CHAPTER 3

Ethics and code of conduct

EXAM FOCUS
An essential part of professional behaviour is the application of the rules of professional
conduct which are binding on all ACCA members in practice. Breaches of these rules can lead
to disciplinary action by the ACCA.

The terms of the audit engagement are an essential part of quality control. This important
topic is covered by ISA 210.

SYLLABUS AND STUDY GUIDE COVERAGE

This chapter covers the following elements of the ACCA study guide:

5 Professional Ethics and Professional Codes of Conduct I

¨ Describe the sources of, and enforcement mechanisms associated with,

professional ethics and professional codes of conduct.

¨ Define the fundamental concepts of professional ethics.

¨ Define the detailed requirements of, and illustrate and analyse the application of,
professional ethics in the context of independence, objectivity and integrity.

¨ Distinguish between the elements of professional ethics applicable to internal

auditors and those applicable to external auditors.

¨ Describe the responsibilities of internal and external auditors for the prevention
and detection of fraud and error.

6 Professional Ethics and Professional Codes of Conduct II

¨ Describe the requirements of professional ethics and other requirements in relation

to the acceptance of audit and review assignments.

¨ Define the detailed requirements of, and illustrate and analyse the application of,
professional ethics in the context of confidentiality and conflicts of interest.

¨ Describe the importance of engagement letters and describe their contents.

In order to cover these elements the follow ing topics are included:

IFAC Code of Ethics for Professional Accountants

ACCA Key features of the Rules of Professional Conduct
ISA 240 Fraud and error
ISA 210 Engagement letters

27
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1 Professional codes of conduct

1.1 Introduction
Accountancy is a profession. All professions have a public interest responsibility to act in an
ethical manner. Professional accountants accept this responsibility and agree to follow the
various codes of conduct that codify w hat is expected of them.

,)$&KDYHSXEOLVKHGD¶&RGHRI(WKLFVIRU3URIHVVLRQDO$FFRXQWDQWV·ODVWUHYLVHGLQ1RYHPEHU
2001. However IFAC believes that, due to legal and cultural differences across the world, it is
not its role to set out very detailed ethical requirements. Thus the IFAC code only deals with
the fundamental principles of ethical conduct, leaving it to the member bodies in each country
(eg, the ACCA in the UK) to develop the detailed standards of conduct that must be followed
in that country.

The responsibility to implement and enforce standards of ethical behaviour therefore rests with
each member body of IFAC, building on the general principles set out in the IFAC Code of
Ethics.

7KLV FKDSWHU SULPDULO\ GHVFULEHV WKH $&&$·V HWKLFDO UHTXLUHPHQWV VLQFH WKH\ DUH VWULFWHU E\
nature than the IFAC requirements, but the IFAC requirements are also mentioned w here
relevant.

1.2 Enforcem ent mechanism

$&&$VWXGHQWVDQGPHPEHUVZKRIDLOWRREVHUYHWKH$&&$·VHWKLFDOJXLGDQFHLQWKH5XOHVRI
Professional Conduct will be called to appear before the Disciplinary Committee. If the most
serious charges are proved, the individual may be expelled from ACCA membership.

1.3 Fundamental principles

ACCA students, affiliates and members are required to observe proper standards of
SURIHVVLRQDO FRQGXFW  7KH $&&$·V HWKLFDO JXLGDQFH LV FRQWDLQHG LQ WKH 5XOHV RI 3URIHVVLRQDO
Conduct.

The fundamental principles set out the obligations placed on all members, w hether or not they
are in practice:

¨ M embers should behave with integrity in all professional, business and personal financial
relationships. Integrity implies not merely honesty but fair dealing and truthfulness.

¨ M embers should strive for objectivity in all professional and business judgements.
Objectivity is the state of mind which has regard to all considerations relevant to the task in
hand but no other. It presupposes intellectual honesty.

¨ M embers should not accept or perform work w hich they are not competent to undertake
unless they obtain such advice and assistance as will enable them competently to carry out
the work.

