AUDIT AND ASSURANCE

BY: SALIMOV MIRZOHID

LECTURE:3
Terminology

Definition

Corporate governance – the system by which business corporations are directed

and controlled. The corporate governance structure specifies the distribution of
rights and responsibilities among different participants in the corporation … and
spells out the rules and procedures for making decisions on corporate affairs.
– OECD
Those charged with governance (TCWG) –individuals with responsibility for
overseeing the strategic direction of the entity and obligations related to the
accountability of the entity, including overseeing the financial reporting process.
– ISA 260
Management – individuals with executive responsibility for the conduct of the entity's
operations.
– ISA 260
Objective

The ultimate objective of a business is to increase long-term shareholder value by enhancing

economic performance.
Corporate governance aims to achieve this through:
•the ethical and moral behaviour of corporate management;
•integrity, transparency and accountability in business activity;
•compliance with laws and regulations; and
•securing reputation and confidence in attracting inward investment.
Key Point

•In general, governance responsibilities involve several oversight activities, including matters
relating to:strategy development and implementation;
•economic development, mergers and acquisitions;
•appointment of professional operating management executives;
•compensation of executives;
•risk and control systems and compliance with laws and regulations; and
•engaging internal auditors and independent external auditors.
 Relevance

Virtually all corporate governance regulations are aimed at listed companies, where the
separation of ownership and control/management have, in several notorious cases (e.g. Enron,
Royal Bank of Scotland, Lehman Brothers), caused severe losses to the shareholders through
mismanagement of company resources, missed opportunities and poor decision-making or
fraudulent activities (including misleading and dishonest financial reporting).
Importance
Research has shown that entities that take good corporate governance practice seriously
are more prosperous over the long term than entities which do not.

•Analysts and policymakers agree that improving corporate governance is crucial to a

company's ability to generate sustainable growth in the future.

•There is a risk that weak corporate governance will lead to financial losses, both for
entities and shareholders. Strong corporate governance helps reduce this risk.
OECD Overview

The mission of the Organisation for Economic Co-operation and Development (OECD) is to
promote policies designed to improve the economic and social well-being of people around
the world.
In 1999, the OECD released its Principles of Corporate Governance. The Principles are an
international corporate governance benchmark. They were last revised in 2015 to account for
recent developments in the corporate sector and capital markets.
UK Code Overview

Exam advice
The UK Corporate Governance Code is an examinable document as an example of best practice and can
be downloaded from www.frc.org.uk.

The UK Corporate Governance Code is a prime example of good corporate governance practice.

•It applies only to listed companies, but it can be used by any entity (private or public) as the basis for best
practice.
•It explains the concept of "comply or explain" and contains 18 Principles covering leadership, stakeholder
relations, board effectiveness, accountability, audit, risk and internal control and remuneration.
•It is supported by guidance, which boards and companies are encouraged to use in applying the Code’s
Principles on:
• Board effectiveness;
• Risk management and internal control (see s.2.5); and
• Audit committees (see s.3).
Division of Responsibilities

The chair should be independent on appointment. For example:

•not an employee (during the last five years);

•no material business relationship (during the last three years);
•not a significant shareholder.

The chair:

•leads the board;

•is responsible for its overall effectiveness in directing the company;
•should demonstrate objective judgment;
•should promote a culture of openness and debate;
•facilitates constructive board relations and the effective contribution of all NEDs;
•ensures that directors receive accurate, timely and clear information.

Key Point
The chairman and CEO should not be the same individual.
 Audit committee

For a listed company, an audit committee is how the board establishes "formal and transparent
arrangements" to meet the corporate reporting and risk management and internal control principles. It is
also best practice for unlisted and other entities.

•An audit committee should comprise at least three independent NEDs (two for a smaller company).
•At least one member must have recent and relevant financial experience.
•As a whole, the committee must have competence relevant to the sector in which the company operates.

Key Point
•Through the audit committee, external auditors are responsible and report to the shareholders, not the
executive management.
•The audit committee enhances the external auditor's independence and provides greater independence
for the internal auditor.

The audit committee’s role considers the risks and controls over the financial reporting process and the
tax, environmental, legal and other regulatory matters that have a material effect on the financial
statements.
Corporate Governance Deficiencies
During the audit of a new client, you listed the following corporate governance practices used by your client.

Deficiency Yes/No Recommendation:

1.The entity has a six-member
board of directors, including
executive and non-executive
directors.
2.The CEO serves as the chairman
of the board of directors.
3.The board includes two
independent NEDs.
4.New board members are
selected by a nominations
committee headed by the
chairman/CEO.
5.The audit committee comprises
two executive directors and the
two NEDs.
 Deficiency Yes/No Recommendation:

6.One of the independent non-

executive audit committee
members recently retired after
serving for ten years as the CFO
of a major corporation.

