Chapter Nineteen Professional Ethics, Independence, and Quality Control

Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

19-1

Chapter Nineteen Professional Ethics, Independence,

and Quality Control

Chapter Nineteen Professional Ethics, Independence,

and Quality Control


19-2

Ethics and Professional Behaviour

Ethics

Professionalism

Refers to a system or code of conduct based on moral duties and obligations that indicate how an individual should

behave in society.

Refers to the conduct, aims, or qualities that characterize or mark a profession or

professional person.


19-3

Theories of Ethical Behaviour

Utilitarianism

Rights-Based Approach

Justice-Based Approach

Recognizes that decision making involves trade-offs between the benefits and burdens

of alternative actions and focuses on the consequences and individuals affected.

Assumes that individuals have certain rights and other individuals have a duty to

respect those rights when making decisions.

Is concerned with issues such as equity, fairness and impartiality.


19-4

Development of Moral Judgment


19-5

Conceptual Framework Approach to Independence


19-6


• The definitions of independence in the frameworks acknowledge that independence only indirectly affects the ultimate goal of auditor objectivity, i.e. to make unbiased audit decisions.

• Independence is considered a relatively observable trait of an auditor that should be correlated with the relatively unobservable trait of objectivity.

• Consequently, auditor independence is viewed as the main mean to ensure and demonstrate auditor objectivity and independence has therefore been in regulatory focus.

Independence of mind relates to the fact of independence, i.e. if the auditor actually behaves without being affected by interests than may impair objectivity.

Independence in appearance relates to perception of independence, i.e. if third parties perceive that auditor interests that may impair objectivity do not exist.


19-7


Threats to auditor independence are pressures and other factors that impair or are perceived to impair an auditor’s

objectivity.

Safeguards to auditor independence are controls that mitigate the effects of the threats.

Independence risk is the likelihood that auditor’s objectivity would be compromised or reasonably would appear to be

compromised to informed investors and other users of the audit report.


19-8


• Self-interest threats arise from the auditors favouring or is perceived to favour self-interests over their interest in performing an unbiased audit.

• Self-review threats arise from auditor’s difficulty to evaluate without bias one’s own work, or that of one’s firm.

• Advocacy threats arise from auditors acting biased in promoting or advocating for or against the auditee.

• Familiarity threats arise from auditors compromising objectivity due to being influenced by a close relationship with the auditee.

• Intimidation threats arise from auditors deterred from acting objectively because they are being, or believing that they are being, overtly or covertly coerced by auditees or by other interested parties.


19-9


Safeguards created and maintained within the auditee.

Safeguards created by the profession, legislation, or

regulation. Safeguards within the

auditor’s and audit firm’s own system and procedures.


19-10

IFAC Code of Ethics for Professional Accountants


19-11

IFAC Code: Fundamental Principles and Conceptual Framework

Part A of the Code establishes the fundamental principles for professional accountants’

behaviour and the conceptual framework for applying those principles.


19-12


A professional accountant in public practice is defined as a professional accountant that provides professional services in

a firm.

• Professional services are defined as services requiring accountancy or related skills performed by a professional accountant including accounting, auditing, taxation, management consulting, and financial management services.

• A firm is defined as a sole practitioner, partnership, or corporation of professional accountants; an entity that controls such parties, and an entity controlled by such parties.

A professional accountant in business is defined as a professional accountant employed or engaged in an executive or

non-executive capacity in such areas as commerce, industry, service, the public sector, education, the not-for-profit sector,

regulatory bodies or professional bodies, or a professional accountant contracted by such entities.


19-13


Integrity Objectivity

Professional Competence & Due Care

ConfidentialityProfessional

Behaviour


19-14



19-15



19-16

IFAC Code: Conduct of Professional Accountants in Public Practice

Part B Professional Accountants in Public Practice illustrates how the conceptual framework contained in Part A is to be applied by professional accountants in public practice in specific situations.


19-17



19-18


19-19



19-20


19-21


Professional Appointment

Second Opinions

Fees & Other Types of Remuneration

Marketing Professional Services

Gifts & Hospitality

Custody of Client Assets Objectivity – All Services

Conflicts of Interest


19-22

IFAC Code: Independence - Assurance Engagements

Assurance Engagement

An engagement in which a professional accountant in public practice expresses a conclusion designed to

enhance the degree of confidence of the intended users other than the responsible party about the outcome of

the evaluation or measurement of a subject matter against criteria.

Independence of Mind

The state of mind that permits the expression of a conclusion without being affected by influences that

compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity,

and professional scepticism.

The avoidance of facts and circumstances that are so significant that a reasonable and informed third party, having knowledge of all relevant information, including

safeguards applied, would reasonably conclude a firm’s, or a member of the assurance team’s, integrity, objectivity, or professional scepticism had been

compromised.

Independence in Appearance


19-23

IFAC Code: Independence - Assurance Engagements

Financial Statement Audit Engagements

Other Assurance Engagements

Listed Entities Engagement Period


19-24

IFAC Code: Independence

• Financial interests. • Loans and guarantees.• Close business relationships with the assurance

clients.• Family and personal relationships.• Employment with assurance clients.• Recent service with assurance clients.• Serving as an officer or director on the board of

assurance clients.• Long association of senior personnel with assurance

clients.• Provisions of non-assurance services to assurance

clients.