¨ M embers should carry out their professional w ork with due skill, care, diligence and
expedition and with proper regard for the technical and professional standards expected of
them as members.

¨ M embers should behave with courtesy and consideration towards all with w hom they
come into contact during the course of performing their work.

The fundamental principles identified in the ACCA Rules of Professional Conduct are very
similar to the fundamental principles in the IFAC Code of Ethics, namely integrity, objectivity,
professional competence and due care, confidentiality, professional behaviour and technical

28
 Chapter 3 Ethics and code of conduct

standards. The IFAC Code highlights the need for confidentiality w hich is included in the
ACCA Rules but not as a fundamental principle.

1.4 Independence, objectivity and integrity

$ PHPEHU·V REMHFWLYLW\ must be beyond question if he or she is to report as an auditor. That
objectivity can only be assured if the member is, and is seen to be, independent.

7KH $&&$·V UHJXODWLRQV LQFOXGH UHTXLUHPHQWV IRU FRQWURO RI ILUPV GHVLJQHG WR HQVXUH WKDW
these are controlled by qualified persons and that their independence from outside influences
is assured. The guidance which follows indicates areas of risk arising from various situations
DQGUHODWLRQVKLSVLQZKLFKDPHPEHU·VLQGHSHQGHQFHDVDXGLWRUDQGKHQFHKLVREMHFWLYLW\PD\
be threatened.

$UHDRIULVN²XQGXHGHSHQGHQFH on an audit client

Objectivity may be threatened or appear to be threatened by undue dependence on any audit

client or group of connected clients.

7KH 5XOHV WKHUHIRUH UHFRPPHQG OLPLWV IRU WKH DPRXQW RI D SUDFWLFH·V LQFRPH Z KLFK FDQ EH
earned from recurring fees from a particular client or group of connected clients. If the limits
ZHUHH[FHHGHGWKHSUDFWLFH·VLQGHSHQGHQFHFRXOGEH FRP SURPLVHG VLQFH LW PLJKW EH XQDEOH WR
make a stand on a particular area of disagreement with the client, since the loss of the client
ZRXOGKDYHDVHULRXVILQDQFLDOHIIHFWRQWKHSUDFWLFH·VIXWXUH

The Rules distinguish between the limits for public interest com panies and other companies.

Action required Public interest companies (ie Other companies

listed companies or banks,
insurance companies etc)

No action required. < 5% of gross practice fees <10% of gross practice fees

Review procedures must be triggered Between 5% and 10% of gross Between 10% and 15% of
to ensure that an independent practice income gross practice income
viewpoint can be maintained.

It is recommended that these limits >10% of gross practice income >15% of gross practice
should not be exceeded for one client. income

Explanatory notes

(a) Gross practice fees

In the case of a member practising part-time, use his gross earned income.

(b) Recurring work

The fees from a num ber of one-off assignments could, if taken together w ith recurring w ork,
give rise to a problem of undue dependence on an audit client. One-off assignments w hich by
their special and repetitive nature become regular assignments, should be treated as if they
were recurring w ork.

(c) Listed companies

In this context, listed companies means companies whose shares or securities have been
admitted to listing by a recognised stock exchange.

The IFAC rules are similar, but do not specify any percentages as in the ACCA rules.

29
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1.5 Other public interest companies

There are some unlisted companies and organisations, in both the private and public sectors,
ZKLFK DUH ¶LQ WKH SXEOLF H\H· EHFDXVH RI WKHLU VL]H RU WKH SURGXFW RU VHUYLFH WKH\ SURYLGH
Examples of such companies and organisations w ould be large charitable organisations and
trusts, major m onopolies, duopolies, building societies, industrial and provident societies or
credit unions, deposit-taking organisations, and those holding investment business client
money.

The above percentages criteria should not be regarded as rigid lim its; other qualitative factors
may be relevant (eg, size and nature of the practice or client, relationship between practice and
client).

A new practice seeking to establish itself, or an established practice reducing its activities, need
not comply with the percentages above (but particular care should be taken to safeguard
independence).

