CHAPTER 2 AUDIT ETHICS & REGULATIONS Context Auditors need to fulfil certain legal requirements Then they need

d to comply with relevant ethical guidelines

Exam Highlight Highly appears 12/2007: explain ACCAs five ethical principles 12/2008: identify threats & recommend safeguards in applied scenario 06/2011: engagement letter

Content Summary 1. Ethics a. Ethical principles Professional behaviour Integrity Competence Confidentiality Objectivity b. Ethical threats & safeguards Self-interest Self-review Familiarity Advocacy Intimidation Management 2. Conflicts of interest arise among clients 3. Legal & Regulatory considerations 4. Auditor a. Eligibility b. Appointment c. Approve of appointment d. Issue of engagement letter e. Removal f. Rights g. Responsibilities

1. ETHICS a. Ethical principles Professional behaviour = respect law & regulations Integrity = straightforward & honest Competence = maintain professional knowledge & skills Confidentiality = not disclose client information UNLESS have a legal duty or a right to disclose Legal duty to disclose if: o o o Client is suspected of money laundering/terrorism/treason ACCA investigate the auditing work A court orders

Right to disclose if: o Client gives a permission o Auditor feels that it is for public interest Objectivity = independent & unbiased opinion

b. Ethical threats & safeguards Self-interest = auditors put their own interest above clients interests Scenario: o Auditors receive gifts from clients Test: value is insignificant or not? o Audit firm/auditor/family member of audit team member owns a direct financial interest (e.g. shares) or indirect financial interest (e.g. pension scheme) in client company ACCA does not allow this case o Auditors fear losing the big client (large portion of income) Test: big client or not? Listed client: audit fees must not be > 10% of total income but when reach to 5% the situation must be reviewed Non-listed client: audit fees must not be > 15% of total income but 10%...reviewed o Personal/business relationship w client Test: business (e.g. Employment) relationship has elapsed more than 2 years? o Auditors fear losing the full income because the audit fee on contingent basis Test: contingent in nature or not? o Lend money to each other Test: is it a loan in normal commercial terms from bank/financial institutions? o Low-balling: set audit fee at unrealistic level to secure work Test: Assign appropriate staff Spend appropriate time on work Comply with the professional & technical standards Safeguards: o Dispose any potential interests o Remove the auditor from audit team (if necessary) o Inform the client for the situation o Use the independent partner to review the work done

Self-review = auditors produce the financial information & review them later Scenario: o Give advice on control & accounting system o Assist the financial calculations o Provide services like tax, valuation, corporate finance o Employment relationship w client Safeguards: o Separate teams provide services: audit, tax, valuation, corporate finance o Use the independent partner to review the work done o Refuse to provide other services if audit objectivity is threatened o Employment relationship w client ended more than 2 years Familiarity = because of close & long-time relationship, auditors feel sympathetic for clients losing interests or too trusting on clients works Scenario: o Auditor audits a company where friends or relatives work o Auditor has been auditing the company many years and developing a close relationship w client o Employment relationship w client Safeguards: No member of audit team are allowed to have a close personal/business relationship with client o For listed company: key audit partner should not continue working after 7 consecutive years and only return to this role after further 2 years o For listed company: engagement partners should not continue working after 5 consecutive years and only return to this role after further 5 years o For listed company: quality control reviewer should not continue working after 7 consecutive years and only return to this role after further 2 years o Employment relationship w client ended more than 2 years Advocacy = auditor is asked to promote the clients position or represent them in some way Scenario: o Taking legal action against client or being sued by a client o Represent for client in a legal case or tax enquiry at court Safeguards: withdraw from the engagement letter o

Intimidation = auditor is pressed to not act objectively Scenario: family/personal/business/close relationship w client Safeguards: o Withdraw from engagement letter o Remove the auditor from the audit team (if necessary) o Employment relationship ended more than 2 years o For listed company: . Management = auditor acts as manager or makes management decision for client Scenario: provide management advices Safeguards: o Ensure client accepts responsibility for all management decisions o Not make decisions and perform work that is the responsibility of companys management

