TOPIC TWO -
AC 732
(prep by: Swedi Zakaria)AUDITING PRINCIPLES AND QUALITIES OF AN AUDITOR
The meaning of professional ethics:
•
Are behavioural aspects established to guide the
activities of a certain profession.
•
Are code of ethics, detailed rules, guidelines,
standard of conducts that provide guidance, encouragement of efforts, and
promoting harmonisation of best practices.
Professional ethics sets standards
of conduct for professional accountants (Auditors) and states the fundamental
principles that should be observed by professional auditors in order to achieve
common objectives.
Auditing like any other profession
is distinguished by certain characteristics including:-
Ø
Mastery of a particular intellectual skill,
acquired by training and education
Ø
Adherence by its members to a common code of
values and conduct established by its administering body e.g NBAA, ACCA,
CIMA,ERB etc
Ø
Acceptance of duties to the society as a whole
FUNDAMENTAL
PRINCIPLES OF PROFESSIONAL ETHICS
Professional Accountants have to
observe a number of perquisites or fundamental principles. Such principles
include:-
ü
Integrity
The auditor should be straight
forward and honest in performing professional services
ü
Objectivity
and independence
•
The auditor should be fair and should no follow
prejudice or bias, conflict of interest or influence of others to override
objectivity.
•
Objectivity means non-allignment, open minded,
neutrality, attitude of fairness, balanced or maintain impartial attitude.
•
Members should not allow bias, conflicts of
interest or undue influence of others to override professional or business
judgements
ü
Professional
competence and due care
•
The auditor should perform professional services
with due care, competence and diligence.
•
And has a duty to maintain professional
knowledge and skill at a level required.
•
To ensure that a client receives the advantage
of competent professional services based on up date developments in practice,
registration and techniques.
•
Members should act diligently and in accordance
with applicable technical and professional standards when providing
professional services
ü
Confidentiality
•
The auditor should respect the confidentiality
of information acquired during the course of performing professional services
•
And should not disclose such information without
proper and specific authority
•
Confidential information acquired as a result of
professional and business relationships should not be used for the personal
advantage of members or third parties
•
The Client- Auditor relationship is like a
Patient – Doctor relationship and therefore should be treated with great
confidentiality
RE CONSOLIDATA SERVICES INC. VS ALEXANDER
GRANT & CO.
Facts: The auditor
determined that the client coy was insolvent. The auditor notified several
customers of the client (Consolidata inc) (the customers were also his clients)
without the consent of Consolidata inc.
Held: The auditor was held liable for such a disclosure.
It should be noted however that the
information obtained from the client can be disclosed where:-
v Consent
has been obtained from the client, employer or other proper source, or
v
There is a public duty to disclose, or
v
There is a legal or professional right or duty
to disclose
The disclosure of the information
may be obligatory or voluntary:-
Obligatory
disclosure is where the member knows or suspects his client to have
committed moneylaundering, treason, drug-trafficking or terrorist offences, he
is obliged to disclose all the information at his disposal to a competent
authority.
Auditing standards require auditors
to consider whether non-compliance with laws and regulations affects the
accounts
Voluntary
disclosure is applicable in the following situations:-
Ø
Disclosure is reasonably necessary to protect
the member’s interests e.g to enable him to sue for the fees or defend an
action for, say negligence
Ø
Disclosure is compelled by process of law, e.g
where in an action a member is required to give evidence of discovery of
documents
Ø
There is a public duty to disclose, say where an
offence has been committed which is contrary to the public interest
Ø
Disclosure it to non-governmental bodies which
have statutory powers to compel disclosure.
ü
Professional
behaviour and judgement
•
The auditor should avoid any conduct, which
might bring discredit to the profession.
ü
Technical standard
The auditor should carry out
professional services in accordance with relevant technical and professional
standards. E.g standard of fieldwork and standard of reporting
ü
Accountability
•
Auditors should carry their work regarding the
public interest and not their interest
• Responsibilities
to the client and other third parties
DESIRABLE QUALITIES OF AN AUDITOR
A professional auditor should
possess minimum of the following qualifications/characteristics:-
Ø An auditor should not only
be independent but also must be seen to be independent
Independence is an attitude of
mind characterised by integrity and an objective approach to professional work
The auditor’s report is an
expression of an opinion and not a statement of facts. For such an opinion to
have authority and credibility, it must be objective. For such a reason he/she
must be independent and must be seen independent or free from any interest
which may detract him from objective thinking and undertaking.
He/ she must possess an
independent mental attitude and this must be manifested by integrity and an
objective approach to audit work.
The auditor must be free from prejudice
and be able to express his opinion without fear or favour.
He must have the ability to form
an opinion and report the facts with unassailable impartiality.