7.The remuneration committee

comprises one executive director
and one NED, and they decide
the remuneration of all board
members.

8.Management is required to
assess the effectiveness of
internal controls on an annual
basis.
1. Which statement regarding the composition of an audit committee in accordance with the
UK Corporate Governance Code is correct?
A.All directors must be executive
B.All directors must be non-executive
C.Some directors may be executive as long as three are non-executive
D.All non-executives must have recent and relevant financial experience

2. Which of the following is NOT a principle of corporate governance?

A.Rights of shareholders
B.Board responsibilities
C.Auditor’s accountability and remuneration
D.Risk management and internal control
3. Which of the following is NOT a provision of the UK Corporate Governance Code?
A.There should be a clear division of responsibilities between the leadership of the board and the
leadership of the company’s business
B.All members of the board, excluding the chairman, should be independent non-executive directors
C.Executive director remuneration should be linked to corporate and individual performance
D.All directors should be subject to annual re-election

4. Who do audit committees normally liaise between?

A.The internal and external auditors
B.The internal auditor and the entities staff
C.Executive and non-executive directors
D.The auditors and the directors

5. Who has ultimate responsibility for a company’s risk management and internal control systems?
A.The board of directors
B.Management
C.The audit committee
D.A risk management committee
Complying with the Code

Key Point
The Code establishes five fundamental principles:
1.integrity;
2.objectivity;
3.professional competence and due care;
4.confidentiality; and
5.professional behaviour.

All students and members of the Chartered Association (e.g. in practice, commerce, internal audit,
education) must observe proper standards of professional conduct and refrain from misconduct.
Failure to observe standards may result in disciplinary proceedings. The ACCA Code of Ethics and
Conduct can be downloaded from Code of Ethics and Conduct | ACCA Global.
Integrity

In all professional, business, personal and financial relationships, the professional accountant should
be straightforward and honest. This implies fair dealing, truthfulness and having the strength of
character to act appropriately, even when facing pressure to do otherwise or when doing so creates
potential adverse personal or organisational consequences.

Activity 1 Integrity

Describe THREE situations in which the integrity of a professional accountant may be threatened.
Possible answer for activity 1

1.As an auditor, if a set of financial statements contain a material misstatement that the directors
refuse to change, an unmodified opinion would not be issued.

2.In the context of other work (e.g. preparing a cash flow forecast), if asked to verify misleading data,
the member would refuse to accept the engagement or withdraw as soon as he becomes aware that
the data is misleading and the client refuses to change.

3.For an accountant in business, being asked by the CFO to sign off on management accounts for the
bank that contain significant differences from the underlying records.
Objectivity

The professional accountant’s exercise of professional or business judgements must not be compromised by:

•bias;
•conflict of interest; or
•undue influence of, or undue reliance on, individuals, organisations, technology and other factors.

Key Point
A professional accountant should not undertake a professional activity if a circumstance or relationship
unduly influences the accountant’s professional judgment regarding that activity.
Professional Competence and Due Care

A professional accountant must:

•Attain and maintain the level of professional knowledge and skill required to ensure their competence based
on current standards and relevant legislation; and
•Act diligently and in accordance with applicable technical and professional standards.

Maintaining professional competence requires a continuing awareness and understanding of relevant

technical, professional and business and technology-related developments. This is achieved through
continuing professional development (CPD).

Diligence encompasses the responsibility to act according to the assignment’s requirements carefully,
thoroughly and on a timely basis.
Confidentiality

The principle of confidentiality requires an accountant to respect the confidentiality of information acquired as
a result of professional and business relationships.

An accountant must be alert to the possibility of inadvertent disclosure (e.g. in a social environment and to close
business associates or family members).

Key Point
Confidential information should not be:

•disclosed to third parties without proper and specific authority or unless there is a legal,
professional right or duty to disclose;
•used for any personal advantage or the advantage of a third party.
Professional Behaviour

An accountant must:
•comply with relevant laws and regulations; and
•avoid any conduct that might discredit the profession.

In marketing and promoting themselves and their work, professional accountants should not bring the
profession into disrepute. They should be honest and truthful and not make:

•exaggerated claims for their services, qualifications or experience; or

•disparaging references or unsubstantiated comparisons to the work of others. A claim such as "We are
the best, better than all the rest" is not professional.
Threats

An accountant must identify threats to compliance with the fundamental principles.

Compliance with the fundamental principles may potentially be threatened by a broad range of
circumstances which generally fall into one or more of the following categories:
•Self-interest threat;
•Self-review threat;
•Advocacy threat;
•Familiarity threat; and
•Intimidation threat.

The term "management threat" is widely used to describe the threats that arise when an audit firm
undertakes an activity that is management's responsibility. However, it is not a separate category of
threat in the Code.

