Chapter 15 - Integrity, objectivity and independence

Question 1

Why is independence and objectivity important for auditors?

Answer 1

Independence ensures objective assurance for stakeholders and maintains public trust. It helps auditors provide unbiased assurance that directors cannot

Question 2

What is the public interest argument for auditor independence?

Answer 2

Companies are public entities governed by rules requiring the disclosure of accurate financial information, critical for maintaining trust in the financial markets.

Question 3

FRC dictates auditors must be independent they need to actually be and perceived to be independent

Answer 3

FRC dictates auditors must be independent they need to actually be and perceived to be independent

Question 4

What are the threats an auditor might face? (6)

Answer 4

MASSIF

Management
Advocacy
Self Interest
Self Review
Intimidation
Familiarity

Question 5

MASSIF (6)

Answer 5

Management
Advocacy
Self Interest
Self Review
Intimidation
Familiarity

Question 6

What are the different ways a self-interest threat may present? (8)

Answer 6

• Financial Interest
• Close business relationships
• Gifts and hospitality
• Loans and guarantees
• Overdue fees
• High percentage of fees
• Lowballing
• Contingent fees

Question 7

What constitutes a self-interest threat related to financial interests?

Answer 7

A self-interest threat arises when the assurance firm, its partners, or immediate family members (not parents) have a direct or material indirect financial interest in the client.

Question 8

What safeguards mitigate self-interest threats related to financial interests?

Answer 8

Disposing of the interest - not good enough to just remove partner from audit team
Removing the individual from the audit team.
Informing the audit committee.
Using an engagement quality control reviewer - 2nd partner review

Question 9

How does an inappropriate close business relationship create a self-interest threat?

Answer 9

Close business relationships such as joint ventures, combining products, or leases between the firm and client compromise objectivity and independence.

Question 10

What safeguards exist for close business relationships? (3)

Answer 10

Avoid entering into such relationships unless immaterial.
Terminate the business relationship.
Ensure all transactions occur at arm’s length - some sort of distance treated the same as everyone else

Question 11

What is the policy for gifts and hospitality?

Answer 11

Gifts or hospitality must be insignificant in value, and firms should have a clear policy on their acceptance to avoid independence threats.

e.g. specific budget allowed

Question 12

When does a loan or guarantee pose a threat to independence?

Answer 12

If a lending institution client lends material amounts to the audit team or firm, it may pose a threat unless safeguards are applied.

Question 13

What safeguard should be applied for loans from a client? (3)

Answer 13

Ensure the loan is immaterial.
Use an independent review.
Avoid entering into new loan arrangements with clients.

Question 14

Why do overdue fees pose a self-interest threat?

Answer 14

Overdue fees create a debtor-creditor relationship between the auditor and client, potentially impairing independence.

Question 15

What safeguard mitigates the overdue fee threat?

Answer 15

Require payment of overdue fees before continuing the assurance engagement.

Question 16

When do high fees from a client pose a threat?

Answer 16

When fees represent a large proportion of the firm’s total income, it creates dependency on the client.

Question 17

What safeguards address high client fees? (4)

Answer 17

Monitor fee dependency thresholds (e.g., 10% for listed companies).
Conduct internal/external quality control reviews.
Consult a third party, like ICAEW.
Resign if the dependency persists.

Question 18

For a listed and non listed company what’s the % of fees (out of the total that is brought into the business) that is flagged as a major safeguarding issue?

What’s the process here?

Answer 18

Listed 10%
Unlisted 15%

No safeguards - must reduce reliance or resign from the audit

Question 19

For a listed and non listed company what’s the % of fees (out of the total that is brought into the business) that is flagged as there may be safeguarding issues?

What’s the process here?

Answer 19

Listed 5-10%
Unlisted 10%

Some safeguards so we need to actively monitors and disclose to clients suit committee and my own firms ethic partner - may require a 2nd partner review consult + involve ICAEW

Question 20

For a listed and non listed company how can I calculate the % of fees that is brought into the business) from a client

Answer 20

Regular audit + non audit fee from client
———————————————————– x100%
Annual total audit + non audit fees

Question 21

What is lowballing, and why is it a threat?

Answer 21

Lowballing is quoting significantly low fees to win an engagement, leading to compromised quality due to resource constraints.

Question 22

What safeguards mitigate lowballing threats? (2)

Answer 22

Ensure adequate staff and time allocation.
Comply with professional standards and guidelines.

Question 23

When does a self-review threat arise?

