2 - independence and the regulatory framework

Question 1

what are the main two things that impact the quality of an audit?

Answer 1

technical competence and independence of the auditor

Question 2

what do the professional bodies do for the audit field? Who is the main one for audit?

Answer 2

professional bodies provide qualifications, supervision of members, monitor quality, take some disciplinary actions.

FRC big boss in audit field, they design standards, corp governance frameworks, monitor audit firms, take disciplinary actions.

Question 3

what is the concept of independence in relation to audit?

Answer 3

closely allied with objectivity - quality that enables auditor to exercise objectivity in providing an impartial and unbiased audit opinion

not quantitative, not easily measurable.

Question 4

why is independence so important for an auditor?

Answer 4

credibility depends on auditor being seen as independent of subject of audit and of interested stakeholders

Question 5

what is independence of mind?

Answer 5

state of mind that permits expression of conclusion without being affected by influences that compromise professional judgement, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism.

Question 6

what is independence in appreance?

Answer 6

the avoidance of facts and circumstances that are so significant that a reasonable and informed third party would be likely to conclude that a firms or an audit team member’s integrity/objectivity or professional skepticism has been compromised.

Question 7

what is professional skepticism? what is it affected by?

Answer 7

it is the attitude of auditors - affected by key aspects:

questioning mindset - have to be questioning that information could be wrong

critical assessment - always thinking of the negative side

independence and objectivity -

thoroughness

professional judgement

documentation - judgement not possible without

Question 8

what are the two types of independence in Mautz and Sharaf (1961)

Answer 8

practitioner independence

profession independence

Question 9

what is practitioner independence?

Answer 9

programming independence (freedom to choose scope of audit),
investigative independence (freedom to access records, mgrs),
reporting independence (freedom to report opinion without unnecessary modification)

Question 10

what is profession independence?

Answer 10

close relationship between accounting profession and business:
apparent financial dependence (audit fees), existence of confidential relationship. organisation of profession: commercial activity - competition, does market concentration lead to dominance of one perspective?

Question 11

what are Shockley (1982)’s 4 pressures on independence?

Answer 11

1. commercial pressure on auditor - competition in auditing profession and desire to obtain and retain client. provision of non-audit or non-assurance services to audit client. dependence, e.g. size of audit fee relative to other income.
2. familiarity - period for which auditor has held position
3. scope for judgement - flexibility of accounting standards
4. risk exposure (external balancing forces) - severity of professional sanctions and their application, extent of auditor’s legal liability, revelation of lack of independence = losing clientele and reputation.

Question 12

what do the ethical codes do? what are the general sources relevant in the UK?

Answer 12

provide guidance to support ethical behaviour. broadly how to behave to ensure independence in audit and that this is seen to be the case.

general sources relevant in UK: IESBA, FRC

specific sources (incorporating above): RSBs, recognised supervisory bodies, and Audit firms.

Question 13

what are the components of ethical codes?

Answer 13

principles of ethical behaviour

threats towards ethical behaviour

safeguards against threats

firm control environment

Question 14

what are the types of threat towards ethical behaviour?

Answer 14

self-interest

self-review

familiarity

advocacy

intimidation

management

Question 15

what is self interest threat?

Answer 15

financial such as owing shares, close business relationships, loans, overdue fees (auditors must collect on time!), lowballing (reduces audit quality), gifts and hospitality.

Question 16

what is self review threat?

Answer 16

difficulty of fairly reviewing one’s own previous judgement or work. sources; recent service with client, preparing accounting records and accounts, taxation services, internal audit services etc.

Question 17

what is familiarity threat?

Answer 17

close relationship makes accountant too sympathetic to position of client/employer. care needed when senior audit staff have long association w client. ACCA suggest partner should be changed at least every 5 yrs. other partners involved every 7 yrs.

Question 18

what is advocacy threat?

Answer 18

promoting client/employer position to extent of compromising own judgement.

Question 19

what is intimidation threat?

Answer 19

accounting succumbs to actual or percieved pressure, e.g. threat of dismissal.

Question 20

what is management threat?

Answer 20

where accountant has participated in relevant mgment decision, e.g. decision about acquisition or investment.

Question 21

what can firms do to safeguard against threats to ethical behaviour?

Answer 21

safeguards created by profession, legislation or regulation; e.g. educational or training requirements, experience requirements, continuing professional development reqs, professional standards etc.

safeguards in work environment; general measures in firm control environment such as ethics partners.

Question 22

what can be done to ensure a good control environment in the firm?

Answer 22

senior partner should oversee function of quality control system ensuring that:

all staff understand documented policies and procedures

communication link with directors of client regarding threats to independence, safeguards and actions taken

partners and staff report family or other personal relationships/financial interests/possible future employment with client firm etc.

there is a channel for staff to voluntarily communicate and issues which might impair objectivity/independence and to ensure protection of whistle blowers.

