Lecture 10 Flashcards
what are the two main approaches to code of professional ethics
-Rules based
-Principles Based
A code based on a set of principles is more flexible in a rapidly changing environment and puts the onus on accountants to consider every situation
what are the Advantages of Principles based guidance
-Active considerations and demonstration of conclusions
-Broad interpretation of ethical situations
-Individual situations covered
-Flexible to changing situation
-Can incorporate prohibitions if required
what are the IFAC Code – Fundamental Principles
-Integrity: straightforward in professional / business relationships
-Objectivity: free from bias, conflict of interest, undue influence of others
-Professional competence and due care: do a professional job in accordance with current standards
-Confidentiality: maintain it (unless legally compelled), not for personal advantage
-Professional behavior: comply with law do not discredit profession or yourself
what is hindsight bias and explain its nature and effects
- its when once people knew what has happened, they overestimate how easy it should have been to predict it
- hindsight bias is said to effect the regulatory process because regulators with advantage knowledge about the misstatements may take the view that misstatements should have been identified by the auditor. Therefore, the auditor’s failure to identify them is portrayed as a lack of prefessional sceptism
what is confirmation bias and explain its nature and effects
- the phenomenon whereby people tend to value evidence that corroborates their existing beliefs more highly than evidence that contradicts them
in other words, auditors to favor information that supports their pre-existing beliefs or expectations while disregarding or undervaluing evidence that contradicts those beliefs - Auditors may overlook or downplay potential risks that contradict their initial assessment.This can lead to an incomplete or inaccurate risk assessment, increasing the likelihood of undetected errors or fraud.
- If an auditor is biased toward confirming the accuracy of financial statements, they may fail to recognize signs of errors, misstatements, or fraudulent activities.
- The effects of confirmation bias can lead to an overall reduction in audit quality. When audit conclusions are biased or based on incomplete evidence, it can result in inaccurate financial reporting, which undermines the trust of stakeholders, such as investors, creditors, and regulators, in the audit process and the financial statements.
what is anchoring bias and explain its nature and effects
- refers to the tendency to rely too heavily on the first piece of information encountered (the “anchor”) when making decisions, even if that initial information is irrelevant or arbitrary
- If an auditor’s initial assumption is anchored on a particular value or piece of evidence , they may give disproportionate weight to this information. This can lead them to overlook or undervalue subsequent evidence that might contradict the initial anchor, thereby compromising the audit’s effectiveness.
- When auditors set materiality thresholds based on the initial information, anchoring bias can result in them setting the threshold too high or too low. Fwhich can impact the scope of the audit and influence which discrepancies or issues are deemed significant.
what is sterotyping bias and explain its nature and effects
- occurs when an auditor forms an assumption about an individual or organization based on preconceived notions, rather than on objective evidence or facts
- Reliance on assumptions: Auditors might rely on stereotypes rather than facts, which can distort their judgment. If auditors stereotype certain clients or industries, they might overlook important data or misinterpret findings, leading to incorrect conclusions.
- Loss of independence: Auditors are expected to maintain objectivity and independence. If they are influenced by stereotypes, their independence may be compromised. leads to Selective scrutiny: Auditors may focus on certain aspects of the audit or ignore others based on biased assumptions about the client’s behavior or practices, leading to skewed results.
IFAC Code – Maintaining Independence what are the steps to maintain independence
Step 1 – Identify threats to fundamental principles
Step 2 – Evaluate the threats identified
Step 3 – Address threats by eliminating them to an acceptable level – which may require the application of safeguards. Where no safeguards are available:
Eliminate the interest or activities causing the threat
Decline the engagement or discontinue it
what are the threats to independence
Self-interest threat (e.g. having a financial interest in a client):
If an auditor or auditing firm has a financial stake in the client, such as owning shares or having a financial investment, they might be less likely to issue an unbiased report. The auditor may feel motivated to overlook certain issues or alter findings to protect their financial interests or Auditors whose compensation or bonuses are linked to the success or retention of specific clients might face a self-interest threat. They could be incentivized to perform audits in a way that benefits the client (or their own income), rather than adhering strictly to professional auditing standards.
Self-review threat (e.g. auditing financial statements prepared by the firm):
- When auditors are tasked with reviewing their own work, they may unintentionally overlook errors or misstatements, as they might be too familiar with the information to critically evaluate it. This can lead to less effective audits, as auditors might not spot discrepancies, inconsistencies, or fraudulent activities that would otherwise be noticeable.
- Independence is crucial for an auditor’s objectivity. The self-review threat directly challenges objectivity because it becomes harder for the auditor to remain impartial when they have prior involvement with the work. An auditor might be reluctant to report problems with work they’ve done or influenced, potentially leading to a biased audit opinion.
Advocacy threat (e.g. promoting the clients position by dealing in its shares):
If an auditor is also providing advisory or consulting services to a client, they may find themselves in a position where they are advocating for the client’s financial position, strategy, or regulatory compliance. This may make it difficult for the auditor to remain impartial when conducting the audit, as they could feel invested in defending the client’s views.
In this situation, the auditor might unintentionally downplay or overlook issues that could reflect poorly on the client, such as financial misstatements or compliance failures
Familiarity threat (e.g. audit team with a family member employed at the client):
If an auditor has worked with the same client for many years, they may develop a sense of familiarity or friendship with the client’s management or key personnel. This can lead to a situation where the auditor might subconsciously overlook certain issues or be more lenient in their assessment because of the established relationship or Independence is a core principle of auditing, and professional skepticism is critical for identifying and questioning potential misstatements. Familiarity can undermine this skepticism, as auditors may become complacent, taking the client’s financial statements at face value rather than critically evaluating them
Intimidation threat (e.g. threats of replacement due to disagreement):
The client’s management or board of directors may exert pressure on the auditor to overlook certain issues, manipulate audit findings, or downplay areas of concern.
If the client threatens to fire the auditor or hire another firm if the auditor reports unfavorable findings, it may create a fear of losing business, thus influencing the auditor to overlook potential issues or soften their report.
Management threat* (e.g. doing something which is the responsibility of management i.e. making key judgement):
Auditors might have a vested interest in maintaining a good relationship with management, especially if the company is a significant client. This can lead to biased judgments or overlook financial misstatements to avoid conflict or losing the client.
If management has the ability to override internal controls, it increases the risk of fraudulent reporting or financial misstatements that auditors may fail to detect, particularly if the auditor is not fully independent.
what are the safeguards to independence
- Safeguards created by legislation, the profession or regulation including:
Education
CPD (Continuing Professional Development)
Standards
Monitoring and disciplinary procedures
Corporate governance - Safeguards within the work environment
for example:
Rotating staff
Separate teams
Liaising with audit committees
Second partner or second office opinion
Consulting the Ethics partner
