Chapter 7: Compliance with Ethical Requirement

Question 1

Front

Answer 1

Back

Question 2

1. What are the two main parts of the study notes on Compliance with Ethical Requirements?

Answer 2

1. PART A – Theory of Ethics: Covers the fundamental principles of ethics and the conceptual framework approach. 2. PART B – Application of Ethics in Case Studies: Discusses practical applications, including specific scenarios involving fees, inducements, litigation, and more.

Question 3

2. What does the principle of Integrity require of a chartered accountant?

Answer 3

Integrity means truthfulness and fair dealings. A chartered accountant must be straightforward and honest in all professional and business relationships. They should not be associated with any communication (reports, returns, etc.) that omits necessary information, is false, misleading, or prepared recklessly. If such issues are later discovered, the accountant should disassociate from that information (e.g., an auditor may withdraw if management refuses to correct errors).

Question 4

3. What is expected under the principle of Objectivity?

Answer 4

Objectivity means that a chartered accountant must not compromise professional judgment due to undue influence, bias, or conflict of interest. They should refrain from performing services if any relationship or circumstance may unduly influence their judgment.

Question 5

4. What does the Confidentiality Principle require and what are its exceptions?

Answer 5

A chartered accountant must ensure the confidentiality of information acquired during professional work and must not disclose or use that information for personal or third‐party advantage. Exceptions include disclosure authorized by the client, disclosure required by law or court (e.g., for non-compliance or legal proceedings), or when disclosure is necessary to comply with professional duties—provided that factors like potential harm and proper communication are considered.

Question 6

5. Define Professional Competence and Due Care for chartered accountants.

Answer 6

It requires maintaining and continuously updating professional knowledge and skills to provide quality service in accordance with current laws and standards. It involves acting diligently, performing work carefully and on time, training and supervising staff, and informing clients about any inherent limitations in the services provided.

Question 7

6. What is expected regarding Professional Behavior?

Answer 7

A chartered accountant should comply with all relevant laws and regulations and avoid any actions that could discredit the profession or adversely affect its reputation.

Question 8

7. What are the three key steps in the conceptual framework approach to ethical compliance?

Answer 8

1. Identify and explain threats to fundamental principles. 2. Evaluate these threats using quantitative and qualitative factors. 3. Apply safeguards to eliminate the threat or reduce it to an acceptable level—or, if necessary, decline the engagement.

Question 9

8. What is a Self-Interest Threat?

Answer 9

It is a situation where an assurance team member’s judgment or behavior might be unduly influenced by a financial interest held by them or their relatives in the audit client.

Question 10

9. What is meant by a Familiarity Threat?

Answer 10

It refers to the risk that a team member might become overly sympathetic to or accepting of a client’s interests due to a long-standing or close relationship.

Question 11

10. Explain the Self-Review Threat.

Answer 11

This threat occurs when a team member is required to review work that they or their firm performed previously in a non-assurance capacity, which can compromise their objectivity.

Question 12

11. What constitutes an Intimidation Threat?

Answer 12

It is when an assurance team member is deterred from acting objectively due to threats, pressure, or coercive tactics from management or others.

Question 13

12. Define an Advocacy Threat.

Answer 13

An advocacy threat arises when an assurance team member promotes a client’s position on a matter to third parties, thereby compromising their own objectivity.

Question 14

13. How should a chartered accountant address identified ethical threats?

Answer 14

By either eliminating the circumstances causing the threat, applying safeguards to reduce the threat to an acceptable level, or, if necessary, declining the engagement.

Question 15

14. What is the general rule regarding independence in audit and review engagements?

Answer 15

The audit firm must remain independent from the audit client throughout the entire engagement period.

Question 16

15. How can quoting a fee lower than that of the predecessor auditor create an ethical threat?

Answer 16

It creates a Self-Interest Threat by potentially reducing audit resources and compromising quality. Safeguards include adjusting the fee or engagement scope and appointing an independent reviewer.

Question 17

16. What threats are associated with overdue fees in audit engagements?

Answer 17

For initial audits, the predecessor auditor’s fee should be settled before engagement acceptance. For recurring audits, significant overdue fees create a Self-Interest Threat. Safeguards include obtaining full or partial payment and assessing whether unpaid fees are equivalent to a loan, which may require withdrawal or reappointment.

Question 18

17. What are Contingent Fees and why are they problematic in assurance engagements?

Answer 18

Contingent Fees are fees based on outcomes (e.g., profit, opinion type, tax savings) and create a Self-Interest Threat as they may bias the auditor toward a favorable outcome. No safeguard can adequately mitigate this threat, so such fees are not permitted in assurance engagements.

