Chapter 4 - Professional ethics Flashcards
Using the helpful acronym, what are the fundamental ethic principles set out in the IFAC Code of Ethics? Define each (5)
PIPCO
What are the common threats to the fundamental ethics principles? Define each (6) Relate these specifically to audit firms and auditors where applicable
- Self-interest threats – Arise when personal or financial interests unduly influence an accountant’s judgment. For example, audit firms face the self-interest threat, simply because the client pays the fee, therefore auditors may be tempted to allow inappropriate accounting treatments in order to keep the client.
- Self-review threats – Occur when an accountant evaluates their own previous work, risking bias or errors. For example, it may be difficult for audit firms to maintain its objectivity if any product or judgement made by the firm needs to be challenged or re-evaluated at a later date (e.g. valuations, aggressive tax schemes, carrying out accounting work)
- Advocacy threats – Happen when an accountant promotes a client’s position, compromising objectivity.
- Familiarity threats – Emerge from close relationships with a client, leading to a lack of professional skepticism. For example, objectivity may be threatened because the auditor becomes too trusting of the client and professional scepticism is impaired.
- Intimidation threats – Occur when an accountant is pressured or coerced into unethical behavior. For example, a client may threaten the auditor with removal if a qualified auditor’s report is produced, therefore influencing the auditor’s judgement.
- Management threat - A management threat arises when an audit firm undertakes work that involves making judgments and taking decisions, which are the responsibility of management, leading to a lack of objectivity and independence.
What are the two types of safeguards that can be put in place to limit threats to the ethical principles? Give examples of both
What are the parts to the FRC Ethical Standard that we will look at in this chapter?
Part A: comprised of
* Overarching Principles and Supporting Ethical Provisions
Part B: comprised of
* Section 1 General Requirements and Guidance
* Section 2 Financial, Business, Employment and Personal Relationships
* Section 3 Long Association with the Audit Engagement
* Section 4 Fees, Remuneration and Evaluation Policies, Litigation, Gifts and Hospitality
* Section 5 Non-Audit/Additional Services
* Section 6 Provisions Available for Small Entities
Outline what is covered in Part A of the FRC Ethical Standard
Part A of the FRC Ethical Standard covers the Fundamental Principles that auditors and audit firms must adhere to in order to ensure integrity, objectivity, and independence in their work:
- Integrity: Auditors must be trustworthy, straightforward honest and fair
behaving in a way that would uphold public trust in the profession. - Objectivity: Auditors must maintain impartiality and avoid conflicts of interest that could impair their professional judgment, ensuring their work is free from bias or undue influence.
- Independent: Auditors must not pu themselves in situations and relationships which make it probable that a reasonable and informed third party would conclude that objectivity either is impaired or could be impaired
Outline what is covered in Part B, Section 1 of the FRC Ethical Standard
Part B, Section 1 of the FRC Ethical Standard specifically deals with the policies, procedures, and roles that audit firms must establish to ensure compliance with the ethical standards outlined in other parts of the FRC Ethical Standard.
Key points covered in Part B, Section 1 include:
Establishing Policies and Procedures: Audit firms must develop and implement effective policies and procedures designed to ensure compliance with ethical standards. This includes measures to address conflicts of interest, independence requirements, and the avoidance of unethical behavior.
Assigning Roles and Responsibilities: Firms should designate individuals or committees with clear responsibilities for overseeing the application of ethical standards. This might include assigning senior personnel to monitor compliance with independence and objectivity rules, particularly in relation to the firm’s relationships with clients.
Training and Communication: The firm must provide training to its staff on ethical requirements, ensuring that all personnel understand their responsibilities and the firm’s expectations for ethical behavior. Regular communication of these policies is crucial for maintaining awareness and compliance.
Monitoring and Review: Audit firms must regularly monitor and review their compliance with the ethical standards to identify potential weaknesses or areas for improvement. This includes internal audits or checks to ensure the firm’s procedures are being followed correctly.
Documentation: The firm should maintain proper documentation regarding its compliance with the FRC Ethical Standard, especially regarding the management of independence and other ethical requirements, so that the firm can demonstrate its adherence to these standards.
What are the key roles set out Part B, Section 1 of the FRC Ethical Standard that audit firms must adopt?
Part B, Section 1 ‘General Requirements and Guidance’ of the FRC Ethical Standard outlines key roles that audit firms must adopt to ensure compliance with the ethical requirements in the standard:
Ethical Compliance Partner: A designated senior partner responsible for overseeing the firm’s overall compliance with the ethical standards, including monitoring adherence to independence and objectivity requirements. This person or group ensures that the firm implements appropriate policies and procedures to support compliance with the FRC Ethical Standard.
