P7 Ch 2

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CHAPTER 2 | Code of Ethics and

Conduct

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1. Professional Ethics

DEFINITION

Ethics is:

“Moral principles which govern a person’s or group’s behaviour”

Ethics is about doing the “right” thing. An action that is illegal is by definition also unethical. An issue that is not illegal may still be unethical, even if there is no legislation to cover the specific matter.

Ways the profession and society encourage ACCA members to be ethical

Behaving ethically is required by all persons registered with ACCA – this includes

members, affiliates and students, whether working in the audit profession or anywhere

else (for example teaching).

Sources of guidance on ethics include:

The ACCA

The IFAC – International Federation of Accountants

Audit firms

National legislation

ISAs – International Standards on Auditing

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Factors affecting Professional Conduct

2. Principles VS Rules Based Approach

Ethical guidance can either be principles based (a conceptual framework approach

providing guidance) or rules based.

Conduct of ACCA

firm personnel

ACCA Examinations

Quality Controls

Peer Review Code of Professional

Conduct

Legislation

ACCA Continuing

Professional

Education (CPE)

ISA’s

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2.1. Advantages of the Rules Based Approach

Certainty

Clarity regarding what is and what is not permitted

However, it is virtually impossible for rule based systems to be able to deal with every

single situation that may arise, particularly across various national boundaries and

especially in a dynamic industry.

2.2. Advantages of the Principles Based Approach

A framework is more appropriate to changing circumstances in a dynamic

profession

Principles may be applied across national boundaries, whereas laws may not

be applied very easily

The responsibility is placed on the auditor to demonstrate that all matters are

considered within the principles of the Framework

A framework approach may include some specific „prohibitions‟ or deal with

specific matters

However, the main disadvantage is that some auditors may be applying wrong or

inadequate judgment, with different auditors reaching different conclusions.

2.3. Principles or Rules?

Both IFAC and the ACCA have decided on a principles based approach, whereas the

USA follows a rules based approach.

IESBA (International Ethics Standards Board for Accountants) develops and promotes

the IFAC Code of Ethics for Professional Accountants, which applies to all professional

accountants, whether in public practice or not.

The ACCA has adopted the IFAC Code of Ethics (with minor changes) – and so all

ACCA members and students are obliged to follow this Code.

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3. The Five Fundamental Principles

The IFAC/ACCA code of ethics and conduct is built around 5 Fundamental Principles:

1. Integrity

2. Professional Behavior

3. Professional Competence & Due Care

4. Confidentiality

5. Objectivity (and Independence)

3.1. Integrity

All members must be straightforward and honest in professional and business

relationships.

Integrity also implies fair dealing and truthfulness.

Members should not be associated with reports, returns, communications or other

information where they believe that the information:

contains materially false or misleading statements contains statements or information prepared recklessly or omits or obscures information required to be included where such omission or

obscurity would be misleading

3.2. Professional Behaviour

Professional accountants should comply with laws and regulations, and refrain from

any activity that would discredit the profession.

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3.3. Professional Competence and Due Care

To maintain professional knowledge and skill at the level required to ensure that

clients or employers receive competent professional service, and to act diligently in

accordance with applicable technical and professional standards when providing

professional services.

Competent professional service requires the exercise of sound judgment in applying

professional knowledge and skill in our work. It requires continuing awareness and an

understanding of relevant technical, professional and business developments.

3.4. Confidentiality

Any audit client information obtained during the course of the audit should not be

disclosed by the auditor to anyone unless:

RIGHT

OBLIGATION

Client had given permission

If ordered by a court

To protect the auditor’s interest in court

To relevant regulatory authorities such

as: Financial Services Authority (FSA),

Charities commission, Money

Laundering Reporting Organization

(MLRO), Police

It is in the Public Interest

If the auditors are in any doubt, they should seek legal advice or consult the ACCA.