Question 19

18. What ethical threat arises from referral fees or commissions?

Answer 19

Referral fees or commissions create a Self-Interest Threat by shifting focus from providing high-quality service to securing financial benefits. Safeguards include disclosing the arrangement to the client and obtaining their advance agreement.

Question 20

19. How can compensation and evaluation policies create ethical threats?

Answer 20

When audit team members are evaluated or compensated based on selling non-assurance services, it creates a Self-Interest Threat that may compromise audit quality. Safeguards include revising the compensation plan or removing the affected individual from the audit team.

Question 21

20. What types of inducements might an auditor receive, and what threats do they pose?

Answer 21

Inducements may include gifts, hospitality, entertainment, donations, appeals to friendship, or preferential treatment. They pose Self-Interest, Familiarity, and Intimidation Threats. Safeguards involve refusing significant inducements, disclosing any accepted inducements to senior management, documenting the arrangement, and, if necessary, removing the team member from the engagement.

Question 22

21. What ethical issues are raised by actual or threatened litigation with an audit client?

Answer 22

Actual or threatened litigation creates a Self-Interest Threat (due to direct financial implications) and an Intimidation Threat (due to pressure or fear of escalation). Safeguards include removing the affected individual from the engagement or appointing an independent reviewer.

Question 23

22. How does holding a financial interest in an audit client create ethical threats?

Answer 23

Holding a financial interest creates a Self-Interest Threat, as the auditor might be swayed by potential personal financial gain from the client’s performance. Factors include the auditor’s role, the relationship if the interest is held by a relative, and the materiality of the interest. Safeguards include disclosure, disposing or reducing the interest, removal from the audit team, and independent review.

Question 24

23. What threat is created by receiving a loan or guarantee from an audit client?

Answer 24

A loan or guarantee creates a Self-Interest Threat due to potential financial dependence. For bank clients, the loan must follow normal lending procedures and be independently reviewed if material; for non-bank clients, material loans may require repayment, removal of the concerned member, or withdrawal from the engagement.

Question 25

24. What is the ethical stance regarding loans or guarantees given to an audit client?

Answer 25

If a loan or guarantee is immaterial, no action is needed. However, if it is material, it should be repaid or the concerned individual removed from the audit team, and in some cases, the firm should consider withdrawing.

Question 26

25. How can purchasing goods and services from an audit client create an ethical threat?

Answer 26

Purchasing goods or services may create a Self-Interest Threat if favorable terms or ongoing supply arrangements bias the auditor’s judgment. Factors to consider include whether the transaction is at arm's length, follows proper tendering procedures, and its magnitude. Safeguards include reducing the transaction size or removing the individual from the audit team.

Question 27

26. What risks are associated with close business relationships between audit team members and an audit client?

Answer 27

Close business relationships can lead to Self-Interest and Intimidation Threats, as personal ties may bias judgment or create pressure to maintain the relationship. Safeguards include reducing the relationship’s significance, removing the individual from the audit team, or withdrawing from the engagement if necessary.

Question 28

27. What ethical threats arise from family and personal relationships with client personnel?

Answer 28

Family or personal relationships may lead to Self-Interest Threats (due to shared interests), Familiarity Threats (reduced professional skepticism), and Intimidation Threats (reluctance to challenge due to personal ties). Safeguards include restructuring responsibilities, engaging an independent reviewer, or removing the affected team member from the engagement.

Question 29

28. What risks are posed by an audit team member's recent service as an employee or consultant of an audit client?

Answer 29

Recent service can lead to Self-Interest Threats (due to potential future employment or bonuses), Self-Review Threats (reviewing one’s own work), and Familiarity Threats (from prior relationships). Safeguards include excluding the individual from the audit team if the service falls within the audit period or restructuring responsibilities with an independent review if it occurred prior.

Question 30

29. What ethical threats are associated with employment of a former audit firm member by an audit client?

Answer 30

This situation creates Self-Interest Threats (potential future business or referrals), Familiarity Threats (from prior relationships), and Intimidation Threats (from undue influence). Safeguards include severing significant connections, modifying the audit plan, assigning experienced personnel, and conducting additional independent reviews.

Question 31

30. What additional threat arises if an audit team member is negotiating future employment with the audit client?

Answer 31

Negotiating future employment creates a Self-Interest Threat because the individual may prioritize future opportunities over audit quality. Safeguards include notifying the firm, removing the team member from the audit engagement, and appointing an independent reviewer.

