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CHAPTER 2
CODES OF ETHICS

Fundamental principles and the conceptual

framework approach
Specific guidance: Independence
Specific guidance: Confidentiality
Specific guidance: Conflicts of interest
Conflicts in application of the fundamental
principles

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EXAM CONTEXT

Professional ethics is a key area of the syllabus and is

likely to be examined regularly in a practical context. A
practical question on ethics came up in the pilot paper
for 15 marks in the optional section. The December 2007
exam included an optional question where 15 marks
were on offer for identifying, explaining and discussing
the ethical and other professional issues involved with
two separate engagements.
The June 2008 sitting required briefing notes to be
produced, assessing the ethical issues (among others)
to be considered as part of client acceptance procedures
for 12 marks in the compulsory section, while offering a
further 17 marks in the optional section for a discussion
of the ethical and other professional issues raised by
three current clients.

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EXAM CONTEXT

The IFAC fundamental ethical principles were touched

upon as part of a 6 mark question on forensic auditing in
December 2008, but yet again, candidates were asked in
the optional section of this exam to identify the ethical
and practice management issues in a specific firm for 20
marks, this time a firm with commercial problems
seeking new ways of boosting revenues with potentially
unethical ventures. This theme was revisited in June
2009 for 17 marks, where ethical and professional issues
were discussed as well as testing theory on professional
competence and due care.
In the exam you are likely to be faced with scenarios
where you have to apply your knowledge, identify ethical
threats and recommend appropriate safeguards.

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The importance of ethics

Key reason that accountants need to have ethical code

is that people rely on them and their expertise. Auditors
claim to give independence view
crucial for
them to be and seen to be ethical (independent)
Provide members with guidance for maintaining a
professional attitude and enhance the accounting
profession
Codify behaviour beyond that which is incorporate in
legislation.

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IFAC and ACCA Codes of Ethics

IFAC and ACCA have taken a principles-based

approach to ethics rather than issue a detailed
set of rules
Advantages of an ethical framework over a set
of rules:

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Forces active consideration in every situation

Prevents narrow interpretation
Allows for variations in situations
Can adapt to changing environment
And can contain specific prohibitions
necessary

where
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ACCA Code of ethics

The code takes the form of a conceptual framework,

setting out five fundamental principles. This recognises
that it is impossible to define every situation that may
give rise to specific threats, and to prescribe specific
safeguards appropriate to widely differing engagements.
The ACCA Code has been based on the IFAC Code of
Ethics for Professional Accountants.
It provides members with guidelines for maintaining a
professional attitude and enhancing the accounting
profession (credibility and confidence)

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Conceptual framework

Integrity
Objectivity
Professional Competence & Due Care
Confidentiality
Professional Behaviour

2.3

The fundamental principles

Integrity Members should be straightforward

and honest in all professional and business
relationships
Objectivity Members should not allow bias,
conflicts of interest or undue influence of
others to override professional or business
judgement
These definitions of integrity and objectivity help
to underline the importance of true and fair
when it comes to the audit opinion.

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The fundamental principles

Professional competence & due care

Members have a continuing duty to maintain
professional knowledge and skill at a level
required to ensure that a client or employer
receives competent professional service based
on current developments in practice, legislation
and techniques. Members should act in
accordance with applicable technical and
professional
standards
when
providing
professional services.

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The fundamental principles

Confidentiality Members should respect the

confidentiality of information acquired as a result of
professional and business relationships and should not
disclose any such information to third parties without
proper and specific authority or unless there is a legal or
professional right or duty to disclose. Confidential
information acquired as a result of professional and
business relationships should not be used for the
personal advantage of members or third parties.
Professional behaviour Members should comply with
relevant laws and regulations and should avoid any
action that discredits the profession.

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Exercise 2.1

You are an accountant with a public practice

firm. Identify which fundamental principles are
compromised by each of the following
observations:

1.

you are frequently ask to complete taxation

computations, but you have no experience on
taxation other that you learned two years ago
during your ACCA studies
A partner has asked you to monitor a particular
client because he is concerned that is running
into difficulty and the partner arranged his bank
loan for him. He has promised to alert the bank
if things start to get bad

2.

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Exercise 2.1
3.

The practice refers private clients to one

particular financial adviser for help with
specialist areas such as personal investments
and borrowing.