W here the gross fee income of an office w ithin a practice is regularly dependent on one client
(or group of connected clients) for more than 15% of its gross fees (10% for listed/public
interest client), a partner from another office of the practice should take final responsibility for
any report made by the practice on the affairs of that client. (The same considerations apply to
every partner whose income from the practice depends significantly on the retention of a
specific audit client or group of connected clients.)

1.6 $UHDRIULVN±RYHUGXHIHHV
The existence of significant overdue fees from an audit client or group of connected clients can
be a threat or appear to be a threat to objectivity akin to that of a loan (see below). The IFAC
UXOHVVWDWHWKDWRYHUGXHIHHVVKRXOGJHQHUDOO\EHUHTXLUHGWREHSDLGEHIRUHWKHIROORZ LQJ\HDU·V
report is signed.

1.7 Area of risk - actual or threatened litigation

$ ILUP·V REMHFWLYLW\ PD\ EH WKUHDWHQHG RU DSSHDU WR EH WKUHDWHQHG Z KHQ LW LV LQYROYHG LQ RU
even threatened with, litigation in relation to a client.

Discussion

W here the claim is material to either the client or the auditor, litigation could represent a
breakdown in the relationship of trust between auditor and client.

Legal action may place the auditor and client in adversarial positions which could:

¨ FDOOLQWRTXHVWLRQWKHDXGLWRU·VDELOLW\WRUHSRUWIDLUO\DQGLPSDUWLDOO\RQWKHDFFRXQWVDQG
¨ affect the willingness of management to disclose relevant information to the auditor.

Illustrations

Litigation arising solely from a fee dispute (or w here the firm is obliged to sue for its fees) may
not impair independence, provided that the am ount of fees is not significant.

The issue by the client of a writ for negligence against the auditor, or the com mencement of
litigation by the auditor alleging eg, fraud or deceit by officers of the company, would be
considered to impair independence.

30
 Chapter 3 Ethics and code of conduct

Conclusion

It is not possible to specify precisely the point at w hich it would become improper for a firm to
continue as auditors. However a firm should have regard to circumstances w here litigation
might reasonably be perceived by the public as in contemplation (eg. where publicity is given to
matters adversely affecting a listed or other public interest company and reference is made to
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1.8 $UHDRIULVN±DVVRFLDWHGILUPVLQIOXHQFHVRXWVLGHWKHSUDctice
$ ILUP·V REMHFWLYLW\ PD\ EH WKUHDWHQHG RU DSSHDU WR EH WKUHDWHQHG DV D UHVXOW RI SUHVVXUHV
arising from associated practices or organisations, or from other external sources, such as
bankers, solicitors, government or those introducing business.

1.9 $UHDRIULVN±IDP LO\DQGRWKHUSHUVRQDOUHODWLRQVKLSV

$ PHPEHU·V REMHFWLYLW\ PD\ EH WKUHDWHQHG RU DSSHDU WR EH WKUHDWHQHG DV D FRQVHTXHQFH RI D
family or other close personal or business relationship.

Discussion

The threat to independence may be less where:

¨ a partner or senior member of staff is not personally engaged on the audit in question;
¨ his or her office is distant from the reporting office;
¨ effective safeguards are in place in the internal procedures of the practice.

A connection with a junior member of staff of the practice is less likely to be a threat than a
connection with a senior member of staff or partner.

Illustrations

Problems may arise where a practice or anyone closely connected with it has a m utual business
interest with a client, or w ith an officer or employee of a client (such problem s can also exist
where the officer or employee is closely connected with a partner or member of staff).

Problems can also arise if an officer or senior employee of an audit client is so closely
connected with the partner or senior member of staff responsible for the conduct of the audit as
WRJLYHULVHWRUHDOIHDUVRIDODFNRILQGHSHQGHQFH)RUWKHSXUSRVHVRIWKLVSDUDJUDSK¶FORVHO\
FRQQHFWHG· SHUVRQV LQFOXGH DGXOW FKLOGUHQ DQG WKHLU VSRXVHV EURWKHUV DQG VLVWHUV DQG WKHLU
spouses, and any relative to whom regular financial assistance is given, or who is otherwise
indebted financially to the partner or senior mem ber of staff.)