Answer 23

A self-review threat occurs when the audit firm prepares records, provides internal audit services, or conducts valuations included in financial statements audited by the firm.

Question 24

What safeguards mitigate self-review threats for valuation services? (3)

Answer 24

Use separate personnel for valuation and audit.
Conduct second partner reviews.
Ensure the client acknowledges responsibility for the valuation.

Question 25

What are the different ways a self-review threat may present? (5)

Answer 25

• Service with an assurance client
• Internal audit services
• Preparing accounting records and financial statements
• Valuation services
• Tax services

Question 26

When does a self-review threat arise in the context of service with an assurance client?

Answer 26

It arises when audit firm members have been a director or employee of the client and were in a position to exert significant influence over the financial statements.

Question 27

What is the safeguard for members with prior relationships with an assurance client?

Answer 27

Members should not be assigned to the assurance team until two years after leaving the client.

Question 28

Why is providing internal audit services to an audit client prohibited?

Answer 28

Providing such services creates a self-review threat because the audit firm would review its own work. This prohibition applies to all audits, whether of a listed or unlisted company.

Question 29

When does a self-review threat arise from preparing accounting records and financial statements?

Answer 29

It occurs when a firm prepares records and then audits them, as this involves reviewing its own work.

Question 30

What safeguards mitigate the self-review threat from preparing accounting records? (4)

Answer 30

Use staff members not part of the assurance team to carry out the work.
Require the source data for the accounting entries to be originated by the client.
Ensure the underlying assumptions are originated and approved by the client.
Avoid preparing accounts for listed clients entirely.

Question 31

When does a self-review threat occur in valuation services?

Answer 31

A self-review threat arises if the audit firm performs valuations that will be included in financial statements it audits, especially if these valuations have a material effect or involve significant subjective judgment.

Question 32

What safeguards should be applied for valuation services? (4)

Answer 32

Conduct a second partner review.
Confirm that the client understands the valuation and its assumptions.
Ensure the client acknowledges responsibility for the valuation.
Use separate personnel for the valuation and audit.

Question 33

What is the safeguard for tax return preparation?

Answer 33

Management must take responsibility for preparing tax return

Question 34

What are the safeguards for tax calculations used for accounting entries?

Answer 34

For unlisted companies, use separate staff.
For listed companies, this is prohibited if material.

Question 35

When is tax planning allowed, and what are the safeguards?

Answer 35

Tax planning is acceptable if advice is clearly supported by precedent. If the advice involves subjective or material judgment, it is prohibited.

Question 36

What safeguards apply for assistance in dispute resolution?

Answer 36

For unlisted companies, use separate teams and consider external consultation.
For listed companies, this is prohibited if material.

Question 37

What is an advocacy threat?

Answer 37

An advocacy threat arises when an auditor promotes or defends a client’s position, such as legal representation or negotiating with creditors.

THREATENS LACK OF INDEPENDENCE

Question 38

What safeguards mitigate advocacy threats? (3)

Answer 38

Use independent departments for different roles.
Avoid direct involvement in advocacy roles.
Make disclosure to audit committee if LISTED company

Question 39

Flashcard 20
Q: How does a familiarity threat arise?
A: Familiarity threats occur from long association with a client or close relationships between audit team members and client staff.

Flashcard 21
Q: What are safeguards against familiarity threats in listed companies?
A:

Rotate audit team members after five years.
Involve independent quality control reviews.
Apply stricter rules for longer tenures (e.g., 7 years for key audit partners).

Question 40

What is a familiarity threat in the context of assurance engagements?

Answer 40

It arises when senior members of an audit firm have a long association with a client, potentially impairing independence due to over-familiarity.

Question 41

What is the safeguard against long association with assurance clients? (2)

Answer 41

Rotating senior staff off the assurance team.
Conducting engagement quality control reviews.

Question 42

What rules does the Code of Ethics specify for long association with listed companies? (3)

Answer 42

No one shall act as the audit engagement partner for more than five years.
The partner cannot participate in the engagement again until five more years have passed.
Other key partners should not act for more than seven years.

Question 43

What is the safeguard for long association with unlisted companies where the partner has been in position for 10 years?

Answer 43

Apply a third-party test:

Ask, “Would a reasonable and informed third party consider the audit firm’s objectivity impaired?”

Question 44

How do family or personal relationships between assurance firms and clients pose a familiarity threat?

Answer 44

They create a risk of compromised independence, especially if the relationship is close or involves individuals in key roles.