4.

You have been given a list of clients who

partners feel are low value. You have been told
to ignore phone calls from them and to only do
their work when all other work has been
completed.

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Answer 2.1
1.

2.

Professional competence due care may

be breached by you unless you make
your reservation clear to your manager.
The firm will breach its obligation unless
the work its checked by a competent
person
Confidentiality, assuming this was not
specifically agreed to by the client as a
condition of obtaining the loan.

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Answer 2.1
3.

Objectivity as the firm may not be sure that this

is the best adviser for each and every client.
Possibly confidentiality if the practice passes
over client names to the adviser without
permission of the client

4.

Professional behaviour as clients have a right to

expect their concerns to be dealt with in a
reasonable time

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Threats to compliance with the

fundamental principles

Self-interest threat when auditor has a

beneficial interest in the client e.g.: financial
interests, incentive compensation arrangements,
undue dependence on fees
Self-review threat when accountant reviews
work he has performed e.g.: auditing a set of
financial statements you have prepared
Advocacy threat
when auditor acts on behalf
of, or as representative of the client e.g.: acting
as an advocate on behalf of an assurance client
in litigation or disputes with third parties

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Threats to compliance with the

fundamental principles
Familiarity threat when relationship with
clients go beyond professional level e.g.:
long association with a client
Intimidation
threat e.g.: threat of
dismissal or replacement, being pressured
to reduce inappropriately the extent of
work performed in order to reduce fees

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Available safeguards

Safeguards that may reduce threats to an acceptable

level can be created by the profession, legislation, and in
the work environment.
Examples include:
Education
Training and experience requirements
Continuing professional development requirements
Corporate governance regulations
Professional standards
External review by empowered third parties
Documented policies and procedures including a
disciplinary mechanism to promote compliance.

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Specific guidance: Independence

The ACCA guidance is very similar to that issued by IFAC.
The IFAC Code discusses independence in the light of the
wider term 'assurance engagements' rather than focusing
solely on audits.
The guidance states its purpose in a series of steps. It aims
to help firms and members:
Step 1 Identify threats to independence
Step 2 Evaluate whether the threats are insignificant
Step 3 If the threats are not insignificant, identify and apply
safeguards to eliminate risk, or reduce it to an acceptable
level.
It also recognises that there may be occasions where no
safeguard is available. In such a situation, it is only
appropriate to:
Eliminate the interest or activities causing the threat
Decline the engagement, or discontinue it
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Revised code of ethics

The International Ethics Standards Board for

Accountants, or IESBA, issued a revised code of
ethics, which strengthens and clarifies the
independence requirements for auditors. The
new code a significant improvement over the
present version dating back to June 2005 will
take effect on 1 January 2011, with transitional
provisions.

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Revised Code - changes

Revisions include:
Providing a definition of 'public interest entities and key
partners
Extending the listed entity provisions to all public interest
entities
Extending partner rotation requirements to all audits of
public entities and to all key audit partners
The establishment of a mandatory 'cooling off' period
before a key partner can join a former audit client
Strengthening guidance on non-audit services.
Requirement for review of the second years audit if total
fees from an audit client (public interest entity) exceed 15%
of the total fees of the firm for two consecutive years
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Revised code: Public interest entities:

Listed entities,
Entities that they have a large number and wide range
of stakeholders. Factors to be considered include:
The nature of the business, such as the holding of
assets for a large number of stakeholders. Examples
may include financial institutions, such as banks and
insurance companies and pension funds;
Size; and
Number of employees.

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Professional skepticism
An attitude that includes:
a questioning mind,
being alert to conditions which may
indicate possible fraud or error and
a critical assessment of audit evidence.

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Professional skepticism

Professional skepticism drives auditor behavior to

adopt a questioning approach when considering
information and in forming conclusions.

In this regard, professional skepticism is strongly

connected to the fundamental ethical principles of
objectivity and auditor independence. The auditors
independence enhances the auditors ability to act with
integrity, be objective and maintain an attitude of
professional skepticism.