Key Point
A circumstance might create more than one threat, and a threat might affect compliance with more
than one fundamental principle.
Self-Interest Threat

A self-interest threat may occur due to the financial or other interests of the professional
accountant (including immediate or close family members). For example:

•undue dependence on total fees from a client;

•loans or guarantees made to or from a client;
•close personal or business relationships with a client;
•audit team member negotiating employment with a client;
•financial interest in a client;
•gifts and hospitality; and
•concern over losing a client or employment security.
Example 1 Self-interest Threats
1.Breuger Co has offered the auditor an additional fee for issuing an unmodified audit opinion
for the current reporting year.

2.Douglas Lu, the auditor of Ayeland Bank, is also a customer of the bank. Ayeland Bank has
offered Douglas Lu preferential rates on his loan and overdraft facilities.

3.Tucker Chartered Accountants, a relatively new audit firm, is conducting the audit for
Tubbletown Co. During a recent conversation, Tubbletown’s CEO wished Tucker success in its
future ventures and promised to take up the offer of non-audit services from Tucker if an
unmodified audit opinion is issued on completion of the audit.
Self-Review Threat

•A self-review threat may arise when a professional accountant does not appropriately evaluate the results
of a previous judgment made by either themselves or another individual within their firm or employing
organisation, which they will rely on when forming a judgment in providing a current service.

•Examples include, but are not limited to:

• reporting on the operation of systems after being involved in their design or implementation;
• a member of an engagement team having previously been employed by the client in a position that
directly influenced the subject matter (e.g. financial statements); and
• business decisions or data being reviewed and justified by the person responsible for making those
decisions or preparing those data.
 Example 2 Self-review Threats
1.Dregger & Co, currently appointed as the auditor of Turnbally Co, was previously engaged
by Turnbally Co to design and implement its digitalised financial control system.

2.Mariana, the audit manager for the statutory audit of Ruger Co, was previously engaged as
a non-executive director of Ruger and the chair of Ruger’s audit committee.
Advocacy Threat

An advocacy threat is created when the professional accountant promotes a client's or employer's
position or opinion to the point that subsequent objectivity may be compromised. If the position has
changed later, there may be pressure to ignore that change.

Examples of advocacy threats include:

•promoting shares in an audit client;
•acting as an advocate on behalf of an audit client in litigation or disputes with third parties;
•commenting publicly on future events in particular circumstances, having made assertions without
detailing the assumptions; and
•where information is incomplete or advocating an argument which is unlawful.
 Example 3 Advocacy Threats
1.Pally & Co has been asked to make representations supporting its audit client, Baroo Co, in applying
for loan facilities from a consortium of banks because Pally & Co had issued unmodified opinions on
Baroo’s financial statements for a few years.

2.Balsyer Co, impressed with the quality of work performed by TT Chartered Accountants on its
statutory audit, has invited TT to be its reporting accountants for its upcoming initial public offering (IPO)
and accompanying promotions to institutional investors.
Familiarity Threat

A familiarity threat can arise when a professional accountant, because of a long or close relationship, becomes
too sympathetic to the interests of a client or employer or too willing to accept their work and explanations.

Key Point
There is a significant risk that professional scepticism will not be sufficiently applied.

Examples of familiarity threats include:

•Over-familiarity (e.g. close or immediate family member) with management 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 insignificant; and
•A former partner of the audit firm becoming a director, officer or employee of a client in a position to exert
direct influence over the financial statements (or other subject matter of the engagement).
 Example 4 Familiarity Threats
1.The CEO of Rublus Co is also the wife of the engagement partner for the company’s statutory audit.

2.Patrick, a former partner in Delim & Co has joined Pack Co as finance director. Patrick was the audit
engagement partner of Pack Co in previous years and Delim & Co is still Pack Co’s auditor this year.
Intimidation Threat

An intimidation threat arises where the professional accountant may be deterred from acting objectively
by actual or perceived pressures, including attempts to exercise undue influence over the accountant.

Examples of intimidation include:

•the threat of dismissal (as an employee) or replacement (as an auditor), for example, over a
disagreement about the application of an accounting principle;
•a dominant personality attempting to influence the presentation of financial information or controlling
relations with auditors (e.g. their appointment);
•being threatened with litigation; and
•being pressurised to reduce necessary work to reduce costs or fees.
 Example 5 Intimidation Threats
1.The finance director of Belmont Co has informed the auditor that the company might start looking for a
new auditor in the event of an unfavourable audit opinion.

2.Balsi Co’s management has informed the auditor, Truf & Co, that it would hold Truf & Co liable for any
drop in share price if the audit opinion is unfavourable.
 Addressing Threats

There are three ways to address threats to the fundamental principles:

1. Eliminate the circumstances, including interests or relationships, that are creating the threats;

For example, a member of the audit team may sell any direct holdings in a client’s shares before the
commencement of the audit.