2. CONFLICTS OF INTEREST ARISE AMONG CLIENTS = Problems arise when auditor works for 2 companies who are in direct competition with each other Dealing with conflicts of interest: Before accepting a new appointment, auditor should inform all involved clients to receive the clients consent to continue the work Auditor should ensure that client information is kept confidential by: o Service each client by different audit teams headed by different audit partners o Audit teams are kept separated o Strict security over the clients files o Strict monitoring procedures e.g. Independent partner to oversee the process o Independent review of all audit files If clients refuse to consent, decline the appointment or resign from an existing team 3. LEGALS & REGULATORY CONSIDERATIONS 4. AUDITOR a. Eligibility Pass an approved set of examination set by RQB (Recognised Qualifying Body) Become a member of RSB (Recognised Supervisory Body) Not a director or employee of the client or any of its associated companies Not an employee of a director Not a business partner of the client or any of its associated companies Not a business partner of a director b. Appointment Pass the ordinary resolution at the company AGM: > 50% of the shareholder votes Shareholders must be noticed before 21 days that the vote will take place c. Acceptance of appointment Client assessment considerations before accepting: Enough resources (time and staff) available Audit fee Clients credit rating Integrity of client and its directors Level of audit risk Level of money laundering risk (identify client source of income) Professional clearance: Ask client for permission to speak to outgoing auditors Permission granted Ask outgoing auditor if there are any reasons why appointment should not be accepted No reason Accept appointment Accept appointment Yes Permission refused Reject appointment No

Ask client if problem can be explained away to auditors satisfaction Yes

d. Issue of engagement letter (ISA 210) Preconditions to issue: Acceptable set of accounting standards have been used or not Efficient internal control for the preparation of financial statements are free from material misstatement Managements responsible to provide all relevant information Auditor have the unrestricted access to persons relating to obtain audit evidence Engagement letter: Objective and scope of audit Responsibilities of auditors and directors Nature of audit work (e.g. testing) Basis to calculate the audit fee Format of reports to be issued e. Removal Resignation OR Forced removal: o Auditors have the right to send a written explanation or to speak to the shareholders at AGM to explain their reason o Once the auditors have resigned or been removed, they must issue a Statement of Circumstances to explain the reason Auditors sometimes do not wish to seek the reappointment, they should politely decline and issue a Statement of Circumstances f. Rights Access all books and records Access all information and explanation Receive notice for AGM Attend and speak at AGM Resign Circulate information to shareholders g. Responsibilities Audit the financial statement and give an opinion: o on true and fair view basis o whether the financial statement are properly prepared in accordance with national rules Issue a Statement of Circumstances when resign or removal to explain the reason Consider fraud (ISA 240) Accidental Error # Deliberate Fraud 2 types of fraud: o Fraudulent financial reporting: deliberate misstatement of amounts/disclosures in financial statement o Misappropriation of assets: theft of company assets ISA 240 states that the primary responsibility for the prevention and detection of fraud lies with management and those charged with governance; not the external auditor but must try to detect frauds Recommendations to assist the auditor: o Professional scepticism

o o

Auditor should remain conscious that material misstatement due to fraud could exist, regardless of how honest management have been in past Discussion amongst the audit team Risk assessment procedures Ask management and internal audit team about their own assessment of the risk of fraud and whether or not they are aware of any frauds Understand how those charged with governance monitor the risk of fraud within the company Analytical procedures to identify possible fraud risks within the financial statements Evaluate fraud risk factors: weakness in controls, economic downturn putting pressure on results, unrealistic profit Consider other information

Response to the risk of fraud: o o Assign more members with specialised knowledge and skills Pay more attention to higher risk areas of the financial statements (e.g. estimates, journals posted around period end, transactions outside the normal course of business)

Report the fraud to management and those charged with governance as soon as possible if fraud is discovered during the audit term Consider Laws & Regulations (ISA 250) If auditors find a material breach, they must: o Report the breach to management o If the breach involves management, report to the highest level (e.g. audit committee) o If the breach involves the highest level, may need to take legal advice o If the breach is severe, consider the effect on companys going concern status