Conclusions

A member should not personally take part in the conduct of the audit of a company if he or she
has, during the period upon which the report is to be made or at any time in the two years
prior to the first day thereof, been an officer (other than auditor) or em ployee of that company.

A practice should not report on a company if a company associated w ith the practice fills the
appointment of secretary to the client (there is no objection to the practice providing assistance
to the company secretary).

1.10 $UHDRIULVN±EHQHILFLDOLQWHUHVWV in shares and other investm ents

$PHPEHU·VREMHFWLYLW\PD\EHWKUHDWHQHGRUDSSHDUWREHWKUHDWHQHGZKHUHKH RUVKHKROGVD
beneficial interest in the shares or other forms of investm ent in a company upon which the
practice reports.

31
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Discussion

A practice should ensure that it does not have as an audit client a company in which a partner
or anyone closely connected with a partner has a beneficial interest.

A practice should not employ a member of staff on the audit of a client if that member of staff,
or a person closely connected with him or her, has a beneficial interest.

Conclusions

W here a partner inherits shares or marries a shareholder, or a relevant investment occurs as a

result of a takeover, the investment should be disposed of at the earliest practicable date. The
same action should be taken where an investment is held in a company w hich subsequently
becomes an audit client.

W here a provision in the Articles of Association of a com pany or an Act of Parliament requires
the auditor to be a shareholder the auditor should hold not m ore than the minimum number of
shares necessary to comply with that provision in the Articles or with the Act, and the
VKDUHKROGLQJ VKRXOG EH GLVFORVHG LQ WKH DFFRXQWV LQ WKH GLUHFWRUV· UHSRUW RU WKH DXGLWRUV·
report.

1.11 $UHDRIULVN±EHQHILFLDOLQWHUHVWVLQWUXVWV
The objectivity of a practice may be threatened or appear to be threatened w here a partner or a
person closely connected with the partner or a member of staff has a beneficial interest in a
trust having a shareholding in an audit client company.

Discussion

W here a trust in which a partner or a person closely connected w ith a partner is a beneficiary
holds or acquires shares in a company audited by the practice where the partner:

¨ is and wishes to remain a trustee, the shareholding should be regarded as equivalent to a

beneficial shareholding, and the practice should cease to report;

¨ is not a trustee, he should cease personally to take part in the audit of the company as soon
as he becomes aware of the shareholding.

W here a member of staff has an interest in a trust having a shareholding in an audit client, that
employee should not be employed on the audit of that client.

1.12 $UHDRIULVN±WUXVWHHLQYHVWP HQW

$ PHPEHU·V REMHFWLYLW\ PD\ EH WKUHDWHQHG RU DSSHDU WR EH WKUHDWHQHG E\ EHLQJ D WUXVWHH RI D
trust that has a shareholding in an audit client company.

Discussion

Independence will be an issue w henever a practice carries out the audit of a company at a time
when a partner, a member of staff or a person closely connected with either is trustee of a trust
holding shares in that company. The threat to objectivity is patent w here the shareholding is in
excess of 10% of the issued share capital of the company or of the total assets of the trust.

Conclusions

The practice should not accept or continue appointment as auditors w here:

¨ the trust holds shares in a listed company or other public interest company; and

32
 Chapter 3 Ethics and code of conduct

¨ WKH KROGLQJ LV LQ H[FHVV RI  RI WKH LVVXHG VKDUH FDSLWDO RI WKH FRPSDQ\ RU WKH WUXVW·V
aggregate investment in the company exceeds 10% of the total assets comprised in the
trust.

1.13 $UHDRIULVN±YRWLQJRQDXGLWDSSRLQWPHQW
W here a partner or member of staff holds shares in any capacity in a company which is an
audit client of the practice they should not be voted on at any general meeting of the com pany
in relation to the appointment, rem oval or remuneration of auditors.