2. Apply safeguards, where available and capable of being applied, to reduce the threats to an
acceptable level; or

3. Decline or end the specific professional activity. This may be the only course of action (i.e. when a
threat cannot be eliminated or reduced to an acceptable level through safeguards).

For example, an auditor may decline to advise a client on a takeover bid where the target company is
another audit client.
Definition
Safeguards – actions, individually or in combination, taken by the professional accountant that
effectively eliminate threats to compliance with the fundamental principles or reduce them to an
acceptable level.

Key Point
The professional accountant’s action is not a safeguard unless it is effective.
Independence, Objectivity and Integrity

Independence is a requirement for all professional accountants and their firms when performing audit engagements.

Key Point
An auditor's integrity and objectivity must be beyond question. Objectivity can only be assured if the auditor is,
and is seen to be, as independent as possible.
Inducements, including Gifts and Hospitality

Offering or accepting inducements might create a self-interest, familiarity or intimidation threat to

particularly the principles of integrity, objectivity and professional behaviour.

An inducement can take many forms, for example:

•Gifts
•Hospitality and entertainment
•Political or charitable donations
•Appeals to friendship and loyalty
•Employment or other commercial opportunities
•Preferential treatment, rights or privileges.

The professional accountant must comply with relevant laws and regulations that prohibit the offer or
acceptance of inducements in certain circumstances (e.g. those related to bribery and corruption).
A firm or audit team member must not accept gifts and hospitality from an audit client unless the value
is trivial and inconsequential.
Any gift that is intended to influence behaviour improperly should not be accepted (even if the value
is trivial and inconsequential).
Fees
Fees for professional services are usually negotiated with and paid by an audit client. This practice is
generally recognised and accepted by intended users of financial statements. However, it creates a self-
interest threat and might create an intimidation threat to independence.

The level of threats created will depend on many factors, for example:

•the level of the fees (having regard to the resources required);

•the extent of any dependency between the fee and the outcome of the service;
•the operating structure and compensation arrangements of the firm;
•the significance of the client to the firm, office or partner;
•the nature of the client (e.g. whether it is a public interest entity); and
•the involvement of those charged with governance (TCWG) in appointing the auditor and agreeing fees.
Level of Audit Fees

Factors that are relevant in evaluating the level of self-interest and intimidation threats created by the level of
the audit fee paid by the audit client include:

•The firm’s commercial rationale for the audit fee; and

•Whether undue pressure has been, or is being, applied by the client to reduce the audit fee.

Actions that might be safeguards to address such threats include having an appropriate reviewer who does
not take part in the audit engagement:

•assess the reasonableness of the fee proposed, having regard to the scope and complexity of the
engagement;
•review the work performed.
Contingent Fees

Definition
Contingent fees – fees calculated on a predetermined basis relating to the outcome of a transaction or
the result of the services performed.

Key Point
A firm must not charge directly or indirectly a contingent fee for an audit engagement.

Contingent fees are also prohibited for non-assurance services (NAS) to audit clients if:

•the fee is material (or expected to be material) to the firm; of

•the outcome of the NAS, and therefore the amount of the fee, depends on a future or current
judgment related to the audit of a material amount in the financial statements.
Total Fees – Overdue Fees

The level of the self-interest threat might be increased if fees payable by an audit client are
overdue during the period of the audit engagement.
It is generally expected that the firm will obtain payment of such fees before the audit report is
issued.

Factors that are relevant in evaluating the level of such a self-interest threat include:
•the significance of the overdue fees to the firm;
•the length of time the fees have been overdue; and
•the ability and willingness of the audit client to pay the overdue fees.

Examples of safeguards include:

•Obtaining partial payment of overdue fees;
•Having an appropriate reviewer who did not take part in the audit engagement review the audit
work.
Public Interest Entities

When for each of two consecutive years, the total fees from a PIE client represent more than 15% of the firm’s
total fees, the firm must:

•determine whether, prior to issuing the audit opinion on the second year’s financial statements, a “pre-issuance
review” (equivalent to an engagement quality review) might be a safeguard to reduce the threats to an acceptable
level; and
•if so, apply it.

Definition
Public interest entity (PIE) – a listed entity, or an entity required by a regulator to be audited as if it were
listed, or an entity of significant public interest due to size or business (e.g. banks).
Key Point
If these circumstances continue for five consecutive years, the firm must cease to be the auditor after the
audit opinion for the fifth year is issued.

The only exception to this requirement is if:

•a regulatory professional body in the relevant jurisdiction agrees that there is a compelling reason to
continue “having regard to the public interest”; and
•a pre-issuance review is performed before the audit opinion is issued on the sixth and any subsequent
year’s financial statements.
Fee Dependency – Not PIEs

When for each of five consecutive years, the total fees from a not PIE client represent more
than 30% of the firm’s total fees, the firm must determine whether either of the following actions might
reduce the threats to an acceptable level, and if so, apply it:

•prior to issuing the audit opinion for the fifth year, a professional accountant who is not a member of
the firm, reviews that year’s audit work; or
•after the fifth year’s audit opinion has been issued (and before the sixth year’s), a professional
accountant reviews the fifth year’s audit work.
Actual or Threatened Litigation

Actual or threatened litigation typically involves the issue (or threat) of a writ against the firm for
negligence or failure to conduct activities professionally resulting in a breakdown of trust.