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In deciding whether to disclose in the Public Interest, the auditor should consider:

The materiality of the monetary values involved Whether members of the public are likely to be involved The seriousness of the matter The likelihood of repetition of the problem The reasons for the client's unwillingness to make the disclosures Relevant legislation, accounting & auditing standards Legal advice obtained

3.5. Objectivity

Objectivity/Independence: an obligation on all members not to compromise their

professional or business judgment because of bias, conflict of interest or the undue

influence of others (free from all economic, financial, and other relationships).

Objectivity/independence is a state of mind. Professional accountants in public practice

must also be independent in appearance. They have to avoid actions and

circumstances that could be seen to affect independence.

Audit firms and members of assurance teams have an obligation to identify and evaluate

circumstances and relationships that create threats to independence. They are expected

to take appropriate action to eliminate these threats or to reduce them to an acceptable

level by applying safeguards.

4. Threats to Objectivity and Independence

IFAC has identified the following threats:

1. Familiarity – becoming too sympathetic to the interests of the client 2. Self-review – reviewing own work 3. Self-interest – other benefits obtained through the relationship with the client 4. Intimidation – actual or perceived threats 5. Advocacy – actual or perceived promotion of the client‟s position or opinion

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The APB (UK only) also added:

6. Management threat – when the auditor makes decisions for the management

For exam purposes you need to know the 6 threats, even though the 6th threat was

issued for the UK.

5. Safeguards (Controls)

Auditors are required to apply/implement safeguards in order to address/reduce the risks

identified.

For some risks we may be able to reduce them to acceptable levels by using safeguards.

In some cases the risks may be so large, that even if we apply safeguards the risks cannot be reduced enough, in which case more extreme action may be required, such as resigning from an engagement.

EXAM TIP

Note that in exam questions, you will need to evaluate all alternatives to

get good marks, and you should not be absolute in your answer.

(use “should” instead of “must”)

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Some general Safeguards:

For the auditor:

• Accountant must be independent of management

• High caliber staff should be employed (competent and experienced)

• Senior staff rotation

• Maintain contact with ACCA and invest in training

• Use separate engagement teams and partners – “Chinese walls”

• Second partner reviews on high risk engagements

• Internal Quality Control Reviews

Within the work environment:

• Document independence policy & procedures

• Publish the ethical Code of Conduct

• External Quality Control Reviews

• Consult other firms & peer reviews

Within the profession:

• Educational, training and work experience requirements

• Regulatory enforcement & Disciplinary action

• Continuous Professional Development/Education (CPD/CPE)

• Corporate Governance requirements

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6. Examples of Risks, Threats and Safeguards

6.1. Objectivity (and Independence)

Some of the most common matters encountered in exams include:

Threat

Risk Safeguards

Familiarity Threat

Working with the same

client for many years,

or offering a wide

range of services

Engagement partner rotation – every 5 years

for listed companies and 10 years for non-

listed companies

Self – Review Threat

Offering a range of

services to a client,

such as tax advice and

audit together

- Chinese walls

- Quality Review Partner

- Accounting and auditing for a listed

company is disallowed

Self Interest Threat

Owning shares or

having other business

relationships with a

client (such as a joint

venture)

- No audit team member should own shares

in a client they work on

- No partner in the audit firm should have

shares in any client of the firm

- If shares are inherited they should be

disposed of as soon as possible

- Audit firm should not enter into a Joint

Venture with a client unless the audit firm

has no control and the relationship is

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immaterial to both parties

Intimidation Threat

Client threatens to

change or sue the

existing auditors

- Integrity of management should be

questioned

- Consider resigning from the engagement

- Consider communicating the matter to the

shareholders using a “letter of

circumstances”

Advocacy Threat

Client asks the auditor

to testify in court to

help the client

- Such requests should be declined if

possible as the auditor is seen to be

protecting the client

- If necessary to testify, state only facts, and

no opinions

- Consider resigning from the engagement

Management Threat

The auditor also offers

IT or HR services and

recommends a specific

software package or a

specific person to the

client

- Auditor should only provide a shortlist of

potential packages or persons

- Final decision should be made by

management

- Use separate teams (Chinese Walls)

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6.2. Controversial Areas

1. The provision of other services No obvious rules from ACCA are provided.

Accounting for listed companies not allowed unless in an emergency.