Independence matters because of:-
The
expectations of those directly affected, particularly the members of the
company. The audit should be able to provide objective assurance on the truth
and fairness of the financial statements that the directors can never provide The
public interest – companies are public entities, governed by rules requiring
the disclosure of information
Ø
An auditor
should be professionally competent
First, one must have the
necessary qualifications to be registered as a Certified Public Accountant
(CPA-PP) or equivalent qualifications e.g ACCA, CISA, CIMA recognised by the administering board and
must have a certificate of practice issued by the board and should have
attended approved Continuing Professional Education (CPE) programmes. The CPE
programme ensures that the practitioner keeps himself aware of the current
issues and developments to enhance knowledge, skills and experience in the area
of competence.All these credentials must be possessed by the person to prove
that he is competent, qualified and experienced enough to know what type and
amount of evidence to accumulate to reach the proper conclusions after
accumulating audit evidence.
On the other hand competence
refers to the ability to perform an audit job to finality.
One is considered to be incompetent
if he/she belongs to either of the following groups:- o A
corporate body, unless allowed by legislation e.g TAC associate o An
officer or servant of the entity being audited o A partner or employee of an officer or
servant of the said entity
o
A related party e.g son, daughter, souse, uncle,
sister wife, mother father, close friends etc
o
A person of unsound mind o A
person declared bankrupt or whose bankruptcy is in progress
Ø
An auditor
should possess a high degree of
professional integrity
Professional integrity means
personal qualities and attributes that are considered essential for the
auditor. These may include probity, uncensored transparency, correct
interpretations of facts, ability to make fair decisions and ability to
exercise reasonable skill, care and caution.
This implies that, the auditor
should be honest and trustworthy to others and be able to make professional
judgement with fairness.
e.g see the facts in the ruling
of RE LONDON & GENERAL BANKING (1895)
where it was held by the court that
an auditor must be honest i.e he must
not certify what he does not believe to be true and he must take reasonable
care and skill before he believes that the what he certifies is true.
Ø
Professional
objectivity
Objectivity refers to a careful
use of protracted procedures and tests to arrive at a conclusion such that a
similar independent test by another person would give the same conclusion.
Auditors should not allow bias,
conflicts of interest or undue influence of others to override professional
judgement. The independence and objectivity of an auditor can be threatened or
impaired in the following forms:-
Ø
Self-interest threat
Self-interest threat may arise as
a result of the financial or other interests of members (auditors) or of immediate
or close family. It may take the form of:-
o
Financial
interest-e.g an audit firm owns shares in the client or is a trustee of a
trust that holds shares in the client
o
Close
business relationships – e.g when the audit firm and an audit client have
an inappropriate close business relationship.
o
Employment
with assurance clients o Partner
on client board o Family
and personal relationships o Gifts
and hospitality- do not accept if the value is clearly significant o Loans and guarantees o Overdue
fees- this constitutes a loan to the client o Percentage
of contingent fees o High
percentage of fees
o
Lowballing
–where a firm quotes a significantly lower fees for an assurance service than
would have been by the predecessor firm, there is a significant self-review
threat.
o
Recruitment
Safeguards available
v
To end the
assurance provision or terminate the other business relationship
v
Disposing of the interest
v
Removing the individual from the team
v
Keeping the client’s audit committee informed of
the situation
v
Using an independent partner to review the work
carried out if necessary
v
Making disclosures to the audit committee about
the fees (in case of contingent fees)
v
Taking steps to reduce the dependency on the
client (in case of high % of fees)
v
Complying with all applicable assurance
standards, guidelines and quality control procedures
Ø
Self - review threat
This threat may occur when a
previous judgement needs to be evaluated by members (Auditors) responsible for
that judgement.
The key area in which there is
likely to be a self-review threat is where a firm provides services other than
assurance services to an assurance client (providing multiple services)
Circumstances that may give rise
to this type of threat include:-
•
Internal audit services
•
Tax services
•
Valuation
services
•
Preparing accounting records and financial
statements
•
General other services
•
Recent service with assurance client
• Corporate
finance
The safeguards available may
include:-
Discussing the issue with
the audit committee
Involving an independent
professional accountant to advise
Obtaining client approval
for work undertaken
Using separate personnel
for the valuation and audit (in case of
valuation services)
Ø
Advocacy
threat
Advocacy
threat
Advocacy threats arise in those
situations where the assurance firm promotes a position or opinion to the point
that subsequent objectivity is compromised.
e.g commenting publicly on future
events in particular circumstances, having made assertions without detailing
the assumptions, or acting as an advocate on behalf of an assurance client in
litigation or disputes with third parties. Advocacy threats might also arise if
the firm promoted shares in a listed audit client.
The safeguards include might
include using different departments to carry out the work and making
disclosures to the audit committee.
Ø
Familiarity threat
A familiarity threat occurs when,
because of a close relationship, members become too sympathetic to the
interests of others. There is a substantial risk of loss of professional
scepticism in such circumstances.
These include situations where
there are family and personal relationships between the client and the firm,
long association with a client, employment with a client and recent service
with a client.
Safeguards
available:
Rotating the senior staff off the
assurance team, obtaining second partner reviews and independent quality
control reviews
Ø
Intimidation threat
Arises when members of the
assurance team may be deterred from acting objectively by threats, actual or
perceived.
These could arise from family and
personal relationship, litigation, or close business relationships. E.g when
the client threatens to sue, or does sue, the assurance firm for work that has
been done previously. The firm is then faced with the risk of losing the
client, bad publicity and the possibility that it will be found to have been
negligent. This may lead to the firm being under pressure to produce an
unqualified report when it has been qualified in the past.