Audit Engagement Partner: The partner leading each audit engagement, responsible for ensuring that the audit complies with all ethical requirements and maintaining the integrity and objectivity of the audit process. The audit engagement partner is responsible for documenting and
reaching a conclusion on the firm’s ethical compliance on a particular audit and communicating on a timely basis any issue that impacts the firms objectivity to those charged with governance.
Independence Partner: For listed clients, the firm’s compliance with
ethical standards should be reviewed by an independent partner. This role involves ensuring that audit teams and individuals do not have conflicts of interest and that policies related to independence, such as non-audit services and relationships with clients, are strictly followed.
Other Auditors: Where other auditors are involved with the engagement (i.e. entities in a group being auditied by different firms), the firm has to be satisfied that they too comply with the ethics rules.
Outline what is covered in Part B, Section 2 of the FRC Ethical Standard
Part B, Section 2 ‘Financial, Business, Employment and Personal Relationships’ of the FRC Ethical Standard focuses on Independence and provides detailed guidance on how auditors and audit firms should maintain their independence from their clients.
Key areas covered in Part B, Section 2 include:
Financial interest: The following parties are not allowed to own a direct financial interest or an indirect material financial interest in an audited entity:
* the audit firm
* any partner in the audit firm
* any person in a position to influence the conduct and outcome of the engagement (eg, a member of the engagement team)
* a person closely associated with any of the former three.
Furthermore, an audit firm or member of the engagement team (inc immediate family) should not enter into any loan or guarantee arrangement with an audited entity that is not a bank or similar institution.
Close business relationships: For audited entities, there should be no close business relationships other than that of the audit engagement except for the purchase of goods:
* in ordinary course of business
* on an arms-length basis
* that are not material to either party
* are inconsequential in the view of an objective, reasonable and informed third party.
Employment with assurance firm from client (client to audit firm): Individuals who have been a director or officer of the client, or an employee in a position to exert direct and significant influence over the subject matter information of the assurance engagement in the period under review or the previous two years, should not be assigned to a position in which he or she is able to influence the conduct and outcome of the audit for two years following the date of leaving the audited entity.
Employment with assurance client (audit firm to client): The action a firm must take depends on the role previously held by the employee at the firm:
* If a partner leaves the firm and takes a director or key management position with an audited entity, and has been involved in the audit in the past two years, the audit firm must resign and cannot reaccept the appointment until two years have passed since the partner’s involvement or the partner leaves the audit client (whichever is earlier).
* If any other former member of the audit engagement team joins the audit client as a director or key management within two years of being involved in the audit, the audit firm must assess whether the composition of the audit team remains appropriate.
Furthermore, auditors (partners or employees) cannot serve as an officer or board member of an audited entity, ensuring continued independence and avoiding conflicts of interest.
Family and personal relationships: When an immediate family member of a member of the audit team is a director, an officer or an employee of the audited entity in a position to exert direct and significant influence over the subject matter information of the audit engagement, the individual should be removed from the audit team.
Outline what is covered in Part B, Section 3 of the FRC Ethical Standard
Part B, Section 3 ‘Long Association with the Audit Engagement’ focuses on the potential threats to auditor independence that can arise from long-term relationships between the audit firm and key members of the audit team or the audited entity
Key areas covered in Part B, Section 3 include:
For Listed Entities: The following partner rotation rules exist:
* Lead audit/engagement partner - must rotate off the audit engagement after 5 years and then cannot be a partner on the audit engagment for a further 5 years. NOTE: The 5 years can be extended by 2 years if necessary to safeguard audit quality (i.e. in times of significant change) but must be disclosed to shareholders
* Other Key Audit Personnel – must rotate off the audit engagement after 7 years and then cannot be a partner on the audit engagment for a further 5 years.
* Audit firm - An audit tender should be carried out every 10 years and there should be a mandatory rotation of audit firm every 20 years
For Non-Listed Entities: Regular rotation is not mandatory, but after
ten years the firm must consider if ‘a reasonable and informed 3rd party would question the partners objectivity’ – if so safeguards should be implemented such as involving additional partners and quality reviews
What is an audit tender?
An audit tender is a formal process in which a company or organization invites audit firms to submit proposals or bids to be appointed as its external auditor.
Outline what is covered in Part B, Section 4 of the FRC Ethical Standard
Part B, Section 4 ‘Fees, Remuneration and Evaluation Policies, Litigation, Gifts and Hospitality’ ocuses on Financial Interests and addresses how auditors and audit firms should manage their financial interests in audit clients to maintain independence and objectivity.
Key areas covered in Part B, Section 4 include:
Percentage or contingent fees: An audit cannot be undertaken on a contingent fee basis - the auditor’s compensation cannot be dependent on the outcome of the audit, such as a percentage of profits or financial results.
