditor; obtain all relevant information by contacting the accountant/auditor and asking for
any relevant facts; and
should be prepared to provide the accountant/auditor with their opinion, given the client’s permission.
¾
If communication with the current accountant/auditor is refused, a second opinion should not be given.¾
Where a hypothetical position is put, the person/firm asked to comment on thisposition should ensure that the nature of their opinion is made clear and that it is based on the hypothetical position put to them. Professional scepticism should be applied as to the nature of the hypothetical position.
3
CONFIDENTIALITY
¾
Two aspects3.1
Improper disclosure
3.1.1
General principle
¾
Information acquired in the course of professional work should not be disclosed to third parties (including other clients and for use within other assignments) without first obtaining the client’s permission. For example, information obtained from oneassignment cannot be used within another, without obtaining the permission of the first client, e.g. the knowledge that one client has going concern problems cannot be used to assess debt collection by another client, unless such knowledge is within the public domain.
¾
Exceptions there is a statutory right or duty to disclose without first obtaining the client’s permission;
there is a requirement made by law, e.g. under obligation of a court order; to comply with quality control reviews of regulatory bodies, e.g. ACCA (usually
included within the letter of engagement); or
to respond to an inquiry or investigation by ACCA or other regulatory body (again, included within a letter of engagement).
3.1.2
General position
¾
Confidentiality is an implied term of a contract between an auditor and client. It is in the public interest that this professional duty of confidence exists.¾
Auditors are normally under NO legal obligation to disclose defaults or unlawful acts (or suspicions thereof) to anyone other than the client’s management, unless specifically required to do so by law.¾
Where there is a right (as opposed to a duty), disclosure should only be made in pursuit of a public duty or professional obligation.3.1.3
Obligatory disclosure
¾
UK examples include actual or suspected offences of: money laundering; proceeds of crime; terrorism;
treason;
drug trafficking.
3.1.4
Voluntary disclosure
¾
In certain circumstances, information may be disclosed whatever its nature. Categories of disclosure include: in the “public interest” to a person having proper interest to receive information, e.g. the police; the stock exchange where the client is listed. Care must be taken to ensure that the concept of “public interest” can be appropriately applied;
to protect the auditor’s interests, e.g. in defending against ACCA disciplinary proceedings; and
authorised by statute.
Illustration 1
During the current year’s interim audit, the auditor becomes aware that the client has been misrepresenting their VAT return to the tax authorities
resulting in an underpayment of VAT. The client refuses to accept the advice of the auditor to notify the VAT authorities, negotiate and correct their returns. The auditor informs the client that they are no longer prepared to act for them in any professional capacity. They also tell the client that they will be
informing the taxation authorities that they no longer act for the client.
Because of client confidentiality, they should not disclose to the tax authorities the reason why they have resigned (unless the client gives permission for them to do so – which is highly unlikely).
In addition, in certain jurisdictions (e.g. the UK) the deliberate underpayment of taxation is classified as proceeds of crime and possibly money laundering. The auditor is therefore under a legal duty to fully report their suspicions to the appropriate authorities (dealing with proceeds of crime) giving full details, even though they do not give a full report to the taxation authorities.
Now, more than ever, it is essential for professional accountants to seek legal advice in such circumstances.
3.2
Improper use of information
3.2.1
Principle
3.2.2
Examples
¾
When a member changes firm or employment he should distinguish between experience gained in the previous firm or employment; and confidential information and documents acquired there.