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Professional skepticism - importance

The application of professional skepticism enhances

the effectiveness of an audit procedure and of its
application and reduces the possibility that the auditor
might select an inappropriate audit procedure,
misapply an appropriate audit procedure, or
misinterpret the audit results.
Reducing the possibility of wrong audit opinion
and thus possibilities of litigation claim

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Professional skepticism - evidence

Professional skepticism is often demonstrated in the various

discussions held by the auditor during the course of an audit.
Audit documentation remains critical in evidencing
professional skepticism because it provides evidence that
the audit was planned and performed in accordance with
ISAs and applicable legal and regulatory
Auditors should document discussions of significant matters
with management, board and others, including the nature of
the significant matters discussed and when and with whom
the discussions took place.

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Threats to independence
Self - interest
Self - review
Advocacy
Familiarity
Intimidation

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Self interest threats

Financial Interest

Gifts and hospitality

Close business relationships

Loans and guarantees

Employment with assurance

client

Overdue fees

% of contingent fees

High % of fees

Lowballing

Recruitment

Partner on clients board

Family and personal

relationships

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Financial interest threat

Exists where an audit firm has a financial interest in
clients affairs (e.g hold shares)

Both Codes state that parties listed below are not

allowed to have direct or indirect material financial
interest in a client

The assurance firm

Partners in the same office
A member of the assurance team
An immediate family member of member of assurance
team

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Financial threat - safeguards

Safeguards:

Action to be taken

Dispose

the interest
Remove individual from the team
Inform clients audit committee
Use an independent partner to
review the work carried out.
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Exercise 2.2

1.

2.

You are the Ethics Partner at Stewart Brice, a firm of

Chartered Certified Accountants. The following situations
exist.
Teresa is the audit manager assigned to the audit of
Recreate, a large quoted company. The audit has been ongoing for one week. Yesterday, Teresas husband inherited
1,000 shares in Recreate. Teresas husband wants to hold
on the shares as an investment.
Stewart Brice has been the auditor of Kripps Bros, a
limited liability company, for a number of years. It is a
requirement of Kripps Bros constitution that the auditor
owns a token $1 share in the company.
Required
Comment on the ethical and other professional issues
raised by the above matters.
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Answer 2.2
(1) Teresa is at present a member of the assurance team
and a member of her immediate family owns a direct
financial interest in the audit client. This is unacceptable.
In order to mitigate the risk to independence that this
poses on the audit, Stewart Brice needs to apply one of
two safeguards:
Ensure that the connected person divests the shares
Remove Teresa from the engagement team
Teresa should be appraised that these are the options and
removed from the team while a decision is taken whether
to divest the shares. Teresas husband appears to want to
keep the shares, in which case, Teresa should be
removed from the team immediately.
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Answer 2.2
The firm should inform the audit committee of Recreate of what
has happened and the actions they have taken. The partners
should consider whether it is necessary to bring in an
independent partner to review audit work. However, given that
Teresas involvement is subject to the review of the existing
engagement partner and she was not connected with the
shares while she was carrying out the work, a second partner
review is likely to be unnecessary in this case
(2) In this case, Stewart Brice has a direct financial interest in
the audit client. However, it is a requirement of any firm auditing
the company that the share be owned by the auditors.
The interest is not material. The audit firm should safeguard
against the risk by not voting on its own re-election as auditor.
The firm should also strongly recommend to the company that it
removes this requirement from its constitution as it is at odds
with ethical requirements for auditors.
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Close business relationship.

Examples:
Material financial interest in Joint venture with client
Arrangements to combine market services and products
Distribution or marketing arrangements under which audit firm
acts as distributor of client's products.

The materiality of the relationship to be judged and if important

audit firm not to participate in such venture with client

If such a relationship exists it should be terminated, unless

interest is clearly insignificant.

Purchasing goods and services from an assurance client on an

arm's length basis does not constitute a threat to independence

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Employment with client

Staff

to be transferred between the

client and the firm or negotiations and
interview to take place.

Audit staff
Try to impress the future
possible employer-Affects objectivity.
A former partner
turned Finance
director - much knowledge of the audit
system.
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Employment with client

Possible safeguards.

Modify assurance plan

Removed from the engagement if employment

negotiations of an individual moving from firm to firms
client are taken place.

Review work by another accountant not involved in the

engagement.

Quality control review of the engagement.

If the client is a public interest entity, a cooling off period

is required (12 months must have passed before a key
audit partner joins the audit client).

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Partner on clients Board

Partner or employee should not serve on the

clients board.

It can be the secretary if the role is strictly

administrative.