19-25

IFAC Code: Provisions of Non-Assurance Services – Types of Services

• Preparing accounting records and financial statements.• Valuation services.• Provisions of taxation services to audit clients.• Provisions of internal audit services to audit clients.• Provisions of IT systems services to audit clients.• Temporary staff assignments to audit clients.• Provisions of litigation support services to audit clients.• Provisions of legal services to audit clients.• Recruiting senior management.• Provisions of corporate finance services to audit clients.• Fees, pricing and partner compensation.• Gifts and hospitality.• Actual or threatened litigation.


19-26

IFAC Code: Provisions of Non-Assurance Services – Examples of Prohibited Activities

Acting in the capacity of management by authorizing, executing or consummating

a transaction.

Making decisions on behalf of management.

Reporting in a management role to those charged with

governance.


19-27

IFAC Code: Provisions of Non-Assurance Services – Examples of Safeguards


19-28

Summary of Code Provisions for Selected Non-Assurance Services to Audit Clients


19-29


19-30


19-31

IFAC Code: Conduct of Professional Accountants in Business

A professional accountant in business is an accountant holding

membership in an IFAC body and is employed or engaged in an executive

or non-executive capacity in an organization other than an audit firm.

Professional accountants in business must comply with the IFAC Code’s fundamental principles and apply

the conceptual framework when threats to the principles exist.

Threats:• Potential conflicts.• Preparation and reporting of

information.• Acting with sufficient expertise.• Financial interests.• Inducements.


19-32

EU Rules on Auditor Independence

From European Commission, Recommendation on Statutory Auditors’ Independence in the EU: A Set of Fundamental Principles (2002):

“A principles-based approach to statutory auditors' independence is preferable to one based on detailed rules because it creates a robust structure within which statutory auditors have to justify their actions. It also provides the audit profession and its regulators with the flexibility to react promptly and effectively to new developments in business and in the audit environment. At the same time, it avoids the highly legalistic and rigid approach to what is and is not permitted which can arise in a rules-based regime. A principles-based approach can cater for the almost infinite variations in individual circumstances that arise in practice and in the different legal environments throughout the EU. Consequently, a principles-based approach will better serve the needs of European capital markets, as well as those of SMEs (small and medium sized enterprises).”


19-33

EU Rules on Auditor Independence

Threats to Independence:• Preparing of accounting records and financial statements.• Design and implementation of financial information technology systems.• Valuation services.• Participating in the audit client’s internal audit.• Acting for the audit client in the resolution of litigation.• Recruiting of senior management.• Audit and non-audit fees (contingent fees, relationship between total fees

and total revenue, overdue fees and pricing).• Litigation.• Senior personnel acting for a long period of time.


19-34

Quality Control Standards

ISQC 1 Quality Control for Firms That Perform Audits and Reviews of Historical Financial Information and Other Assurance and Related

Services Engagements

• Leadership responsibilities for quality within the firm.

• Ethical requirements.• Acceptance and continuance of client

relationships and specific engagements.• Human resources.• Engagement performance.• Monitoring.


19-35

Elements of Quality Control


19-36


19-37

Selected Quality Control Policies and Procedures


19-38


19-39

Monitoring Quality Control

Provide an evaluation of:

(1) Adherence to professional standards and regulatory and legal requirements.

(2) Whether the quality control system has been appropriately designed and effectively implemented.

(3) Whether the firm’s quality control policies and procedures have been appropriately applied, so that reports that are issued by the firm or engagement partners are appropriate in the circumstances.


19-40

Monitoring Quality Control

Procedures for monitoring include:

• Inspection procedures of a selection of completed engagements.

• Analysis of— New professional standards and regulatory and legal requirements.— Written confirmation of compliance with policies and procedures on

independence.— Continuing professional development, including training.— Decisions related to acceptance and continuance of client

relationships and specific engagements.• Determination of any corrective actions to be taken and improvements to

be made in the system.• Communication to appropriate firm personnel of weaknesses identified in

the system, in the level of understanding of the system, or compliance with it.

• Follow-up by appropriate firm personnel to ensure that any necessary modifications are promptly made to the quality control policies and

procedures.


19-41

Quality Assurance Programmes of Firms’ Practices

• Mandatory or voluntary review.

• Firms and auditors covered by reviews.

• Selection and qualities of reviewers.

• Scope and thoroughness of reviews.

• Frequencies of reviews.

• Sanctions initiated as a result of negative outcomes of reviews.

• Public reporting of outcomes of reviews and sanctions imposed.

• Public oversight of programs.


19-42

Quality Assurance Programmes of Firms’ Practices - Regulations

IFAC SMO 1 Quality Assurance

EU 8th Directive

European Commission, Recommendation on

Quality Assurance for the Statutory Audit in the EU:

Minimum Requirements

PCAOB


19-43

End of Chapter 19

Documents

Chapter Nineteen Professional Ethics, Independence, and Quality Control