¾
A member should not deal in the shares of a company with which he has a professional association as it might make it appear that he was turning information obtained in his professional capacity to his own advantage.4
CONFLICTS OF INTEREST
4.1
Two types
4.2 Member v client 4.3 Client v client
¾
The implications arising from possession and use of confidential information are separate issues.4.2
Member v client
4.2.1
Principle
¾
Members should place clients’ interests before their own.¾
A firm should not accept or continue an engagement in which there is or is likely to be a significant conflict of interests between the firm and the client.¾
Any financial gain which accrues or is likely to accrue to the firm as a result of the engagement (other than properly earned fees etc) will ALWAYS amount to a significant conflict of interest.¾
The test is whether a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, would consider the conflict of interest as likely to affect the judgement of members and firms.4.2.2
Commission
¾
Where any commission, referral fee or reward may be earned for the introduction of a client, or as a result of advice given to a client, a self-interest threat arises.¾
Safeguards include disclosing to the client, in writing that such commission, etc will be received;
as soon as practicable, of its amount and terms; and
4.3
Client v client
4.3.1
General
¾
There is nothing improper in a firm having two or more clients whose interests may be in conflict.¾
However, the firm’s work should be so managed to avoid the interests of one client adversely affecting those of another.¾
Where the acceptance or continuance of an engagement would, even with safeguards, materially prejudice the interests of any client the appointment should not be accepted or continued.4.3.2
Managing conflict between clients’ interests
¾
All reasonable steps should be taken to ascertain whether any conflict of interests exists or is likely to arise in the future.¾
Relationships with existing clients need to be considered before accepting a new appointment and regularly thereafter.¾
A relationship which ended over 2 years before is unlikely to give rise to conflict.4.3.3
Disclosure
¾
A material conflict of interests between existing or potential clients should besufficiently disclosed to all clients involved so that they may make an informed decision whether to engage or continue their relationship with the firm.
4.3.4
Safeguards
¾
Use different partners and teams of staff for different engagements.¾
Standing instructions etc to prevent leakage of confidential information between different teams and sections within the firm (application of “Chinese walls”).¾
Use of confidentiality agreements signed by employees and partners of the firm.¾
Regular review of the situation by a senior partner or compliance officer not personallyinvolved with either client.
¾
Advising at least one or all clients to seek additional independent advice.¾
Where a conflict of interest poses a threat to one or more of the fundamental principles, including objectivity, confidentiality or professional behaviour, that cannot be4.3.5
Disengagement
¾
When necessary should be done as speedily as is compatible with the interests of the clients concerned.Illustration 2
All of the current Big 4 firms were formed through the mergers of major firms (originally referred to as the “Top 10”). As the number of audit & assurance firms reduced, it was not uncommon for two major competitor companies to find that they became clients of the same firm. Despite assurances given concerning the confidentiality of information and being able to minimise and control conflicts of interest, many competitor companies decided between them that one of them would need to change advisors.
Example 2
Required:
Comment and conclude on the following situations:
Solution
(1) The audit senior of Neutron, a limited liability company, is having an affair with the credit controller and is staying with her during the week and leaving the audit files in the boot of his car overnight. There are no other audit staff available that the client considers to be capable of replacing him on the assignment.
Comment –
Conclusion –
(2) A part-time partner in Spoils & Co is also a councillor in the local authority. She has been acting for Radnor Ltd whose business venture now requires planning permission from the local authority. The partner sits on the planning committee and recently vigorously opposed a similar application.
Comment –
(3) In an effort to reduce audit fees your client, Finders Ltd, has employed an accountant on a temporary basis to assist you with your audit work. The client feels that it will be cheaper for the temporary accountant to perform some of the audit testing, replacing one member of your staff.
Comment –
Conclusion –
(4) Trainees of Porterhouse, a firm of Certified Accountants, have been offered overdraft facilities up to $3,000, on student terms, by a client bank.
Comment –
Conclusion –
5
INDEPENDENCE IN OTHER PROFESSIONAL AND
BUSINESS ROLES
5.1
Other professional roles
¾
Covers work areas such as taxation services, preparation of accounts, cash flows, corporate advisory services, management consultancy and reporting or secondment to management with clients who are not assurance clients.Typical examples are illustrated below.
5.1.1
Family and personal relationships
¾
An objective approach to any assignment may be threatened or appear to be threatened as a consequence of a family or other close personal or business relationship.¾
In particular, problems may arise where a close family member, has a mutual business interest with a client or with a director, officer or employee of a client.¾
Safeguards include: initial consideration as to whether it is proper to accept appointment in the context of any conflict of interest which may exist;
adequate disclosure of every such conflict to all relevant parties;
continual review of the appropriateness of continuing to act, including, if necessary, arrangements to consult with another professional accountant outside the firm.