1.14 $UHDRIULVN±ORDQV
Objectivity may be threatened or appear to be threatened by a loan to or from an audit client.

Discussion

A practice or anyone closely connected with it should not, either directly or indirectly or by
way of trust or other interm ediary:

¨ make a loan to or guarantee borrowings by an audit client;

¨ accept a loan from such a client; or
¨ have borrow ings or other obligations guaranteed by such a client.

This advice does not normally apply to:

¨ any account in credit w ith a client clearing bank or similar financial institution;

¨ a loan, overdraft or home mortgage from an audit-client financial institution in the normal
course of business and on normal commercial terms by a partner or member of staff,
provided that:

² the loan is not applied so as to subscribe to partnership capital; and

² the partner is not an engagement partner in relation to the client.

1.15 $UHDRIULVN±JRRGVDQGVHUYLFHVKRVSLWDOLW\
Objectivity may be threatened or appear to be threatened by acceptance of goods, services or
hospitality from an audit client.

Discussion

Goods or services should not be accepted by a practice or by anyone closely associated w ith it
unless the value of any benefit is modest.

Acceptance of undue hospitality poses a similar threat.

The IFAC rules confirm these points. Neither the firm nor any member of the audit team
should accept gifts or hospitality from a client unless the value is clearly insignificant.

1.16 $UHDRIULVN±SURYLVLRQRIRWKHUVHUYLFHV to audit clients

There are occasions where objectivity may be threatened or appear to be threatened by the
provision to an audit client of services other than the audit.

Discussion

There is no objection in principle to a practice providing services to a client in addition to the

audit. However, care must be taken not to perform management functions or to make
management decisions.

In the case of many audit clients it is comm on to provide a range of accountancy services,
which may include participation in the preparation of accounting records. However, in the

33
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case of a listed company or other public interest company audit client a practice should not
SDUWLFLSDWH LQ WKH SUHSDUDWLRQ RI WKH FRPSDQ\·V DFFRXQWV DQG DFFRXQWLQJ UHFRUGV VDYH LQ
relation to assistance of a routine clerical nature or in emergency situations. (Such routine
clerical assistance might include, for example, w ork on the finalisation of statutory accounts,
including consolidations and tax provisions. The scale and nature of such w ork should be
regularly reviewed.)

In all cases in which a practice is concerned in the preparation of accounting records for an
audit client the following safeguards should be observed:

¨ the client should accept responsibility for the records as its own;

¨ the practice should not assume the role of management conducting the operations of an
enterprise; and

¨ the practice should make appropriate audit tests even w here it has processed or
maintained certain records.

M embers are warned in particular of the dangers of inadvertently being draw n into the
provision of management functions where a range of services has been provided to an audit
client over a period of years. A member should be careful not to go beyond the advisory role
and drift into the management sphere.

: KHUHFRQVXOWDQF\RUVLPLODUZRUNLVFDUULHGRXWRQDUHJXODUEDVLV LW PD\ EHFRPH ´UHFXUULQJ

ZRUNµDQGWKHUHIRUHEHFRPHDWKUHDWWRLQGHSHQGHQFHRQWKHJURXQGVRIIHHLQFRPH

Recruitment of key financial and administrative staff for an audit company is an instance
where a practice should proceed with care. W hilst it is acceptable for the practice to advertise
IRU DQG LQWHUYLHZ SURVSHFWLYH VWDII DQG SURGXFH D ¶VKRUW OLVW· DQG UHFRP PHQGDWLRQV WKH final
decision in every case as to w hom to engage should be left to the client.

1.17 AreasRIULVN±SURYLVLRQRIVSHFLDOLVWYDOXDWLRQV to audit clients

$ILUPVKRXOGQRWDXGLWDFOLHQW·VILQDQFLDOVWDWHPHQWVZ KLFKLQFOXGHWKHSURGXFWRIDVSHFLDOLVW
valuation carried out by it or an associated practice or organisation in the same country or
overseas.