Matters to consider:

• The perception that the company gave its auditors some lucrative consultancy work in exchange for a “clean” audit report

• Self-review threat

2. “Opinion shopping”

If a company is not happy with the audit opinion from its current auditors may

approach other auditors for second opinion.

Matters to consider:

• The other auditors may give negligent opinion to get the client

• The current auditors may be put under pressure to accept the second opinion (in order not to lose the client)

3. Takeover bids (acquisitions) It is possible that both companies are audited by the same firm. There would be a

conflict of interest if the audit firm were to advise both companies during the bid

period.

It is not improper for the firm to remain as auditor of both companies, but the Rules

state that firms should not act as lead advisers for any of the parties involved in such

a situation.

4. Share issues Firms should not underwrite or sponsor issues to the public by clients which they

audit. Financial involvement of this kind would endanger the independence of the

audit firm.

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5. Joint Ventures Audit firms should not enter into a joint venture with a client unless:

1 - the audit firm has no control within the joint venture, and

2 - the interests are immaterial for both parties.

6. Lowballing Charging a price that is too low – see chapter 5 for details

7. Conflict of Interest

A conflict of interest is a situation in which someone in a position of trust, such as an

auditor, has competing professional or personal interests with another party.

Members and firms should not accept or continue engagements in which there are, or

are likely to be, significant conflicts of interest between members, firms and clients.

There are two situations:

Member vs. Client

When members compete directly with a client or have a joint venture or similar

arrangement with a major competitor of a client.

E.g. both client & audit firm are bidding for the acquisition of an educational centre

Client vs. Client

When auditors perform services for clients whose interests are in conflict, or the clients

are in dispute with each other in relation to the matter or transaction in question (auditors

work for both).

The problem is the potential leakage of information from one client to another

(confidentiality). Firms may be forced into a position where they may have to choose

between the interests of different clients.

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In cases where a conflict of interest is identified, auditors should, depending on the

situation:

• Notify the client of the member's business interest

• Notify all known relevant parties that the member is acting for two or more parties

• Notify the client that the member does not act exclusively for any one client in the provision of proposed services

…and obtain their consent – Transparency!!!!

KEY POINT

Audit firms should always place (existing) clients’ interests before their own

Safeguards for Conflicts of Interest:

Use different partners and teams of staff for different engagements (Chinese walls)

Give instructions and take necessary steps to avoid leakage of confidential information between teams

In depth “client screening” before accepting appointment Regular review of the situation by a senior partner or compliance officer Suggest that at least one of the clients should seek additional advice (as a final

resort)

8. Detailed Threats and Safeguards 8.1. Self – Interest Threat

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RISK EXAMPLE SAFEGUARD

1.1

Financial

Interest

Direct/ indirect financial interest

in a client by:

- the firm

- the partner

- a member of the audit team

- an immediate family member of

any of the above

(spouse or dependent minor

child)

- Dispose of interest( if by

firm/partner/immediate family) - Remove from the audit team - Inform the client of the interest - Use an independent partner to review the

work performed

1.2

Close business

relationships

(+ intimidation

threat)

- A joint venture between the

client and the firm/director

- Combine a product from a client

with a product from the firm

- A firm distributes client‟s

products and vice versa

- Other commercial transactions

eg renting office space to/from

client

- Should drop any such venture or end the

assurance provision

- remove the member from the audit team

- purchase goods from client at arms‟ length

(unless the number of transactions are

substantial)

1.3

Employment with

a client

(+ self-review,

intimidation and

familiarity threat)

- Dual employment

- A member of the audit team

may try to impress possible

future employer

- An ex partner, now a Financial

Director in a client has too much

knowledge of our systems

Factors to consider:

- the individual‟s role in the client

- the influence on the assurance

service he had previously

- length of time since individual

has left

- Dual employment is not allowed

- Modify the assurance strategy

- senior person on the job has at least as

much knowledge and experience as the ex-

member

- reconsider the audit team composition

- involve an external accountant to review

- quality review of the work performed

- if the ex member was the audit partner in

the last 2 years, then firm must resign

- an ex member now working for a client

should not receive any payment from the

firm nor should he be owed big amounts

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1.4

A partner is on

client board

- should not serve on the board, unless he is

the company Secretary

1.5

Family and

personal

relationship

Close family of 1st degree

(parent, child, sibling)

Consider:

- individual‟s responsibility on

assurance engagement

closeness of the relationship

- if a director is a family member of a

member of the audit team, then the member

must be removed from the team

- even if the employee is not part of the audit

team, still must consider independence

- the firm must have procedures to report

family relations

- perform a quality control review

- discuss it with the audit committee

1.6

Gifts and

Hospitality

Gifts by client.

Consider:

- value (to the recipient)

- frequency, nature and cost

- to immediate family

- decline the gift

1.7

Loans and

Guarantees

- the client is a bank

- the client is not a bank

Bank:

- if the amount borrowed from the client is

immaterial and at commercial terms then it

is ok

- if the amount is material, then an

independent review must be carried

Not Bank:

- the firm, its staff and their family must not

enter into any loan relationship with a client

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1.8

Overdue fees

(+intimidation

threat)

- Must always ask for settlement before

issuing the audit report of the next year

1.9

Percentage or

contingency fees

Firm‟s fees relate to the outcome

of the work

- must not enter in any assurance

engagement with contingency fees

1.10

High % of fees

Large proportion of firm‟s total

fees comes from one client.

Consider:

- structure of audit firm

- length the audit firm has been

trading

- Discuss with the audit committee

- Steps to decrease dependency

- Quality control reviews

- Consult with 3rd party (ICAEW)

- when the annual income exceeds 10% (5%

for listed) then the firm must review that

there is no threat to independence and

appropriate safeguards must be

implemented

For Listed Cos the % must be disclosed to

the Board and the firm must reduce non-

audit work provided. If the company is not

listed, then we must carry an independent

quality review and disclose fact to ethics

partner

- Presumption of dependency – when fees

regularly exceed 15% (or 10% for listed)

there is a presumption that safeguards

cannot be adequate to reduce the risk to an

acceptable level (so remove the risk

altogether)

1.11

Lowballing

Fees quoted are significantly

lower in order to gain the tender

- the firm must demonstrate and record that

appropriate staff and time is spent on the

audit

- compliance with all standards, guidelines

and control procedures

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8.2. Self – Review Threat

RISK EXAMPLE SAFEGUARD

2.1

Service with

an assurance

client

(+ self-interest,

familiarity)

- When the employee has worked

with the client in a significant

position

- when audit staff is loaned to

clients

- the member of the audit team

used to work for the client more

than 2 years ago, but he held a

significant position

- if the audit staff worked with the client in

the last 2 years, then the member should

be taken off the audit team or not audit his

activities

- Not allowed unless the audit staff is to

perform non-managerial functions

- perform quality review of that person‟s

work

- discuss with the audit committee

2.2

Preparing

accounting

records and

Financial

Statements

Usually the auditor assists the

management and gives advice

about accounting treatments

Ensure the risk is at an acceptable level by:

- using staff that is not part of the audit

team to do accounts prep

- have policies that prohibit staff to make

managerial decisions on behalf of the client

(ensure have Informed management at

client)

- the data for the entries is provided by the

client

- assumptions in the accounts are

made/agreed by the client

- for listed companies, it is not allowed

2.3

Valuation

Services

(+ management

threat)

Making assumptions for future

developments, methodologies,

techniques in order to calculate a

value for an asset or a liability or

the business in general

Eg provisions

- second partner review

- client understands the valuation and

assumptions used

- client is responsible for the valuation

- use different staff for valuation and audit

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2.4

Taxation services

(+ self-review,

Self-interest,

management,

Advocacy)