Question 45

What are the factors to evaluate in cases of family or personal relationships between assurance firms and clients? (3)

Answer 45

The individual’s responsibilities on the assurance engagement.
The closeness of the relationship.
The role of the other party at the assurance client.

Question 46

What is the safeguard when family or personal relationships exist between assurance staff and client staff? (2)

Answer 46

The individual should be removed from the assurance team.
Establish quality control policies requiring disclosure if a close family member is promoted within the client.

Question 47

When does an intimidation threat occur?

Answer 47

Intimidation threats arise when the client exerts pressure, such as threatening to sue or terminate the auditor’s services.

Question 48

What are safeguards against intimidation threats? (3)

If the litigation is at all serious what’s the process? (1)

Answer 48

Disclose the threat to the audit committee if listed.
Remove affected individuals from the team.
Involve an independent accountant for review.

If the litigation is at all serious, it may be necessary to resign from the engagement

Question 49

What is a management threat?

Answer 49

A management threat occurs when the audit firm undertakes tasks that involve making management decisions, creating a conflict with its assurance role.

Question 50

How can a management threat be avoided?

Answer 50

Auditors should not undertake any decision-making role or act on behalf of management in any form.

Question 51

In each of the following cases, indicate the principal threat that the assurance firm is facing.

(a) Peter Perkins recently resigned as finance director of Assiduous Limited. Peter joined the
assurance firm that provides the audit to Assiduous after his notice period of six months.
 Self Interest threat  Self Review threat  Intimidation threat  Advocacy threat  Familiarity threat

(b) Artifice Limited has suggested to the engagement partner that a qualified audit report would be unacceptable in the current year because the company is considering a flotation.
 Self Interest threat  Self Review threat  Intimidation threat  Advocacy threat  Familiarity threat

(c) Anonymous Limited has requested that the audit team should not be changed from the previous year as they got on well with client staff.
 Self Interest threat  Self Review threat  Intimidation threat  Advocacy threat  Familiarity threat

Answer 51

a. Self Review threat
b. Intimidation threat
c. Familiarity threat

Question 52

What’s a flotation?

Answer 52

• Raising capital, companies may access private funding opportunities before making a final decision to go public
• IPO (Initial Public Offering)
• List on stock exchange
• Become a PLC (Public Limited Company)

Question 53

What’s a qualified audit report?

Answer 53

It is a modified opinion, not true and fair

Question 54

What factors must be considered before accepting a new client? (3)

Answer 54

Illegal activities of the client.
Apparent dishonesty of the client.
Questionable accounting practices.

Question 55

If a company has an audit committee what type of company can I assume It is?

Answer 55

A LISTED COMPANY (aka quoted company)
Tend to be stricter

Question 56

Notable Co is a small assurance firm that has been asked to take on the statutory audit of the following two companies. For each of the companies, indicate on what basis the audits could be accepted, if at all.
Notorious Limited is a small company that has had a number of HMRC investigations in recent years. The company has had to pay a number of back taxes where incorrect figures had been declared. Recently a director was banned from being a director for five years for wrongful trading. This person has left Notorious and a new managing director has been appointed, who has intimated to the firm that improved corporate governance is at the top of his agenda.
A Do not accept
B Accept with safeguards
C Accept with no safeguards

Pristine plc is a listed company that has good references from all parties whom the firm made enquiries of. It has requested that Notable Co both prepare and audit the financial statements. It does not feel that these services are divisible.
A Do not accept
B Accept with safeguards
C Accept with no safeguards

Answer 56

B Accept with safeguards - low materiality so increase testing on risky area, appoint more senior staff/expertise, increase sample size and demand higher fee

A Do not accept - Self review threat + Listed company = Prohibited

Question 57

What framework does the ICAEW Code provide for resolving ethical conflicts? (6)

Answer 57

Consider the following:

1 Relevant facts.
2 Relevant parties. (who is involved)
3 Ethical issues involved.
4 Fundamental principles in question. (pipco)
5 Internal procedures. (told ethic partner or audit committee)
6 Alternative actions. (e.g. 1. RESOLVE INTERNALLY 2. ICAEW, 3. LEGAL ADVICE 4. RESIGN)

The accountant should then consider which is the course of action that most aligns with the fundamental principles.

Question 58

What are alternative actions that can be taken to resolve ethical conflicts (4)

Answer 58

1. RESOLVE INTERNALLY
2. ICAEW
3. LEGAL ADVICE
4. RESIGN

Always resolve internal before externally

Question 59

You are a trainee in the audit department of Harris Brothers & Co. You have recently started your training, have not attended any courses and have attended one audit, where you carried out some simple audit tests under supervision from the audit senior.