Note however corporate governance codes

require company secretary role to be beyond the
administrative tasks.

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Personal / Family relationships.

The individuals responsibilities on the assignment, the

closeness of the relationship and the role of the other party
at the assurance client (director or just employee) must be
considered.

If influence considered significant the person should be

removed from the assignment.
Safeguards

The firm should have quality control procedures that

require staff to disclose such relationships.
If there is a violation:
Quality control review of the audit
Discuss the matter with audit committee

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Gifts and hospitality

Unless the gift is clearly insignificant

should not be accepted and even these
should be approved by a partner.

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Loans and guarantees

The client is a bank OR other situations.

If lending institution:
Immaterial amounts and under normal commercial terms not
considered as a threat to independence.

If amounts material then a review from another partner in another office

will reduce the risk.

Loans to members of the firm if under commercial terms not

considered a threat.

If not lending institution:

Any loans from clients that are not lending institutions should not be
made.

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Overdue fees

Client owes big amount of fees to audit firm

(making a loan to client)
Safeguards

Discuss the matter with the audit committee or

other involved in governance to put a repayment
schedule

Resign if matter not resolved.

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Contingent fees

Fee calculated on a predetermined basis

relating to the outcome or result of the work
performed.

Ethical guidelines state that a firm should not

enter into any fee arrangement for an assurance
engagement under which the fee is contingent
on the result of the assurance work.
It is also inappropriate to accept contingent fee
for non assurance work from an assurance client

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High % of fees

Firm should be alerted when the total fees

generated by assurance client represent large
proportion of firms total fees.

The public may perceive that a members

objectivity is likely to be in jeopardy where the
fees for audit and recurring work paid by one
client or group of connected clients exceed 15%
of the firms total fees. Where the entity is listed
or public interest, this figure should be 10%.

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Safeguards

Discuss with audit committee

Take steps to reduce dependency

Obtain external /internal quality control

Consult independent party such as ACCA

For audit clients that are listed / public interest entities,

the Code states that where the total fees from the client
represent more than 15% of the firms total fees for two
consecutive yeas, then a review should be conducted
by external body.

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Lowballing

Firm quotes a significant lower fee level for an

audit service than predecessor firm

Newly appointed firm should

Maintain records such that the firm is able to
demonstrate the appropriate staff and time are
spent on the engagement
Comply with all applicable assurance standards
and quality control procedures

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Recruitment

Recruiting
senior
management
for
assurance client threat to independence
Not to take decisions. Their involvement
to be limited to reviewing a shortlist of
candidates providing the client has drawn
up the criteria by which they are selected

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SELF REVIEW THREAT

Refers to the threat of independence where the

assurance firm provides additional services other than
assurance services to an assurance client.

Remember that in the USA the Sarbanes Oxley rule

considers auditors that offer certain non audit services to
listed companies as being non independent.
(bookkeeping, valuation, internal audit, legal services)

The ACCA & IFAC rules provide guidance to members

regarding non-audit services.

A distinction need to be made between Public interest

company (all companies that for some reason- size,
nature , product- are in the public eye) and small
owner-managed business.

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SELF REVIEW THREAT

Recent services with assurance company

General other services

Preparing accounting records and FS

Valuation services

Tax services

Internal audit services

Corporate finance

Other services

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Recent service with assurance

company

Being a director or officer or an employee of the

assurance company before the assurance engagement
the previous two years.
Safeguards

Obtaining quality control review of the individuals work

Discussing the issue with the audit committee

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General services

The services stated below should not be

offered:

Authorize and execute a transaction

Determine which recommendation to be
implemented.
Report in a management capacity to those
charged with governance.

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Preparing accounting records and

statements
Financial
Significant risk exists since the accountant will audit his own

work. For public interest company the service regarding

the preparation of accounting records should not be offered
unless an emergency arises. However assisting clients in
the preparation of the F/S is routine service for the
assurance firm.
Safeguards

Using staff other than the assurance team staff

Obtain clients approval-Audit committee.

For any clients , assurance firms are not allowed to:

Determine or change Journal Entries without clients
consent.
Authorize or approve transactions.
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source documents (e.g. purchase orders)
ACCA

Valuation services

These should not be carried out by audit firms if the valuation

will be material to the financial statement.