When litigation with an audit client occurs or appears likely, self-interest and intimidation threats are
created.

The significance of the threat will depend on:

•the materiality of the litigation;
•whether the litigation relates to a prior audit engagement.

Safeguards that may be applied include:

•independent review of the work carried out and subject to the litigation; and
•if the litigation involves a member of the audit team, removing that individual from the audit team.
Financial Interests

Financial interests may be held and controlled directly (e.g. personal shareholdings) or indirectly (e.g.
through a pension fund).

Holders of a relevant interest (e.g. direct interest or material indirect interest) in an assurance client are
at risk, and the self-interest threat should be assessed.

The threat depends on whether the relevant interest is held by:

•a partner (regardless of any involvement in the audit);
•an employee; or
•an immediate or close family member.
Audit Team Members and Partners

A relevant interest in an audit client cannot be held by:

•An audit team member; or
•Any partner in the office of the engagement partner; or
•Their immediate family (i.e. spouse, partner or dependent).

If held, there are no safeguards that would reduce the threat to an acceptable level, so:
•the individual must dispose of the interest; or
•the firm disengage from the audit; or
•the audit team member/partner resigns from the firm.
Family and Other Personal Relationships

Personal relationships (e.g. through mutual business interests or close friendship) or family relationships
(e.g. by marriage or birth) between a member of the audit team and a client's directors, officers and other
employees create self-interest, familiarity or intimidation threats.

The significance of the threats will depend on factors such as:

•the nature or closeness of the relationship;
•the position held by the family member/client's employee; and the role of the audit team member.

The more senior the individuals involved, the greater the threat. Therefore, an individual cannot be a
member of an audit team if an immediate family member:

•Is a director or officer of the audit client;

•Is an employee in a position to exert significant influence over the preparation of the client’s accounting
records or the financial statements on which the firm will express an opinion; or
•Was in such a position during any period covered by the engagement or the financial statements.
Activity 2 Family and Other Personal Relationships

Suggest how the threats arising in each of the following situations should be addressed:
1.A trainee's uncle is a director of an assurance client.
2.A trainee's friend from university is the credit controller of an audit client.
3.An audit manager's fiancée is the credit controller of an audit client.
4.A partner's sister is a director of a company.

1.The trainee should not be a member of the assurance team.

2.If the trainee remains on the team, he cannot be involved in auditing sales or receivables.
3.The manager should not be involved with the audit as he would be responsible for directing and reviewing
the audit work on receivables carried out by trainees.
4.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 from the audit.
Loans and Guarantees

Loans and guarantees to an audit client by a firm, audit team member or immediate family are prohibited unless
immaterial to both:
•the firm (or individual) making the loan or guarantee; and
•the client.

Loans and guarantees from an audit client that is not a bank (or similar institution) are similarly prohibited.

Where the client is a bank (or similar institution), loans (including mortgages, bank overdrafts and credit card
balances) and guarantees cannot be accepted unless made under routine lending procedures, terms and
conditions. Even in this situation, a self-interest threat may arise if the loan is material to the loan recipient.

Where such loans are material, safeguards are required to address the self-interest threat (e.g. an independent
review of audit work).
Many firms prohibit their partners (and the firm) from having any 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 financial institution concerned.
Provision of Non-assurance Services to Assurance Clients

There is no objection to providing non-assurance services (NAS) to audit clients. In doing so, the firm better
understands its clients' processes, controls, business and financial risks. However, auditors are barred from
providing additional NAS to listed company clients in some jurisdictions.

Under corporate governance codes (e.g. the UK Corporate Governance Code), audit committees must
specifically approve non-audit services provided by auditors, ensuring that independence has not been
impaired and that there is no threat to any fundamental principle.

Key Point
Where the Code expressly prohibits the provision of a NAS to an audit client, that is regardless of the
materiality of the outcome or results of the NAS on the financial statements.

Key Point
If a threat cannot be reduced to an acceptable level by applying safeguards, the NAS cannot be provided.
Prohibition on Assuming Management Responsibilities

Key Point
A firm must not assume management responsibility for an audit client.

Assuming management responsibility in providing a NAS creates self-review and self-interest threats. It
can also create familiarity threat and even advocacy threat (because the firm becomes too closely aligned
with the views and interests of management).

Providing advice and recommendations to assist management in discharging its responsibilities

is not assuming management responsibility. (However, this might create a self-review threat.)