High percentage of fees: There are a number of safeguards put in place regarding the level of fees audit firms can received from clients:
* Where total fees for both audit and non-audit services will regularly exceed 15% (10% for a listed entity) the firm must not act as auditor.
* Where total fees (audit and non-audit services) from an audited entity are expected to regularly exceed 10% of the annual fee income of the audit firm (5% in the case of a listed company) the audit engagement partners should disclose that fact to the ethics partner and those charged with governance of the audited entity and consider whether appropriate safeguards should be applied to reduce the threat to independence.
* Where non audit services are permitted, they are limited to no more than 70% of the audit fee, calculated on a rolling three-year basis.
Lowballing: Where the fee quoted is significantly lower than would have been charged by the predecessor firm the engagement partner must be satisfied that:
* The appropriate staff and time are spent on the engagement irrespective of
the fee
* All applicable assurance standards, guidelines and quality management procedures have been complied with
* Fee has not been influenced by the provision of non-audit services
Gifts and hospitality: Unless the value of a gift or hospitality is clearly insignificant, a firm or a member of an engagement team should not accept them. (Reasonable and informed 3rd party test). There should be a firm’s policy on the extent to which gifts, hospitality etc may be accepted from audited entities.
Briefly, what is the purpose of Part B, Section 5 of the FRC Ethical Standard?
Section 5 distinguishes non-audit services provided to public interest entities (PIEs) from those provided to non-PIEs taking a different approach for each.
The standard simply gives a list of permitted services. If a service is not on the
list then it cannot be provided. For non-pies, other services may to be acceptable subject to the audit partner’s assessment of:
* The significance of threats to objectivity and independence
* The effectiveness of the available safeguards (must consult with the Ethics Partner and Those Charged with Governance)
* What a reasonable and informed third party would think about the impact on the firm’s objectivity and independence and the quality of the safeguards in place
* Whether the client has ‘informed management’
It is never appropriate for the audit firm to find itself in a position where it undertakes, or is perceived as undertaking, a management role or it advocates for a client. This is a key consideration where an additional service is possible.
What is a public interest entity (PIE)?
A Public Interest Entity (PIE) is an entity that has significant public impact due to its size, nature, or the number of stakeholders involved. PIEs are subject to additional regulatory and auditing requirements due to their importance in the economy and society.
Key characteristics of a PIE include:
* Listed Companies: Companies whose shares or securities are traded on a public stock exchange.
* Banks and Financial Institutions: Institutions that are involved in banking or financial services and whose operations are of public concern.
* Insurance Companies: Entities in the insurance sector with substantial public exposure.
For the following services, outline the rules regarding providing these service for PIEs and non-PIEs, and briefly explain why they are in place:
* other audit engagements
* internal audit
* valuation services
* IT services
* tax services
* transaction services
* restructuring advice
* recruitment & remuneration advice
* accounting & payroll
Other audit engagements:
* PIE: Other assurance engagements are permitted as they also require the auditor to maintain objectivity. However, the auditor must remain mindful of the total fees earned from the client and any reliance on that client.
* Non-PIE: Similar considerations apply to Public Interest Entities (PIEs). The decision regarding the provision of non-audit services or other engagements must be made in the context of the specific circumstances of both the client and the audit firm.
Internal audit:
* PIE: The provision of internal audit services is prohibited for audit clients.
* Non-PIE: Same as PIE.
Valuation services:
* PIE: Valuation services are prohibited when they require significant judgment and are material to the financial statements.
* Non-PIE: Same as PIE.
IT services:
* PIE: The firm should not undertake work on IT systems that are important to any significant part of the accounting system or the production of the financial statements.
* Non-PIE: Same as PIE.
Tax services:
* PIE: The firm must not prepare, calculate or provide tax advice including deferred tax.
* Non-PIE: The firm must not undertake tax services that would result in the firm advocating for the client.
Transaction services:
* PIE: Transaction related services are ‘one-off’ engagements such as due diligence work. Such work often involves undertaking a management role and is prohibited for listed companies
* Non-PIE: Subject to consideration of management role/advocacy
Restructuring advice:
* PIE: Limitations on advice relating to an entity in distress
* Non-PIE: Subject to consideration of management role/advocacy
Recruitment & remuneration advice:
* PIE: The firm is prohibited from providing recruitment services of any director or employee where this would mean taking on responsibility for the appointment. The firm shall not provide advice on measurement criteria in relation to any director or employee’s remuneration
* Non-PIE: Same as PIE.
Accounting & payroll:
* PIE: Providing accounting and/or payroll services is prohibited
* Non-PIE: Only permitted so far as management role not adopted and services are mechanical/routine
Each rule is implented either to prevent potential self-interest threats that might impair the auditor’s independence and objectivity or where the auditor could be reviewing their own work, thus compromising their independence and objectivity in the external audit process.