If the valuation not material the service may be offered

provided the following safeguards are applied to reduce the
risk to an acceptable level.
Safeguards

Second partner review

Ensure client understand the valuation and assumptions

used

Ensure clients acknowledge responsibility of the valuation

Using separate personnel for the valuation and the audit.

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Corporate finance

An assurance firm is not allowed to

Promote, deal or underwrite an assurance clients shares

Commit the client to a transaction or accomplish a
transaction on the client behalf.

Other services such as defining corporate strategy,

identifying possible sources of capital and advice on
reconstruction may be provided, providing are carried
out by different staff and no management decisions are
taken on behalf of the client.

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Internal audit services

Internal audit services

Can be provided (not in the USA) provided the client

understand that he is responsible for establishing, monitoring
and maintaining the system.
The board and/or the audit committee approve the work of
the internal audit team
The assurance company staff implementing the internal audit
system is not involved in the assurance assignment.

If the client is a public interest entity, then internal audit

services must not be provided if related to financial
accounting systems and financial reporting

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Taxation services

Tax return preparation does not generally

threaten independence as long as managements
takes responsibility for the returns.

Tax calculations for the purpose of preparing the

accounting entries may not prepared for public
interest entities, except in emergency situations.
For non-public interest entities, it is acceptable
provided that safeguards are applied.

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Temporary staff assignments

Staff may be loaned to an audit client for a short period of time.

Staff must not assumed management responsibilities.
Safeguards:
Not including the loaned staff in the audit team
Not giving loaned staff any responsibility during audit for
functions that they performed during their temporary staff
assignment
Conducting an additional review of the work performed by
loaned staff

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Other services

IT services

Litigation support

Legal services.
If such assignments are undertaken, the
assurance firm should ensure that adequate
safeguards are in place to reduce the threat of
independence. Otherwise they should not be
undertaken.

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ADVOCACY THREAT

Arises in situations where the assurance firm is in a

position of taking the clients part in a dispute or promoting
interests of the client

Examples:
Offering legal services
Provide evidence as expert witness
Defend the client in a legal case
Represent client with negotiations with bank regarding
debt reconstruction

Safeguards
Different department offering the service
Disclosures to audit committees
Withdraw from the assignment if risk to independence too
high.
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FAMILIARITY THREAT

A serious threat of independence may arise if the

assurance firms staff becomes over familiar with the
client and its staff such as

Family and personal relationships with client

Employment with assurance client
Recent service with assurance client

Most of the risks above covered under self-interest

guidelines

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Long association of senior personnel

with an assurance client

The long relationship of senior staff with assurance clients may be

a serious threat of independence.
Safeguards:

Monitor the relationship between staff and clients staff

Rotate senior staff and partner of the assurance team (key audit
partners must be rotated 7 years after originally became key audit
partner for the client)
Involve second partner review
Obtaining internal quality control review.

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Intimidation Threat
An intimidation threat arises when a professional
accountant is deterred from acting objectively by threats,
actual or perceived. Situations which might create
intimidation threats include:
(a) Threats of dismissal.
(b) Threats of litigation.
(c) Pressure to reduce fees or the extent of work performed

The audit firm may be under pressure to issue an

unqualified report that otherwise will not be issued.
SECOND OPINION
Client may ask second opinion from other audit firm on
application of accounting on reporting standards
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Intimidation threat - Safeguards

Disclose to the audit committee the nature and extent of litigation.

Remove affected individuals from the assignment

Involving an additional professional accountant on the team to

review work done

Resign from the assignment if the litigation is material.

SECOND OPINION
If a firm asked for second opinion must seek permission from the
client to communicate with the appointed auditor.

Take great care if asked to give second opinion.

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Exercise 2.3

You are a partner in a firm of chartered certified

accountants. The following issues have emerged in relation
to three of your clients:
(a) A Ltd is a major client. It is listed on a major Stock
Exchange. The audit team consists of eight members, of
whom Paul is the most junior. Paul has just invested in a
personal pension plan that invests in all the listed
companies on the exchange.
(b) You are at the head of a team carrying out due diligence
work at Electra, a limited company which your client, Power
Ltd, is considering taking over. Your second in command on
the team, Peter, has confided in you that in the course of his
work he has met the daughter of the managing director of
Electra, and he is keen to invite her on a date.