- advise on a specific issue

- substantial tax planning

- the firm promotes tax structures

which influence the financial

statements

- tax services provided by different staff

- tax services reviewed by an independent

partner

- obtain external tax advice

- tax computations reviewed by

independent staff

Should not:

-Accept to promote tax advice where in

doubt of accounting treatment

-Accept to provide services on a contingent

fee basis where engagement is material to

the firm/ tax laws are still uncertain

-If in tax advice, seek to take management

role

-Tax advice and representation in court

where issue is material

2.5

Internal audit

services

(+ management

threat)

The management of the company

is responsible for establishing,

maintaining and monitoring the

system of internal controls

- an employee of the client is appointed as

internal audit officer

- the client approves all the work of the

internal audit

- the firm must refuse if for the audit it relies

too much on the internal audit work

performed by the firm

- the firm must refuse if in providing the

internal audit services it will perform a

managerial role

2.6

Corporate finance

services

(+ advocacy)

- promote, deal or underwrite

client‟s shares

- commit, effect a transaction on

behalf of the client

Other services:

- defining corporate strategies

- identifying source of capital

- provide structuring advice

- not allowed

- not allowed

For other services:

- use different staff

- no management decisions are taken by

the firm

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2.7

Information

technology

(+ self-review,

management)

- designing and implementing an

IT system

- provision of off the shelf

packages

- not allowed if the system is a significant

part of the accounting system

- not allowed if the firm undertakes the role

of management

- allowed

2.8

Litigation support

services

(+self-review,

management,

advocacy)

- offering themselves as expert

witnesses in a court case against

client

- if it involves a subjective estimation of a

likely outcome not allowed

8.3. Advocacy Threat

RISK EXAMPLE SAFEGUARD

3.1

Contingency

Fees

Contingency fees depending on

the outcome of a possible

situation eg obtaining finance

- use different departments to carry out the

work

- disclose to client‟s audit committee

- withdraw from engagement if risk to

independence is too high

- Cannot act as advocates in a resolution of

a dispute material to FS.

3.2

Legal Services

Defend the client on a case in

which the firm had offered legal

services

3.3

Corporate

finance

The firm is involved in advising on

debt restructuring or bank

negotiations for the client.

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8.4. Familiarity Threat

RISK EXAMPLE SAFEGUARD

4.1

Family / close

relation with

the client

Examples as above

Where the independence is

jeopardized by the audit firm

becoming over familiar with the

client. In this case there is the risk

of loss of professional skepticism

4.2

Employment

with client

4.3

Recent service

with client

4.4

Long

association

with client

When the senior members of staff

have a long association with the

client

- rotating senior audit staff

- independent (internal) quality control

For Listed companies:

- the partner and staff for quality control

review must rotate every 7 years and not

return for 2 years

- the audit engagement partner must

rotate every 5 years and not return for 5

years

- if the quality control partner becomes the

audit engagement partner, the combined

service is for maximum 7 years

- a key audit partner (coordinator of a group

audit) must rotate every 7 years and not

return for 2 years

For any company

- where the audit engagement partner has

held the role for 10 years, consideration

must be given not only to independency but

also to perceived independency.

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4.5

Recruitment

(also

management,

familiarity,

self-interest,

intimidation)

Helping the client with recruitment - only allowed in drawing short list with the

clients‟ criteria

- Not allowed for listed companies

8.5. Intimidation Threat

RISK EXAMPLE SAFEGUARD

Actual and threatened litigation –

when the client threatens to sue

or sues for work performed,

therefore there is risk of losing the

client, bad publicity etc

- disclose to audit committee of the client

- removing affected individuals from the

team

- involving an additional professional

accountant to review the work

5.2

Close

business

relations

5.3

Family and

personal

relations

5.4

Assurance

staff working

for client

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8.6. Management Threat

RISK EXAMPLE SAFEGUARD

6.1

Management

threat

Big cross over with self-review.

It is the threat of making, or

appear to be making,

management decisions.

- ensure that there is “informed

management” at the client, one which

receives results from non-audit services

and makes its own decisions