This guidance is not retrospective in effect. However, in those instances in w hich a firm is
required to report on financial statements incorporating valuations previously undertaken by it
or its associates, the firm should implement appropriate arrangements and safeguards to
include independent review by a partner unconnected with the engagement.

1.18 Review procedures

To guard against loss of independence, every audit firm should establish review procedures,
including an annual review, to:

¨ satisfy itself that each engagement may be accepted/continued; and

¨ identify situations where independence may be at risk so that appropriate safeguards can be
applied.

W herever the review procedures indicate that an audit assignment should be accepted or
continued only with additional safeguards against loss of independence, the engagement
SDUWQHU·VGHFLVLRQDQGWKHUDQJHRIVDIHJXDUGVDSSURSULDWHWRWKHDVVLJQPHQWVKRXOGEHVXEMHFW
to an independence review by a partner unconnected with the engagement.

Discussion

Such safeguards against loss of independence should include the following, according to the

34
 Chapter 3 Ethics and code of conduct

size and circumstances of the practice and the size and circum stances of the clients:

¨ the inclusion of a manager or other qualified employee in the audit team;

¨ rotation of the engagement partner; and
¨ rotation of senior members of staff.

It may be prudent to adopt a procedure under w hich staff engaged on an audit assignment are
able in the last resort to report any area of concern to a partner other than the engagement
partner.

1.19 Sole practitioners and small firms

Since all the safeguards suggested above will not be available to the sole practitioner w ithin his
or her practice, the practitioner should set up alternative standing arrangements to consult
externally w ith another member. W here the arrangements are with another practitioner they
could include provisions as to the maintenance by the latter of client confidentiality and an
undertaking not to accept instructions from any client w hose work is the subject of review for a
period of tw o years thereafter.

To the extent that a small firm may find difficulty in implementing the safeguards referred to
above, the partners should set up external consultation arrangements appropriate to their
particular circumstances.

Discussion

: KHUH WKH SUDFWLWLRQHU·V RZ Q UHYLHZ LQGLFDWHV WKDW DQ DXGLW HQJDJHPHQW VKRXOG RQO\ EH
DFFHSWHG RU FRQWLQXHG ZLWK DGGLWLRQDO VDIHJXDUGV WR SURWHFW WKH SUDFWLWLRQHU·V LQGHSHQGHQFH
he or she should undertake such consultation before proceeding further. The extent of the
consultation w ill vary according to the nature of the problem; in some cases it may be confined
to a discussion of principles; in others it may involve an examination of the file or a discussion
of personal relationships.

A sole practitioner should not accept or continue appointment as auditor of a com pany at a
time w hen he is trustee of a trust holding shares in that company, unless he has made
arrangements for such consultation.

1.20 Conflicts of interest

This deals w ith two types of conflict of interest: conflicts between the interests of a firm and a
client, and conflicts between the interests of different clients.

The implications arising from the possession and use of confidential information are separate
issues.

A firm should not accept or continue an engagement in w hich there is or is likely to be a

significant conflict of interest between the firm and its client.

W hether a significant conflict of interest exists w ill depend on all the circum stances of the case.

The test is whether a reasonable observer, aware of all the facts, would consider the interest as
likely to affect the objectivity of the firm.

However, any material financial gain w hich accrues or is likely to accrue to the firm as a result
of the engagement (other than in the form of fees or other reward from the client for its
services, or comm ission etc, properly earned and declared) will always amount to a significant
conflict of interests for this purpose.

There is, on the face of it, nothing improper in a firm having tw o or m ore clients whose
interests may be in conflict. In such a case however, the work of the firm should be so
managed as to avoid the interests of one client adversely affecting those of another. W here the

35
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH,QWHUQDWLRQDO

acceptance or continuance of an engagement w ould, even with safeguards, materially

prejudice the interests of any client the appointment should not be accepted or continued, or
one of the appointments should be discontinued.

All reasonable steps should be taken to ascertain whether any conflict of interests exists or is
likely to arise in the future, both in regard to new engagements and to the changing
circumstances of existing clients.

Relationships with existing clients need to be considered before accepting a new appointment
and regularly thereafter.

