Chapter 15 Integrity, objectivity, and independence Flashcards
1.1 Key concepts (of integrity, objectivity, and independence)
Confidence in financial reporting requires the auditor to provide an opinion on the accounts which can be trusted. In order to achieve this, the auditor must be objective in reaching the opinion and demonstrate independence from the audit client.
- Integrity: implies not merely honestly, but fair dealing and truthfulness
- Objectivity: a state of mind which excludes bias and has regard to all considerations relevant to the task in hand
- Independence: freedom from situations and relationships that may lead to a reasonable and informed third party to conclude that objectivity is impaired
2.1 Threats and safeguards
The FRC ethical standard covers threats to independence and objectivity, suggesting safeguards where possible. Some situations there are no safeguards, in which case the engagement should be declined or discontinued.
2.2 Self-interest threat
The following gives threats to independence and objectivity:
- Financial interest: guidance is the audit firm; any partner or member of the audit team (or immediate family member) must not hold a financial interest in a client
- Business relationships: the audit firm must not participate in a business relationship with a client
- Employment with audit firm and client: dual employment is prohibited
- Audit partner leaves to take up employment with a client: the firm should resign as auditor and cannot take the audit for two years
- Employee of audit firm negotiating employment with a client: employee to inform audit firm, firm to remove the employee from the engagement and perform a review of their recent work on the client
- Close personal and family relationships: staff with close personal or family relationships with a member of client staff should not work on the engagement
- Gifts and hospitality: do not accept gifts or hospitality from a client unless the value is trivial
- Loans: loans from the auditor are prohibited, loans from the client to the auditor are also prohibited unless made by a bank in the normal course of business
- Overdue fees: consider resignation if fees remain unpaid
- Contingent fees: contingent fees are prohibited
- Fee dependence (non-listed client): when regular fee income exceeds 10% of firms fee income, disclose to ethics partner and those charged with governance at the client, the implement quality control review of the audit. When fee income exceeds 15% of the firm’s you cannot act as auditor
- Fee dependence (listed client): when fee income exceeds 5% of the firm’s, disclose to ethics partner and those charged with governance at the client, implement independence quality control review of the audit and seek to reduce fees. When regular fee income exceeds 10% of the firm’s fee income you cannot act as the auditor.
- Lowballing: firm may charge any audit fee, but the engagement partner should document that adequate resources have been allocated to comply with auditing and ethical standards
- Fee cap for listed clients: total fees from non-audit services should be no more than 70% of the average audit fee for the last 3 years
2.3 Self-review threat
The following gives threats to independence and objectivity:
- client staff joins the audit firm: no involvement in audit for two years
- audit staff complete loan assignment to client: prohibited for audit staff to be loaned to a client
- accounting services offered to an audit client: non-listed clients allowed with safeguards of separate teams, mechanical and technical work only and quality control review of audit. Not allowed for listed clients
- valuation services offered to an audit client: non-listed clients not allowed if material and subjective, if immaterial this is allowed with safeguards such as separate teams, second partner review and management acknowledge responsibility for valuation. Not allowed for listed clients
- preparing tax calculations for accounting entries in an audit client: non-listed clients this is allowed with safeguards with separate teams, review of tax work by independent tax partner and a quality control review of audit. Listed clients do not prepare tax calculations for the purpose of making material accounting entries
- internal audit services offered to an audit client: providing internal audit services to an audit client is prohibited for both listed and unlisted entities
- IT services offered to an audit client: IT services are prohibited for all entities where they relate to the accounting or financial management system, or where they involved taking the role of management.
2.4 Familiarity threat
The following gives threats to independence and objectivity:
- Recruitment services provided to an audit client: prohibited for both listed and non-listed clients, including advising on appointment of directors and employees, or advising on a remuneration package
- Close family or personal relationships: audit firm employees who have close relationships with client staff should not work on the audit
Long association scenarios:
- Non-listed engagement partner: situation should be monitored over time to ensure the risk is not too significant for the audit firm. The audit firm may decide to rest the engagement partner from the engagement for a period of time to ensure independence is not impacted
- Listed: engagement partner: rotate off after five years (can extend to seven with audit committee approval). No return for five years.
- Listed: quality control review partner: rotate off after seven years, no return for five years
- Non-listed client becomes listed: engagement partner: take previous service into account, if severed more than four years can only continue for two more. No return for five years
- Listed: other senior staff: review independence after seven years
2.5 Advocacy threat
The following gives threats to independence and objectivity:
- Corporate finance services offered to audit client: the firm is not allowed to promote, deal, or underwrite a client’s shares, if services are offered risks must be appraised and safeguards implemented where possible (separate teams, second partner review, disclosures to audit committee)
- Legal services offered to an audit client: an audit firm must not act as a solicitor representing the client in a legal case, if legal services are offered, risks must be appraised and safeguards implemented where possible (separate teams, second partner review, disclosures to audit committee)
- Representing an audit client in a tax tribunal or court to resolve a tax dispute: prohibited if the issue is material to the accounts, otherwise can be carried out with safeguards such as separate teams and advice obtained from an external tax professional
2.6 intimidation threat
- Close family or personal relationships: audit firm employees have close relationships with client staff should not work on the audit.
- Business relationships: audit firm must not participate in a business relationship with a client
- Audit partner leaves to take up employment with a client: firm resigns as auditor and cannot take the audit for two years
- Actual or threatened litigation: disclose to those charged with governance at the client, consider resignation
2.7 Management threat
- Any additional non-audit service provided to an audit client where the auditor may take on a management role: do not take management roles, use engagement letter to clarify the responsibility of management for decision making and put limits on the audit firms involvement. Establish informed management
3.1 Resolving ethical conflicts
Ethical guidance for accountants is principles based. The ICAEW code of ethics sets out the framework for members to follow when faced with an ethical conflict, the professional should consider the following:
- Relevant facts
- Relevant parties
- Ethical issues involved
- Fundamental principles related to the matter
- Established internal procedures
- Alternative courses of action
The individual should then consider the most appropriate action, if this is unclear, they should refer the matter to the ethics partner if in house and the ICAEW ethics helpline for external help.
4.1 Conflicts of interest and the accountant
Professionals in industry may face more pressure to behave unethically, whose employers are not bound by the codes of ethics applying to the accountancy profession, for example the board may put pressure on them to prepare overly optimistic budgets to increase the company’s change of securing a loan. The ICAEW code of ethics gives advice to accountants in such situations. They advise to try resolve the matter internally, then obtain advice from the ICAEW, seek legal advice, and then consider resignation as a last resort.