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Exercise 2.3

(c) Your longest standing audit client is Teddies, which

you have been involved in for ten years, four as
engagement partner. You recently went on an extended
cruise with the managing director on his yacht.
Required
Comment on the ethical and other professional issues
raised by the above matters. Your answer should outline
the threat arising, the significance of the threat, any
factors you have taken into account, and, if relevant, any
safeguards you could apply to eliminate or mitigate
against the threat.

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Answer 2.3
(a) In relation to A Ltd, there is a threat of self-interest arising, as
a member of the audit team has an indirect financial interest in
the client.
The relevant factors are as follows:
The interest is unlikely to be material to the client or Paul, as
the investment is recent and Paul's interest is in a pool of
general investments made in the exchange on his behalf
Paul is the audit junior and does not have a significant role
on the audit in terms of drawing audit conclusions or audit risk
areas
The risk that arises to the independence of the audit here is
not significant. It would be inappropriate to require Paul to
divest his interest in the audit client. If I wanted to eliminate all
elements of risk in this situation, I could simply change the
junior assigned to my team, but such a step is not vital in this
situation.
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Answer 2.3
(b) In relation to Power Ltd, two issues arise. The first is that
the firm appears to be providing multiple services to Power
Ltd, which could raise a self-interest threat.
The second is that the manager assigned to the due
diligence assignment wants to engage in a personal
relationship with a person connected to the subject of the
assignment, which could create a familiarity threat.
With regard to the issue of multiple services, insufficient
information is given to draw a conclusion as to the
significance of the threat. Relevant factors would be
matters such as the nature of these services, the fee income
and the team members assigned to each. Safeguards
could include using different staff for the two assignments.
The risk is likely to be significant only if one of the services
provided is audit, which is not indicated in the question.
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Answer 2.3
In relation to the second issue, the relevant factors are these:
The assurance team member has a significant role on the team
as second in command
The other party is closely connected to a key staff member at
the company being reviewed
Timing
In this situation, the firm is carrying out a one-off review of the
company, and timing is a key issue. Presently Peter does not
have a personal relationship which would significantly threaten
the independence of the assignment. In this situation, the
safeguard is to request that Peter does not take any
action in that direction until the assignment is completed.
If he refuses, then I may have to consider rotating my staff on
this assignment, and removing him from the team.

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Answer 2.3
(c) In relation to Teddies, there is a risk that my long
association and personal relationship with the client will
result in a familiarity threat. This is compounded by my
acceptance of significant hospitality on a personal level.
The relevant factors are:
I have been involved with the client for ten years and have
a personal relationship with client staff
The company is not a listed or public interest company
It is an audit assignment

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Answer 2.3

The risk arising here is significant, but as the client is

not listed, it is not extremely important. However, it would
be a good idea to implement some safeguards to
mitigate against the risk.
I could invite a second partner to provide a hot review of
the audit of Teddies, or even consider requesting that I
am rotated off the audit of Teddies for a period, so that
the engagement partner is another partner in my firm.
In addition, I must cease accepting hospitality from the
directors of Teddies unless it is clearly insignificant

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Exercise 2.4

1.

2.

For each of the following situations, identify the

threat to independence and suggest potential
remedies:
A bank has requested a reference from the firm
about a client that is seeking additional funding.
The client promises to be a valuable client if the
business succeeds in raising extra funds.
The client has told the firm that has received a
cheaper quote from a rival for conducting the
annual audit and that it is considering changing
auditor next year.

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Exercise 2.4
3.

4.
5.

The firm has been asked to conduct an internal

audit for the client of the effectiveness of a
recent IT investment. The IT investment was
project managed by the consulting division of
the accounting practice.
A partner at the office conducting the audit
holds 20% of the equity of the client
The managing partner and the Chairman of the
client often play golf together

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Answer 2.4
1.

Advocacy threat. The reference could be biased to

help the client to get the funding. The reference could
be externally reviewed or the relationship disclosed to
the bank (which presumably they realize already).

2.

Intimidation threat. The present audit and future

audits may be soft to keep client happy or superficial
to save costs and so allow a competitive fee to be
charged. Stay its original audit plan and give clear
account for time spent to client.

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Answer 2.4
3.

4.

5.