5.1.2
Loans and guarantees
¾
Loans, or a guarantee of a loan, to or from any client constitute a threat or an apparent threat to objectivity. The considerations for assurance clients apply to all clients.¾
In addition, as with assurance clients, any significant overdue fees may also be considered as a loan.5.1.3
Gifts and hospitality
¾
Acceptance of gifts by the accountant, or their close family members, from clients may give rise to self-interest threats or intimidation (e.g. threat to make knowledge of the gift public).¾
Where gifts or hospitality which a reasonable and informed third party, havingknowledge of all relevant information, would consider clearly insignificant are made, it may be concluded that the offer is made in the normal course of business without the specific intent to influence decision making or to obtain information.
¾
In general, gifts or hospitality should only, therefore, be accepted if the value of any benefit is modest.5.1.4
Beneficial interests in shares and other investments
¾
Any investment in any client, which may cause the accountant’s objectivity to be called into doubt, must be avoided.5.2
Business roles
¾
Members in business are bound by the same fundamental principles and the same standards of behaviour and competence as apply to all other members of ACCA. Being an employee, they owe a duty of loyalty to their employers as well as to their¾
The following provides an overview of the ACCA ethical responsibilities of members in business, e.g. as an internal auditor, financial or management accountant.5.2.1
Independence
¾
The concept of independence, which is central to the role of members in public practice, has no direct relevance to members in business, whose first duty is to their employer.¾
Independence is not an end in itself, it is merely a means of securing a more important result, namely an objective approach to work. The requirement for objectivity is of equal importance to all members.¾
Members in business cannot be fully independent of their employers and thus it is all the more important that they strive constantly to maintain objectivity in every aspect of their work, e.g. an internal auditor will have a self-review threat if they are required to audit any business function for which they have direct responsibility.5.2.2
Objectivity
¾
Objectivity is the state of mind which has regard to all considerations relevant to the task in hand but no other. It presupposes intellectual honesty.¾
It follows that the interests of a member’s employer should no more affect the objectivity of a member’s judgement in a professional matter than his/her own interests.5.2.3
Integrity
¾
Members in business must observe the terms of their employment. These cannot, however, require them to be implicated in dishonest transactions.¾
If members in business are instructed or encouraged to engage in any activity which is unlawful, they are entitled, and required, to decline.5.2.4
Potential conflicts
¾
As a consequence of their responsibilities to their employing organisation, members may find themselves under pressure to act or behave in ways that could directly or indirectly threaten compliance with the fundamental principles. Such pressure may be explicit or implicit; it may come from supervisors, managers, directors or otherindividuals within the employing organisation.
¾
Examples of conflicting acts include: acting contrary to law, regulation, technical or professional standards; facilitating unethical or unlawful earnings management strategies;
lying to, or otherwise intentionally misleading others, e.g. auditors, regulators; issuing, or otherwise being associated with, a financial or non-financial report that
¾
Safeguards that may be used include: obtaining advice where appropriate from within the employing organisation, an independent professional advisor or a relevant professional body (eg ACCA); the existence of a formal dispute resolution process within the employing
organisation; and
seeking legal advice (but without breaching confidentiality).