Question 23

what are some of the responsibilities of the ethics partner?

Answer 23

ensure adequacy of policies and regs relating to independence, compliance with ethical standards and effective communication to partners and staff.

provide related guidance to individual partners

engagement partner has lead responsibility for independence/ethical compliance on engagements

Question 24

which partner is subject to the EQCR, and what is the review process?

Answer 24

subject to engagement quality control review (EQCR):

• Assess compliance with codes regarding the audit engagement,
• Form independent opinion regarding the adequacy of the safeguards applied,
• Consider the adequacy of the engagement partner’s opinion regarding independence,
• Evaluate significant judgements made and conclusions reached in the auditor’s report.

Question 25

what are the specific measures in the FRC ethical standard?

Answer 25

section 2 - financial/business/employment/personal relationships

section 3 - long association

section 4 - fees, remuneration, gifts and hospitality, litigation

section 5 - non-audit/additional services

Question 26

what is a relevant interest in terms of auditor relations?

Answer 26

direct or indirect interest over which have control. member of audit team must not have relevant interest in audit entity so must divest or be removed from engagement. in practice, audit firm may require partners/employees to have no direct financial interests in any clients of firms whether or not they are involved with audit (independence of appearance).

Question 27

what is a personal relationship in terms of auditor relations?

Answer 27

relationship between member of audit team and employee able to influence accounting

may create self interest, familiarity or intimidation threats. if engagement partner who’s involved or they’re uncertain what course to take, consult ethics partner.

Question 28

what is the issue with long association in audit partners?

Answer 28

using same senior personnel over extended period may create familiarity and self interest threats. generally, key audit partner for PIE must be replaced after 5 yrs and not reappointed for further 5. some extensions possible where entity becomes listed during partner’s tenure or audit committee of entity feel rotation at 5 yrs would endanger audit quality in particular circumstances. even with partner rotation, risks may arise from long association between firm and client.

Question 29

what is the issue with long association between audit firms/clients?

Answer 29

historically, auditor appointment a commercial decision for company and its shareholders. UK corp governance code 2012 introduced recommendation to retender every 10 yrs, but subject to comply or explain

Question 30

what is fee dependence? why does it cause issues?

Answer 30

when total fees from client are large proportion of fees, creates self interest and intimidation threats. significance of threat depends on various factors like age of business. safeguards include reducing dependency (growth in fee base), not undertaking the investment at all. fees exceeding 10% for PIE or 15% for non-listed entities = large proportion of fees. consult with ethics partner where 5-10% for PIE and review threats.

Question 31

what kind of non-audit/additional services are common?

Answer 31

internal audit

information tech services

valuation services

tax services

legal services

corporate finance services

accounting services

transaction related services

Question 32

how can threats from providing additional services be safeguarded against?

Answer 32

assess significance of threat before accepting engagement for other services. if level of threat can’t be reduced to acceptable level by safeguards then do not accept. nature of safeguards not prescribed given variation in types of service and circumstances. therefore important to conduct and document assessment then arrive at judgement on safeguards appropriate to situation. may involve role separation, independent monitoring within firm, staff remuneration shouldn’t be dependent on selling other services to audit client.

Question 33

what rules relate specifically to PIE clients and non-audit services?

Answer 33

for PIE clients, certain non-audit services prohibited and fees from permitted services limited: services considered to give rise to too great a conflict of interest and compromise the auditor’s independence. fee income from remaining permitted non-audit services capped at 70% of average audit income over 3 preceding financial years. non auditing services required by legislation not subject to cap.

prohibition applies to: auditors network, subsidies/parent of audited entity if incorporated in EU, for period covered by audit and up to issue of audit report.

Question 34

what are the entry and supervision requirements for auditors?

Answer 34

prescribed by companies act 2006. RQBs (recognised qualifying bodies) grant qualification to practice as auditor based on technical examination and experience amd RSBs set and supervise standards of practice by members, including monitoring.

professional bodies generally perform both roles. thus, set and enforce standards of entry and continuing membership. includes monitoring compliance with continuing professional development requirement post-qualification: member needs to ensure appropriate level of training/dev each year and conform to professional body.

Question 35

how is the audit practice monitored?

Answer 35

RSBs check firms comply with audit regulations and auditing standards. audit firms not involved in major listed firms normally visited at least once in 6 years, firms auditing listed companies or other significant entities more often. reviewers discuss risk issues with key audit staff and review audit files. report to audit registration committee (ARC) in the RSB. ARC gives audit firm indication of result of examination. follow up action where problems identified and not satisfactorily resolved.

Question 36

who are the FRC?

Answer 36

overall responsibility in UK for regulation of accounting, auditing and acturial profession, including UK corp gov code.

management: chair and dep chair appointed by gov. senior mgment largely drawn from senior figures in business, professional and financial community.

structure reflects various roles of council, setting standards and monitoring behaviour.