W herever a significant conflict between the interests of different clients or potential clients is
identified sufficient disclosure should be made to the clients or potential clients concerned,
together with details of the safeguards proposed below, so that they may make an informed
decision as to w hether to engage the firm or continue their relationship w ith the firm.

W here adequate disclosure is not possible by reason of the constraints of confidentiality the
firm should not accept or continue both assignments.

W here a firm becomes aware of a possible conflict between the interests of two or m ore clients
all reasonable steps should be taken to manage it and thereby avoid any adverse consequences.

These steps should include the following safeguards except w here they are inappropriate:

¨ the use of different partners and team s of staff for different engagements;

¨ standing instructions and all other steps necessary to prevent the leakage of confidential
information between different teams and sections within the firm;

¨ regular review of the situation by a senior partner or com pliance officer not personally
involved with either client; and

¨ advising at least one or all clients to seek additional independent advice.

1.21 Changes in professional appointments

The ethical code of conduct applies to the relationship between audit firm s as well as to that
between auditor and client.

A member w ho is asked to accept nomination as auditor should, except where the company or
organisation has not previously had an auditor:

¨ UHTXHVW WKH SURVSHFWLYH FOLHQW·V SHUPLVVLRQ WR FRP PXQLFDWH ZLWK WKH DXGLWRU ODVW
appointed. If such permission is refused he should decline nomination.

¨ on receipt of permission, request in writing of the auditor last appointed all information
which ought to be made available to him to enable him to decide whether he is prepared to
accept nom ination.

A member receiving such a request should request permission of the client to discuss the
FOLHQW·V DIIDLUV IUHHO\ ZLWK WKH SURSRVHG QRPLQHH ,I WKLV UHTXHVW LV QRW JUDQWHG WKH P HPEHU
should report that fact to the proposed nom inee, w ho, if a member, should not accept
nomination.

On receipt of permission from the client, the member should:

¨ disclose fully all information needed by the nominee to enable him to decide whether to
accept nom ination.

¨ discuss freely with the proposed nominee all matters relevant to the appointment of which
the latter should be aware, and disclose fully all information w hich appears to him to be
UHOHYDQW WR WKH FOLHQW·V DIIDLUV RU ZKLFK PD\ EH UHDVRQDEO\ UHTXHVWHG E\ KLP RI WKH
proposed nominee.

36
 Chapter 3 Ethics and code of conduct

The same principles apply in respect of changes of appointment for all recurring professional
work.

1.22 Additional professional work

A member invited to undertake professional work additional to that already being carried out
by another accountant, who w ill still continue w ith his existing duties, should, as a matter of
professional courtesy, notify the other accountant of the work he is undertaking. This
notification need not be given if the client advances a valid reason against it. The member
undertaking the additional w ork has the right to expect of the continuing accountant full co-
operation in carrying out his assignment.

1.23 Audit committees

An audit com mittee is a com mittee of the Board of Directors established to give additional
assurance regarding the quality and reliability of financial information used by the Board, and
the financial statements issued by the business.

The audit com mittee is generally composed of non-executive directors, three to five in number.
It should meet at least twice a year and should present its findings to the Board of Directors.

It could typically have the follow ing powers.

¨ Ability to obtain any necessary information from management.

¨ Permission to consult with external auditors.

¨ Review of the financial content of all sections of the annual report.

¨ Liaison with external auditors, including a review of audit findings and recom mendations
on the appointment and remuneration of auditors.

¨ 5HYLHZRIPDQDJHPHQW·VP RQLWRULQJRILQWHUQDOFRQWUROV

¨ Liaison with internal auditors.

¨ Specific oversight responsibilities, particularly in regulated industries such as the financial

services sector.

The existence of a strong audit committee will enhance the independence of auditors, since the
com mittee w ill offer an unbiased interface between the auditors and the executive directors.
For this reason, an increasing number of stock exchanges and governm ents are requiring
companies to establish audit comm ittees.