What is a transaction service?
Transaction services are specialized advisory services provided by professional firms to support businesses through mergers, acquisitions, disposals, and other significant transactions, focusing on financial due diligence and valuation to help clients make informed decisions
Briefly, what is the purpose of Part B, Section 6 of the FRC Ethical Standard?
Part B, Section 6 provides limited exemptions from certain prohibitions on assurance services for smaller entities that are not public interest entities (PIEs).
The aim is to offer proportionality—recognising that the threats to independence may be lower and that smaller entities often rely on their auditors for additional support. However, auditors must still apply safeguards to ensure objectivity is maintained.
What three issues dealt with by the ethical standards are covered under Part B, Section 6 of the FRC Ethical Standard? Detail and explain each
Part B, Section 6 provides relaxations for smaller entities and covers the following three issues:
Fee Dependence
Exempts audit firms from requiring an external quality review when fees from a client are between 10%–15%, as long as this is disclosed to the ethics partner and those charged with governance.
Non-Audit Services
Restrictions are waived if:
* There is informed management at the client
* The audit firm increases its cycle of cold reviews
* The departure is disclosed in the auditor’s report
Partners Joining Audit Client–
Restrictions are relaxed if:
* There is no threat to independence or integrity
* Appropriate disclosure is made in the auditor’s report.
What is ‘informed management’ and what conditions must be met for an audit firm to rely on it as a safeguard?
‘Informed management’ refers to the client’s ability to independently evaluate and act on the results of non-audit services.
To be considered as informed management, the following conditions must be met:
* The client must have a genuine opportunity to choose between alternative courses of action.
* A designated member of management must be assigned to receive and assess the results of the non-audit service.
* That individual must have the capability and authority to make independent decisions and judgments based on the information provided by the audit firm.
To rely on ‘informed management’ as a safeguard, the audit firm should assess whether it exists and
request that management document their understanding of informed management (ie confirm in writing that it exists).
Under what circumstances may an auditor disclose information received in confidence from a client?
The professional accountant should not disclose information received in confidence except in the circumstances set our below and should not use confidential information to their own personal advantage or the advantage of third parties:
- Client Given Permission: The auditor may disclose information if the client authorizes the disclosure, such as when the client agrees to report a fraud to the authorities.
- Disclosure Required by Law: The auditor may be required to disclose confidential information if legally mandated, such as reporting regulatory breaches to regulators or reporting suspected money laundering to the National Crime Agency (NCA).
- Disclosure in the Public Interest: The auditor may disclose information if there is a professional duty or right to do so, and it is justified in the public interest. This could include situations where disclosure is necessary for the protection of the public or to prevent harm, as long as it is not prohibited by law.
In all cases, the auditor should carefully consider legal requirements and seek legal advice if necessary before making any disclosure.
What is meant by an ‘informant’ in the context of ‘confidentiality’, and what steps do the ICAEW set out to deal with a scenario when you are approached by one?
An informant refers to an individual who provides the auditor with confidential or sensitive information, often relating to illegal or unethical conduct, such as fraud or other financial misconduct. This person may not be the client but could be someone within the organization or outside it who has access to confidential details.
If this happens the professional accountant should:
* Advise the informant to pass on the information to his employer in accordance with company procedures.
* Protect the identity of the informant to the extent that this is possible.
* Take care in the way that this information is used, if at all.
Under the ICAEW Code of Ethics, what are the suitable safeguards that can be put in place to mitigate conflicts of interest?
Under the ICAEW Code of Ethics, the following safeguards can be implemented to mitigate conflicts of interest:
* Disclosure of the Circumstances: Disclose the conflict of interest to relevant parties, such as the client, to ensure transparency and allow for informed decision-making.
* Obtaining Informed Consent: Obtain informed consent from the client to continue acting despite the conflict of interest. This ensures that the client is aware of the situation and agrees to proceed.
* Use of Confidentiality Agreements: Implement confidentiality agreements that are signed by employees to protect sensitive information and prevent its misuse.
* Establishing Information Barriers: Ensure no overlap between different teams working on the client engagement to prevent the sharing of sensitive information and having physically separate teams working on different aspects of the client’s affairs. Set up careful procedures for disseminating information beyond the barrier and maintaining proper records when this occurs.
* Regular Review of Safeguards: Conduct regular reviews of how the safeguards are being applied, with a senior individual (not involved in the client engagement) overseeing the process to ensure their effectiveness.
* Ceasing to Act: If the conflict cannot be effectively managed, the auditor should cease to act for the client to maintain independence and objectivity.
These safeguards help ensure that conflicts of interest are managed effectively and that the auditor’s independence and ethical standards are upheld.