Self-review threat: if it can be shown that there is no

proper independence from the consulting division.
Check independence or decline request.
Self-interest threat: the partner should dispose his
interest and his work to be reviewed. Disciplinary
actions according to internal code of ethics.
Familiarity threat: however this does not appear to be
significant problem (assuming the managing partner
has no connection with the audit) for now, so no action
needed.

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Exercise 2.5
ANYIA & 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 Egypt 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. The firms 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.
2. The audit senior of Neutron Co is having a relationship
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.
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1.

Exercise 2.5
3.

Trainees of Porterhouse, a firm of

Certified Accountants, have been offered
overdraft facilities up to $5,000, on
student terms, by a client bank.
Required:
Comment and conclude on the above
situations

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Answer 2.5
1.

Total income from client in current year is likely to create

undue dependence: [(800k + 1,600k) (7,500k +
1,600k) 26%].
Competence of temporary staff would need to be
established.
Possible safeguard different staff members/partner
assigned to audit and special investigation.
Conclusions As existing clients, in particular, are
likely to perceive undue dependence special
investigation should be declined. Engagement partner
on audit should be rotated.

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Answer 2.5
2.

Objectivity appears to be threatened by personal

relationship. Even if credit controller is not regarded as
a senior employee the seniors objectivity may be
impaired, e.g. when reporting weaknesses in credit
control.
Senior is not keeping audit working papers in safe
custody could result in breach of duty of
confidentiality.
It is not up to the client to determine who is capable of
undertaking the assignment otherwise this would
constitute undue influence.
Conclusion Senior should be replaced immediately.
Audit timetable may have to be put back. The Senior's
work should be reviewed as soon as possible and, if
necessary, re-performed.

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Answer 2.5
3.

Loans (including overdrafts) on normal commercial

terms may be accepted by members of staff (including
trainees).
Student terms may be normal commercial if the bank
offers them to all accountancy trainees not just those
of Porterhouse. If not normal commercial, is benefit
significant?
Conclusion Engagement and compliance partners
should consider the above before decide if acceptance
of the offer will (or not) appear to threaten objectivity.

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Specific guidance: Confidentiality

Both IFAC and ACCA recognise a duty of confidence and
several exceptions to it.
The ACCA gives guidance relating to confidentiality in the
Code of Ethics and Conduct. A member acquiring
information in the course of his professional work should
not use, nor appear to use, that information for his personal
advantage or for the advantage of a third party.
Where a member agrees to serve a client in a
professional capacity both the member and the client
should be aware that it is an implied term of that agreement
that the member will not disclose the client's affairs to any
other person without the client's consent or if not within the
terms of certain recognised exceptions.
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Exceptions
Obligatory disclosure
If a member knows or suspects his client to have
committed a terrorist offence, an offence of treason or
a money laundering offence or drug trafficking, he is
obliged to disclose all the information at his disposal to
a competent authority. Local legislation may also
require auditors to disclose other offences.
The auditor may also be obliged to provide
information where court demands disclosure. Refusal
to provide information is likely to be considered
disrespect of court with the auditor being liable for this
offence.
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Exceptions
Voluntary disclosure
To comply with technical standards. For example they
should report any non-compliance with law or regulation
to the proper authorities. (ISA 250)
Disclosure is reasonably required to protect the
members interests (enable him to sue a client for fees
or defend an action against them e.g. negligence)
There is a public duty to disclose e.g. the client has
committed an action against the public interest such as
unauthorised release of toxic chemicals

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Disclosure to protect accountants

interests

Enables the accountant to defend themselves

against a criminal charge or suspicion
Resist proceedings in relation to taxation offence
Resist legal action by a client or third party
Enable accountant to sue for their fees
Enable accountant to defend themselves against
disciplinary proceedings by ACCCA or other
body

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Disclosure in the public interest

ACCA gives further on disclosure in the public interest.
Accountants should usually seek legal advice before making
disclosures.
The courts have never given a definition of 'the public
interest'. This means that again, the issue is left to the
judgement of the auditor. It is often therefore appropriate for
the member to seek legal advice.
It is only appropriate for information to be disclosed to
certain authorities, for example, the police.
Information
can be also disclosed to other nongovernmental bodies (tax authorities, environment and
health and safety inspector) provided that the proper
authority under which information is required, exists.
Unless he is satisfied that such statutory authority exists
auditor should decline to give any information until he has
obtained his client's authority.
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Disclosure in the public interest