Key Point
To avoid assuming management responsibility when providing any NAS to an audit client, the firm must be
satisfied that management makes all judgments and decisions that are the proper responsibility of
management.
Accounting and Bookkeeping Services – Self-review Threat

Examples of accounting and bookkeeping services include:

•Preparing accounting records and financial statements;

•Recording transactions;
•Payroll services.

Key Point
Such services must not be provided to a PIE audit client.
Valuation Services – Self-review or Advocacy Threat

A valuation involves making assumptions about future developments and applying specific methodologies
and techniques to compute a particular value, or range of values, for an asset, a liability or the whole or
part of an entity.

PIE Not-PIE

If valuation involves a significant degree of

If valuation might create a self-review threat, service
subjectivity and will have a material effect, service
cannot be provided.
cannot be provided.

Safeguards for a not-PIE client include:

•independent review of the audit or the valuation work; and

•excluding members of the valuation team from the audit.
Tax Services – Self-review or Advocacy Threat

Tax services include activities such as:

•Tax return preparation;
•Tax calculations to prepare the accounting entries;
•Tax advisory and tax planning services;
•Tax services involving valuations; and
•Assistance in the resolution of tax disputes.

•Tax return preparation services do not usually create a threat because:

• they are based on historical information presented under existing tax law; and
• tax returns are subject to review or approval by the tax authority.

•Preparing tax calculations (current and deferred) for the accounting entries that will be subsequently audited
creates a self-review threat.
• This is prohibited for a PIE audit client, if material;
• Appropriate safeguards should be applied to a not-PIE audit client.
•Tax advisory and tax planning services comprise a broad range of services which might create a self-
review or advocacy threat.

• Such services that might create a self-review threat for a PIE are prohibited;
• Where permitted, as well as the usual safeguards, the firm may obtain “preclearance” from the tax
authorities.

•For tax services involving valuations, the provisions of the Code for valuation services may apply

•Providing assistance in the resolution of tax disputes to an audit client might create a self-review or
advocacy threat. For example, when the tax authorities have notified the client that arguments on a
particular issue have been rejected and either the tax authority or the client refers the matter to a tribunal
or court.

Key Point
•A firm must not assist in the resolution of any tax dispute which involves:Acting as an advocate for the
audit client before a tribunal or court;
•Amounts which are material to the financial statements.
Internal Audit – Self-review Threat

Many internal audit services will not be directly related to the financial systems and preparation of the
financial statements. They may be undertaken without threat to independence by the external auditors.

For a PIE audit client, internal audit services that relate to the following are prohibited:
•internal controls over financial reporting;
•financial accounting systems that generate information for the client's accounting records or financial
statements; or
•amounts or disclosures that relate to the financial statements.

For not-PIE audit clients, professionals who are not audit team members may perform the service as a
safeguard.
IT Systems Services – Self-review Threat

Providing services to an audit client that involve the design and implementation of financial
information technology systems that generate information forming part of that client's financial
statements, may create a self-review threat.

For a PIE audit client, a firm cannot provide services that involve designing or implementing IT
systems that:
•form part of the internal controls over financial reporting; or
•generate information for the client's accounting records or financial statements.
Recruiting Services – Self-interest, Familiarity or Intimidation Threats

The recruitment of senior management for an audit client may create current or future self-interest,
familiarity and intimidation threats.

The significance of any threat will depend on:

•the role of the person to be recruited;
•the nature of the assistance requested; and
•any conflicts of interest or relationships between the candidates and the firm providing the advice or
service.

Key Point
An audit firm is prohibited from acting as a negotiator on an audit client’s behalf.
The following recruiting services are prohibited for any audit client for the positions of director, officer or
senior management in a position to exert significant influence over the accounting records or financial
statements:

•Searching for candidates;

•Undertaking reference checks;
•Recommending who to appoint;
•Advising on terms of employment, remuneration or benefits of a particular candidate.
Corporate Finance Services – Self-review or Advocacy Threat

Examples of corporate finance services include:

•assisting an audit client in developing corporate strategies;
•identifying possible targets for the audit client to acquire;
•advising on disposal transactions;
•assisting in finance raising transactions;
•providing restructuring advice; and
•providing advice on financing arrangements that will directly affect amounts reported in the financial
statements.
Key Point
•The following corporate finance services are prohibited for any audit client:Those involving promoting,
dealing in or underwriting an audit client's shares.
•Those whose effectiveness depends on a particular accounting treatment which is in doubt and material.

Safeguards that may be applied include:

•Using professionals who are not members of the audit team to perform the service;
•Independent review of the audit work or service.
Long Association of Senior Personnel

A familiarity threat arises when senior staff have been involved with an audit engagement for a significant
time.
A self-interest threat might be created due to an individual’s concern about losing a long-standing client or
interest in maintaining a close personal relationship with a member of senior management or TCWG. Such
threats might influence the individual’s judgment impairing objectivity and reducing professional
scepticism.