Safeguards available include:-
•
Disclosing to the audit committee the nature and
extent of the litigation
•
Removing specific affected individuals from the
engagement team
•
Involving an additional professional accountant
on the team to review work.
Note: if the litigation becomes so serious it
may be necessary to resign from the engagement, as the threat to independent is
too great.
It should be remembered that the
same firm of accountants could provide both external and internal audit
services to the same client.
An audit firm’s services portfolio
could also include:-
v
Management consultancy
v
Corporate finance services
v
Tax planning
v
Recruitment assistance (e.g Delloite and Touche,
KPMG, etc)
v
Information technology sservices
v Valuation
services
v
Preparing financial statements
v
Asset management
From these multiple services
offered, the following problems may be perceived:-
The
perception that a company gave its auditors some lucrative consultancy work in
exchange for a clean report The
auditors may end up making management decisions for the company which would
harm independence The
auditor undertaking sel-review, that is auditing his own work
TUTORIAL QUESTIONS
Q1: Why is it necessary to apply
professional ethics in auditing and accounting field ?
Q2: Write short notes on each of
the following terms:-
I.
Integrity
II.
Objectivity
III.
Professional competence and due care
IV.
Confidentiality
V.
Professional behaviour
Q3: (a) Which of the following are
legitimate reasons for breach of client confidentiality?
I.
Auditor suspects client has committed treason
II.
Disclosure needed to protect auditor’s own interests
III.
Information is required for the auditor of another
client
IV.
Auditor knows client has committed terrorist offence
V.
There is a publicly duty to disclose
VI.
Auditor considers there to be non-compliance with law
and regulations
VII.
Auditor suspects client has committed fraud
(b) Of the above reasons, which are voluntary disclosures and which are
obligatory disclosures?
Q4: Discuss the advantages and
disadvantages of auditing standards to auditors.
Q5: Explain the concept of
objectivity , with reference to:-
I.
External auditors
II.
Internal auditors
NOTE: outline any
general threats to objectivity that exist.
Q6: ‘’It has been suggested that
the most important matter affecting the credibility of the auditor is that of
independence’’ .
REQUIRED:
I.
Discuss, giving examples, matters other than
independence, which might be relevant in relation to the credibility of the
auditor and the steps that the accounting profession has taken or might take in
relation to them.
II.
Discuss the following situations in the context of the
independence of the auditor, showing clearly the principles involved:-
a)
The audit manager in charge of the audit assignment of
BAC 2 CO.LTD holds Tshs. 1,000 Tshs
1,500 ordinary shares in the company (total shares in issue- 100,000). The
audit partner holds no shares.
b)
The audit fee receivable from MTM Co.LTD, a private
company is Tshs. 150,000,000. The total fee income of the audit firm is Tshs.
1,050,000,000.
c)
The auditor senior in charge of the audit of CRDB bank
LTD has a personal loan from the bank of TShs. 3,000,000 on which she is
currently paying 13% interest.
d)
The audit partner is responsible for two audit
assignments, HOI CO.LTD and HAI CO.LTD. HOI CO LTD has recently tendered for a
contract with HAI CO LTD for the supply of material quantities of goods over a
number of years. HAI CO.LTD has asked the audit partner to advise on the
matter.
QUESTION 7:
The objectivity of the external auditor may be threatened or appear to
be threatened where:
(i) There is undue dependence on
any audit client or group of clients.
(ii) The firm, its partners or
staff have any financial interest in an audit client.
(iii)There are family or
other close personal or business relationships between the firm, its partners
or staff and the audit client.
(iv) The firm provides other
services to audit clients.
(a)
For each of the four examples given above, explain why
the objectivity of the external auditor may be threatened, or appear to be
threatened, and why the threat is important
(b)
Describe NBAA’s requirements that reduce the threats
to auditor objectivity for each of the four examples given above
QUESTION 8:
(a) Explain the situations where an auditor may
disclose confidential information about a client. (b) You are an audit manager in McKay &
Co, a firm of Chartered Certified Accountants. You are preparing the engagement
letter for the audit of Ancients, a public limited liability company, for the
year ending 30 June 2006. Ancients has grown rapidly over the past few years,
and is now one of your firm’s most important clients. Ancients has been an
audit client for eight years and
McKay & Co has provided audit, taxation and
management consultancy advice during this time. The client has been satisfied
with the services provided, although the taxation fee for the period to 31
December 2005 remains unpaid.
Audit personnel available for this year’s audit are
most of the staff from last year, including Mr Grace, an audit partner and Mr
Jones, an audit senior. Mr Grace has been the audit partner since Ancients
became an audit client. You are aware that Allyson Grace, the daughter of Mr
Grace, has recently been appointed the financial director at Ancients.
To celebrate her new appointment, Allyson has
suggested taking all of the audit staff out to an expensive restaurant prior to
the start of the audit work for this year.
Required:
Identify and explain the risks to independence arising in carrying out
your audit of Ancients for the year ending 30 June 2006, and suggest ways of
mitigating each of the risks you identify
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