The ACCA guidance states that there are several factors

that the member should take into account when deciding
whether to make disclosure.
ACCA guidance
The size of the amounts involved and the extent of likely
financial damage
Whether members of the public are likely to be affected
The possibility or likelihood of repetition
The reasons for the client's unwillingness to make
disclosures to the authority
The gravity of the matter
Relevant legislation, accounting and auditing standards
Any legal advice obtained

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Exam focus point

If you are required to make judgements

about whether such a disclosure should
be made in a given scenario, you should
apply a checklist like in the previous slide
to the scenario to ensure you have shown
evidence of your consideration of all the
relevant factors.

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EXERCISE
2.6

Identify which of the following situations would compel an

auditor to disclose otherwise confidential facts to an
appropriate authority:
(a) The auditor of a chain of launderettes suspects that several
cash inflows have been the result of illegal acts.
(b) The auditor of a golf club has found evidence that a director
is paying parking tickets and speeding fines using the
companys cash book.
(c) The auditor of a manufacturing business believes that the
client has terrorist sympathies. He has heard the client make
several comments that he believes support this theory.
Based on these comments, he has called the integrity of the
management into question and thinks that it is likely that he
is involved in illegal terrorist activity.
(d) The auditor of a pension fund believes that the directors
have little regard to internal control and has evidence that
they have been breaking guidelines from the regulator
regarding
holding client money.
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ANSWER 2.6

(a) Before informing authorities about Money Laundering, the

auditor should report it to the firms MLRO, who will be
properly trained in spotting money laundering and will have
appropriate experience to know what further evidence is
required. The auditor must be careful not to tip the client off
during the process of looking into this matter further.
(b) Although this casts doubt on the integrity of management,
the auditor would not report this to any authority. The auditor
should inform his or her senior who can decide appropriate
action. This is likely to be to communicate with the
shareholders at the AGM (if the fines are substantial) or to
report to the audit committee, if the client has one. This is
unlikely in a small business.
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ANSWER 2.6

c) Here, the auditor seems to have no or little

evidence. Although terrorist offences constitute a
situation when the auditor does have an
obligation to disclose, care must be taken not to
be over sensitive and act on vague suspicion.
(d) Pension funds hold the publics money and
as a result are usually more significant when
deciding on whether or not to report wrongdoing.
In this situation, the auditor should make the
appropriate facts known to the regulator.

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CONFLICTS OF INTEREST

Conflict of interest may arise between

1.Members of the assurance firms and clients interests

When members compete directly a client
In the case of significant conflict between members and
client the member should refuse or discontinue the
assurance assignment.
2.Conflict of interests between different clients
Assurance firms have clients who are in competition with each
other.
In the case of conflict between clients, the firm must
ensure that the fact that the firm is auditing both clients is
not a subject for a dispute otherwise the assignment should
not be accepted or discontinue.
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CONFLICTS OF INTEREST

When the audit firm considers the acceptance of a client in

direct competition with another client the following safeguards
should be applied:

Notify the existing client affected and ask his consent.

Notify all known parties affected that the firm acts on behalf
of two or more parties in respect of a matter that a possible
conflict of interest may arise and obtain their consent so to
act
Notify existing and potential clients that the member does not
act exclusively for any one client
Using separate audit teams for the assignments
Set procedures to prevent access to information
Confidentiality agreements signed by partners and staff
Regular review of the safeguards by independent partner
Advise on both parties to seek additional independence
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ACCA

Conflicts in application of the

fundamental principles
The

Code of Ethics and Conduct gives some general

guidance to members who encounter a conflict in the
application of the fundamental principles

Example: An auditor discovers a fraud

report could conflict with confidentiality

- conflict: duty to

Matters to consider:
The resolution process should include consideration of:
Relevant facts
Ethical issues involved
Fundamental principles related to the matter in question
Established internal procedures
Alternative courses of action
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Conflicts in application of the

fundamental principles
Unresolved conflict
If the matter is unresolved, the member should consult
with other appropriate persons within the firm.
They may wish to obtain advice from ACCA or legal
advisers.
If after exhausting all relevant possibilities, the ethical
conflict remains unresolved, members should consider
withdrawing from the engagement team, a specific
assignment, or to resign altogether from the
engagement.

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