For a PIE, an individual cannot act in any of the following roles (or a combination thereof) for more than
seven cumulative years (the “time-on” period):
•The engagement partner;
•The individual responsible for the engagement quality review (see Chapter 5);
•Any other key audit partner role.

After the time-on period, the “cooling-off” period is:

•Five years – engagement partner;
•Three years – engagement quality reviewer;
•Two years – other key audit partners.
Employment with an Audit Client

Employment relationships with an audit client might create a self-interest, familiarity or

intimidation threat.

A familiarity or intimidation threat might be created if a director or officer of an audit client (or an
employee in a position to exert significant influence over the financial statements) was a partner of the
audit firm or a member of the audit team.

Safeguards to address familiarity or intimidation threats include:

•modifying the audit plan;

•assigning a sufficiently experienced audit team; and
•quality review.

An audit team member who recently served as a director, officer or employee of the audit client might
create a self-interest, self-review or familiarity threat. Therefore, an audit team should not include an
individual who served with the audit client during the period covered by the audit report.
Serving as a Director

Serving as a director or officer of an audit client creates self-review and self-interest threats.

Key Point
A partner or employee of the firm must not serve as a director or officer of an audit client of the firm.

Serving as Company Secretary for an audit client is

similarly prohibited unless:

•Specifically permitted under local law, professional rules or practice;

•Management makes all relevant decisions; and
•Duties and activities performed are limited to routine and administrative
(e.g. preparing minutes and maintaining statutory returns).
Activity 4 Independence for Audit Engagements
Comment and conclude on the following THREE situations.

1.Trainees of Porterhouse, a firm of Certified Accountants, have been offered overdraft facilities up to $3,000,
on student terms, by a client bank.

2.Ambit Co is preparing to apply for listing (admission) to a recognised stock market while offering a proportion
of its shares to the public. The directors have asked Schilling & Co, as their auditors, to set up and maintain
the company's share register on a computer database.

3.Sean & Co is the auditor of Starck Co. 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.
Answer to the situation 1

1.Comments - Loans (including overdrafts) on normal commercial terms may be accepted by staff
members (including trainees)."Student terms" may be standard commercial terms if the bank offers
them to all accountancy trainees, not just Porterhouse’s. If these terms are not normal commercial
terms, the next step is to determine if the benefit is more than "modest".

2.Conclusions - Porterhouse's engagement and compliance partners may decide that acceptance of
the offer will not appear to threaten objectivity even if the terms are special. However, as a safeguard,
it should be confirmed that the terms are no more favourable (or no less unfavourable!) than those
offered to other trainees. If more favourable, the loans (overdrafts) should be declined.
Answer to the situation 2

1.Comments - Provided this is a simple matter of entering data into the database and the directors
of Ambit have approved the specific programme used by the auditor, the nature of additional
service is unlikely to threaten objectivity (i.e. no managerial involvement).As a public interest
company (intention to list), recurring fees (audit + maintenance) should not exceed 15% of gross
practice income. In addition, a pre-issuance review of the audit file must occur.

2.Conclusions - The additional service is likely to be acceptable within ethical constraints.

Answer to the situation 3

1.Comments - Starck Co will become a public interest entity when the shares are listed. The 19% of total
fees may not affect independence if the recurring element is less than 15%. However, 19% may be
undesirably high in appearing to detract from objectivity.Safeguard: Ensure that the recurring element of the
fee will be less than 15% of the firm’s total fee income. If not, determine whether a “pre-issuance review” of
the audit might be a safeguard to reduce the threats to an acceptable level.
2.The scenario implies that Sean & Co permits non-partner staff to hold shares in clients. Accordingly, the
senior tax manager should not be involved with Starck’s audit (e.g. calculating tax liabilities, reviewing tax
audit working papers) to avoid a self-interest threat
3.Safeguard: Ensure that the senior tax manager does not have any involvement with the audit of Starck. If
he does, he must dispose of his shares immediately.
4.Staff involved in the special assignment should not have similar responsibilities on the audit to avoid a
self-review risk. The more senior the staff, the higher the familiarity risk.

5.Conclusions - Provided that the recurring element of fees does not exceed 15% of total fee income and
appropriate safeguards (as above) are implemented, any threats to the fundamental principles should have
been reduced to an acceptable level.
Second opinion

A second opinion is when a professional accountant is asked for an opinion on the application of
accounting, auditing, reporting or other standards or principles by an entity that is not an existing client.
This is also sometimes referred to as "opinion shopping".

Key Point
Providing a second opinion to an entity that is not an existing client may threaten compliance with the
fundamental principles, unless the advice sought is insignificant.
Threats to the Fundamental Principles

A self-interest threat to compliance with the principle of professional competence and due care
arises when 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.