5.2.5
Preparation and reporting of information
¾
Information (e.g. financial and management) should be prepared or presented fairly, objectively, honestly and in accordance with relevant professional standards so that the information will be understood in its context.¾
Self-interest and/or intimidation threats to objectivity, competence and performance may arise through pressure (by others, e.g. superiors, or for personal gain) to produce misleading information or become associated with such information produced by others.¾
Safeguards include consultation procedures with superiors, audit committees, ACCA. If safeguards prove inappropriate, the individual concerned should refuse to be associated with the misleading information and consider informing appropriate authorities, seeking legal advice or resigning.5.2.6
Financial interests
¾
In certain circumstances, the financial interests of employees (e.g. shares, options, bonuses), or knowledge of financial interests of close family members, could give rise to threats of self-interest and confidentiality, e.g. price sensitive information.¾
Safeguards include: policies and procedures for a committee independent of management to determine the level or form of remuneration of senior management;
disclosure of all relevant interests, and of any plans to trade in relevant shares, to those charged with the governance of the employing organisation, in accordance with any internal policies;
internal and external audit procedures;
up-to-date education on ethical issues and the legal restrictions and other regulations around potential insider trading
5.2.7
Inducements
¾
Members or close family of the member may be offered an inducement intended to encourage unethical behaviour. Inducements may take various forms, including gifts, hospitality, preferential treatment and inappropriate appeals to friendship or loyalty.¾
Intimidation threats to objectivity or confidentiality are created if such an inducement is accepted and it is followed by threats to make that offer public.¾
Safeguards include: refusal of the inducement where clearly not insignificant;
communication channels to report to higher authorities, e.g. management or audit committees;
taking legal advice.
5.2.8
Offering inducements
¾
Members should not offer an inducement (e.g. a bribe or “consultancy fee”) toimproperly influence the professional judgement of a third party or to obtain a financial or other reward for their business or themselves.
¾
If the pressure to offer an inducement comes from the employing company, ethical conflict resolution must be considered, which may well mean resignation from the employment of the firm.5.2.9
Disclosing confidential information
¾
Confidentiality is the duty to keep private another person’s information given or obtained in confidence. Such information acquired or received in the course of work must not be disclosed unless there is a right or obligation to do so or consent from the employer to whom the duty of confidentiality is owed has been received.¾
The duty of confidentiality is not only to keep information confidential, but also to take all reasonable steps to preserve confidentiality.¾
However, under certain circumstances, the withholding of confidential information creates specific risks in relation to: being required by law to disclose information to the appropriate public authorities, for example in connection with anti-money laundering or anti-terrorist legislation; producing documents or other provision of evidence in the course of legal
proceedings;
being permitted by law to disclose and are authorised by the employer to do so; believing that confidential information should be disclosed in the public interest,
for example where the employing organisation has committed, or proposes to commit, a crime or fraudulent act; or
having a professional duty or right to disclose, when not prohibited by law:
¾
to comply with technical standards and ethics requirements;¾
to protect professional interests in legal proceedings; or¾
When considering to disclose confidential information in the public interest, the following factors must be taken into account: legal constraints and obligations (seek legal advice);
whether members of the public are likely to be adversely affected (is the matter truly in the public interest?);
the gravity of the matter, for example the size of the amounts involved and the extent of likely financial damage;
the possibility or likelihood of repetition;
the reliability and quality of the information available; and
the reasons for the employer’s unwillingness to disclose matters to the relevant authority.
FOCUS
You should now be able to:
¾
define and apply the fundamental principles of professional ethics of integrity, objectivity, professional competence and due care, confidentiality and professional behaviour;¾
define and apply the conceptual framework; andEXAMPLE SOLUTION
Solution 1 — Undue dependence
(1) The 15% rule need not be applied when a practice is being established, but safeguards are necessary.
Family relationship may cause a problem if a disagreement arises. Even if his cousin is not considered to be a close family member, objectivity may still appear to be
threatened.
Safeguard – arrangement for consultation and review of audit file with another practitioner.
In due course Petr may have a qualified employee (for inclusion in the audit team) or enter into a partnership (allowing rotation of engagement partner).
Competence to carry out the audit must also be considered. For Petr, this is a significant audit and it is essential that he has the technical expertise (e.g. gained from his recent employment) to carry out the work.
Conclusion – Decline, unless safeguards and technical competence are adequate,.
(2) The 15% rule applies to recurring work. Nevertheless, objectivity should be reviewed with respect to audit assignment as audit fee >10%. Total income from client in current year is likely to create undue dependence: [(800k + 1,600k) ÷ (7,500k + 1,600k) ≈ 26%]. It is extremely unusual for the client to bear the additional costs to the practice caused by its lack of resources. The partners must be absolutely convinced that they would be able to resist any pressure that the client might exert before accepting.
Compete