An audit manager has asked you to attend the inventory count of Brox Bros, which has a large amount of inventory, which is subject to an annual inventory count. There are very few other controls over the inventory at Brox Bros. Inventory is highly material to Brox Bros’ financial statements. No other audit staff will be attending the inventory count.

Which of the following is the most appropriate course of action for you to take:
A Perform the work
B Refer to training partner
C Contact ICAEW

Answer 59

B Refer to training partner

You should refer this matter to the training partner. You have no experience or training to undertake this work. The risks attaching to the audit tests being carried out are high. The person allocating the work must have allocated you in error.

Question 60

How should accountants handle implicit or explicit conflicts of interest? (3)

Answer 60

Do not act contrary to law or standards.
Avoid facilitating unethical strategies.
Resolve the conflict internally or seek legal advice.

Question 61

What is the last resort when resolving a conflict of interest?

Answer 61

Resignation is the last resort if the conflict cannot be resolved.

Question 62

Imo is a qualified accountant. She has recently moved out of practice and taken up the position of financial controller of a small, non-listed company, Lavender Lane Limited. The company has a short term cash flow problem.

Imo was recently called into the board meeting and asked if she could defer some income from the previous financial year so as to influence when the tax (both VAT and corporation tax) would be due on those sales. The directors were insistent that such deferral was necessary and that she should consider this request more in the nature of an order.

Which two of the following possible courses of action are likely initially to be the most appropriate in this situation?
A Report her concerns to the audit committee of the board of directors
B Seek advice from ICAEW
C Take steps in line with the company’s formal dispute resolution process
D Take advice from her legal advisors
E Resign her job

Answer 62

B, D
It is unlikely to be appropriate to make disclosure to the audit committee in this case, as Lavender Lane Limited, a small, unlisted company, is unlikely to have one. Given the instructions have come from the board of directors, it will be fruitless to take steps in line with the company’s formal dispute resolution process. Thus, resolving the situation internally is not possible in this situation.

Imo should seek advice from ICAEW and then take advice from her legal advisors. Resigning her job is not an initial option and should only take place if the other options have been unsuccessful.

Question 63

4 Allisons LLP is a firm of chartered accountants. It has a reputation for excellence in the banking and insurance industry and has been invited to accept engagements by various institutions as follows.
(1) The audit of Nationally plc, the leading building society in the UK. 40% of staff members of Allisons LLP who have mortgages have mortgaged their home with Nationally.
(2) The audit of Cash It Ltd, a large business which banks cheques and cash items for the general public and also advances loans. A member of the proposed audit team was impressed by the loan rate offered to the team during the tendering process and took out a loan with Cash It Ltd to buy a car.
Which, if any, of the above companies present a major threat to the independence of Allisons LLP, if the engagement were to be accepted?
A Nationally plc and Cash It Ltd
B Cash It Ltd only
C Nationally plc only
D Neither Nationally plc nor Cash It Ltd

Answer 63

B Cash It Ltd only
Cash It Ltd is a threat as it is implied that an audit team member took advantage of the loan rate mentioned in the audit tendering process. Nationally plc is not a threat as it is acceptable for staff to have mortgages on commercial terms with an audit client who is a mortgage provider, especially if it is the leading building society. SAMPLE EXAM

Question 64

7 In accordance with FRC’s Ethical Standard, in which three of the following engagements is there a significant threat to independence?
A Alan Johnson has been the audit engagement partner of Domino Ltd for 11 years.
B Betty Thomson has been the audit engagement partner of Beetle Group plc, a listed company, for seven years.
C Having been the audit engagement partner of Risk Group plc, a listed company, for five years, Colin Jackson resigned as audit engagement partner three years ago; following a reshuffle in the firm, he has just been assigned as a key partner involved in the audit of Risk Group plc.
D Donna Matthewson has recently been appointed as the audit engagement partner of Scrabble plc, a listed company; she previously held this position six years ago.

Answer 64

A Alan Johnson has been the audit engagement partner of Domino Ltd for 11 years.
B Betty Thomson has been the audit engagement partner of Beetle Group plc, a listed company, for seven years.
C Having been the audit engagement partner of Risk Group plc, a listed company, for five years, Colin Jackson resigned as audit engagement partner three years ago; following a reshuffle in the firm, he has just been assigned as a key partner involved in the audit of Risk Group plc.
There is no significant threat to the independence of the audit engagement of Scrabble plc, as the partner had previously rotated off the client six years ago and is allowed to return to the same position after five years.