The second opinion may create undue pressure on the judgement and objectivity of the entity’s
appointed auditor (i.e. threatening another professional accountant’s independence).

Actions to Address
Examples of actions that might be safeguards to address such a self-interest threat include:

•Obtaining information from the current auditor with the client's permission.
•Describing the limitations surrounding any opinion in communications with the client.
•Providing the current auditor with a copy of the opinion.

The client's current auditor should:

•Seek the client's permission to reply to the request for information.
•If given, provide all information, facts and assumptions relevant to its professional opinion.
Disclosure of Confidential Information

Duty (obligatory disclosure) Right (voluntary disclosure)

UK examples include actual or suspected offences In certain circumstances, information may be

of: disclosed, whatever its nature. Categories of
•Money laundering disclosure include:
•Proceeds of crime •In the "public interest" to a person having proper
•Drug trafficking interest to receive information (e.g. the police, the
•Terrorism stock exchange for a listed client).
•Corruption •To protect the auditor's interests (e.g. defending
•Tax evasion against ACCA disciplinary proceedings).
•Insider dealing •If not prohibited by statute.

Definition
Public interest – the collective well-being of the community of people and institutions the professional
accountant serves.
Example 6 Improper Disclosure
During the current year's interim audit, the auditor becomes aware that the client has misrepresented its
sales tax return to the tax authorities, resulting in an underpayment of sales tax. The client refuses to accept
the auditor's advice to notify the tax authorities and negotiate and correct the returns.

The auditor informs the client that he is no longer prepared to act for them in any professional capacity. He
also tells the client that he will be informing the taxation authorities that he no longer acts for the client.
Because of client confidentiality, he should not disclose to the tax authorities why he has resigned (unless the
client gives permission for him 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. Therefore, the auditor is under a legal duty to report his
suspicions to the appropriate authorities (dealing with proceeds of crime), giving full details, even though he
does not provide a complete report to the taxation authorities.

It is essential for professional accountants to seek legal advice in such circumstances.

Conflict of interest

A conflict of interest creates threats to compliance with the principle of objectivity (and might threaten
compliance with the other fundamental principles). Such threats might arise when there is a conflict
between:
1.the professional accountant's interests and the client's interests.
2.the interests of two or more clients.
Professional Accountant v Client

Key Points
•Professional accountants should place clients' interests before their own.

•A firm should not accept or continue an engagement in which there is or is likely to be a

significant conflict of interest between the firm and the client.

•Any financial gain that 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.
Client v Client

Key points
•The firm's work should be managed to avoid the interests of one client adversely affecting those of
another.
•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.

Safeguards include:

•Separate engagement teams are provided with clear policies and procedures for maintaining
confidentiality.
•Appropriate reviewer, who is not involved in providing the service or otherwise affected by the
conflict, reviews the work performed to assess whether the critical judgments and conclusions are
appropriate.
Example 7 Conflicts of Interest
All of the current Big Four firms were formed through the mergers of major firms (originally
referred to in the 1980s as the "Top 10"). As the number of audit and 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 the
information and being able to minimise and control conflicts of interest, many competitor
companies decided that one of them would need to change advisers.
1. The directors of Exit Co, a listed company, have decided to issue an annual environmental and social
responsibility report and have asked the company’s auditors, Stu & Co, to provide an assurance report on it.
If accepted, the fee income from Exit Co would be slightly less than 15% of Stu & Co’s total fee income.
What should Stu & Co do now?
A.Resign from Exit Co
B.Decline the additional work
C.Rotate the audit engagement partner
D.Determine whether a pre-issuance review might be a safeguard
2. For which TWO of the following situations should an auditor make a VOLUNTARY disclosure?

1.If an auditor knows or suspects his client is engaged in money laundering

2.Where disclosure is made to non-governmental bodies
3.Where it is in the public interest to disclose
4.If an auditor suspects his client has committed terrorist offenses
A.1 and 4
B.1 and 3
C.2 and 4
D.2 and 3
3. Accepting gifts could be considered to present which of the following threats?
1.Self-interest threat
2.Advocacy threat
3.Familiarity threat
4.Intimidation threat
A.1 only
B.1 and 3
C.1, 3 and 4
D.1, 2, 3 and 4
4. Which of the following statements about safeguards against threats to the ethical principles is
TRUE?
A.A safeguard is any specific or considered action that could be taken by the professional accountant in
relation to an identified threat
B.The action is only considered to be a safeguard if it is found to be effective
C.A safeguard is only considered to be effective if completely eliminates the threat to compliance with the
ethical principles
D.Seeking advice on the threat from a third party is an appropriate safeguard in some circumstances
5. Which of the following is NOT true of independence of mind?
A.Allows an individual to act with integrity
B.Allows an individual to exercise objectivity and professional scepticism
C.Assures the ability and competence of the individual to carry out the work
D.Permits the expression of a conclusion without being affected by influences that compromise
professional judgment