Question 32

31. What threats are posed by loaning personnel to an audit client?

Answer 32

Loaning personnel creates a Self-Review Threat (as the individual may later review their own work), an Advocacy Threat (if they become involved in promoting the client’s interests), and a Familiarity Threat (from developing close relationships with client staff). Safeguards include ensuring the loan is for a short duration, restructuring responsibilities if the personnel join the audit team, and conducting an independent review of their work.

Question 33

32. What risks arise from using the same audit team member over a long period (e.g., more than 3 years)?

Answer 33

Long-term association may result in Familiarity Threats (leading to overly close relationships) and Self-Interest Threats (due to job security concerns). Safeguards include rotating team members, restructuring responsibilities, engaging independent reviewers, and conducting independent quality control reviews.

Question 34

33. What ethical issues can arise from providing accounting and bookkeeping services to an audit client?

Answer 34

Such services may create a Self-Review Threat if the audit team later reviews the work they performed. For listed companies these services are not permitted; for unlisted companies, only routine or mechanical services (e.g., recording transactions, preparing statements) performed by non-audit personnel with independent review are acceptable.

Question 35

34. How are tax services treated in terms of ethical threats?

Answer 35

Preparation or review of tax returns generally poses no threat. However, tax calculations for accounting entries can create a Self-Review Threat, and assistance in resolving tax disputes may generate both Self-Review and Advocacy Threats. For unlisted companies, these services should be performed by separate teams and subject to independent review.

Question 36

35. How should a chartered accountant handle conflicts between fundamental ethical principles?

Answer 36

They should consult (anonymously if necessary) with colleagues, professional bodies, regulatory authorities, or legal counsel, and use professional judgment to resolve the conflict. If unresolved, withdrawing from the engagement may be necessary.

Question 37

36. What role does professional skepticism play in upholding ethical principles?

Answer 37

Professional skepticism ensures professional competence and due care by prompting additional procedures in high-risk situations, safeguards integrity through thorough verification of information, and upholds objectivity by mitigating bias.

Question 38

37. What factors should be considered when evaluating threats to ethical compliance?

Answer 38

Consider both quantitative and qualitative aspects such as the magnitude of the threat, the nature of relationships involved, the effectiveness of existing policies and procedures (e.g., complaint systems, training requirements, regulatory standards), and any new information that may impact the threat level.

Question 39

38. What factors should be considered when disclosing confidential information?

Answer 39

Before disclosure, consider whether any party (including third parties) may be harmed, ensure that all relevant and substantiated information is known, evaluate the proposed type of communication, and confirm that the addressees are appropriate recipients.

Question 40

39. (Case Study 10.1a) What ethical threats arise if audit partners stay in hotels managed by Awesome Hotels Limited (AHL)?

Answer 40

This situation may create Self-Interest and Familiarity Threats by blurring professional boundaries. Safeguards include avoiding such personal benefits, ensuring full disclosure, and implementing independent reviews.

Question 41

40. (Case Study 10.1b) What ethical issues arise when an audit team member inherits 100,000 shares in Hunza Limited (HL)?

Answer 41

Inheriting a significant number of shares creates a Self-Interest Threat as the financial interest may compromise objectivity. Safeguards include immediate disclosure to the firm, disposing of or reducing the shareholding, and possibly removing the team member from the engagement.

Question 42

41. (Case Study – Shah Motors) What ethical threats are associated with preferential treatment and familial involvement at Shah Motors (SML)?

Answer 42

Preferential treatment (such as helping a team member’s relative secure early vehicle delivery) and including a client’s relative on the audit team can create Self-Interest, Familiarity, and Conflict of Interest Threats. Safeguards include full disclosure, independent review, and reassigning responsibilities where necessary.

Question 43

42. (Case Study 0.7) What threats are posed in the scenarios of Muneer and Danial?

Answer 43

For Muneer, a close relative holding shares in the audit client creates Self-Interest and Familiarity Threats. For Danial, a long association with the audit engagement may result in Familiarity and Self-Interest Threats. Safeguards include proper disclosure, potential removal from the engagement, and rotating team members.

Question 44

43. (Case Study Q.8 – Stark Co) What ethical threats and safeguards arise in the Stark Co scenario?

Answer 44

Multiple threats exist: • Nepotism/Familiarity Threat from including Mr. Son’s daughter on the audit team; • Self-Interest Threat from the audit senior receiving investment advice from Stark Co; • Inducement Threat from accepting a balloon flight instead of a yacht and from fee arrangements based on a percentage of tax saved or fixed fees for dispute representation. Safeguards include removing conflicted individuals, ensuring independent reviews, full disclosure, and strict adherence to fee and engagement policies.