1.24 ,QGHSHQGHQFH±WKHH[WHUQDODQGLQWHUQDODXGLWFRQWH[WV
The internal auditor is a servant of management while the external auditor is the agent of the
shareholders. This generally accepted statement has an implied subtext that the internal
auditor lacks the same degree of objectivity and independence. This can be regarded as a
simplistic view today. Internal audit is now recognised as an important aspect of managerial
control. It is an essential control in the global business environment of the 21 st century. It can
be postulated that internal auditors should enjoy the same degree of independence as external
auditors for the following reasons:

¨ They have a duty of care to senior management w ho em ploy them as trusted responsible
agents.

¨ They have an ethical duty of independence and objectivity.

¨ They are assumed to be put on enquiry by suspicious circumstances (the test of diligence)
and therefore they have a duty to report any irregularity.

37
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH,QWHUQDWLRQDO

¨ They are trusted to discharge their duties with competence.

The importance of internal audit is dealt with in greater detail in the next chapter.

2 Confidentiality (ACCA Statement 3.3)

Information confidential to a client or em ployer acquired in the course of professional work
should not be disclosed except w here consent has been obtained from the client, employer or
other proper source, or w here there is a legal right or duty to disclose.

W here a member is in doubt as to w hether he has a right or duty to disclose he should, if

appropriate, initially discuss the matter fully within his firm or organisations. If that is not
appropriate, or if it fails to resolve the problem, he should consider taking legal advice.

A member acquiring or receiving confidential information in the course of his professional

work should neither use nor appear to use that information for his personal advantage or for
the advantage of a third party.

W hen a member changes his firm or employment he is entitled to use experience gained in the
previous firm or employment but not confidential inform ation acquired there.

A member should not deal in the shares of a company w ith w hich he has a professional
association at such a time or in such a manner as m ight make it seem that he was turning to his
ow n advantage information obtained by him in his professional capacity.

It may be a criminal offence in certain circumstances to use confidential information for an

improper purpose. For example, in many countries a law has been passed to prohibit the use
of unpublished price-sensitive information for personal gain (insider dealing).

3 The client/auditor relationship

3.1 Knowing the client
An auditor w ho holds office under statute assumes considerable responsibilities. He has a
duty of care to carry out his w ork competently. He should not take on engagements which he
cannot properly fulfil. The auditor is assumed to carry out his task displaying a reasonable
VWDQGDUGRIVNLOODQGFDUH7KHLQWHUSUHWDWLRQRI´UHDVRQDEOHµLVKLJKO\VXEMHFWLYHDXGLWRUVDUH
generally judged by the opinions of their peers. Important features, therefore, of a good
auditor/client relationship are:

(a) understanding how the business operates, its strengths and its weaknesses, the
markets served, the products it supplies;

(b) a good w orking relationship with the key members of the management team;

(c) a clear understanding of the nature of the services provided by the auditor to his client;

(d) an awareness of Z KDW FDQ EH UHJDUGHG DV ¶EHVW SUDFWLFH· DQG WKH DELOLW\ WR LPSOHPHQW
the latest professional developments.

On being asked to accept appointment as auditor to a new client, there are various matters that
the auditor should consider before accepting such an appointment. The m ore important of
these are:

Does the firm have the capability and resources to carry out the audit?

The auditor w ill need to determine:

(a) the size, location and nature of business of the prospective client;
(b) the tim ing of the audit;
(c) the number and degree of experience of the staff required;

38
 Chapter 3 Ethics and code of conduct

(d) the current com mitments of the firm;

(e) WKHILUP·VH[SHULHQFHLQWKHDXGLWRIVXFKDEXVLQHVV

Is the firm independent of the client?

The auditor m ust establish the independence of the firm in the context of the IFAC Code of
Ethics and the ACCA Rules of Professional Conduct with regard to such issues as fees and
shareholdings.

39
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH,QWHUQDWLRQDO

Are there any other reasons for not accepting appointment?

Before starting a new audit the proposed new auditor should comm unicate w ith any existing
auditor both as a matter of courtesy and also to enquire w hether there is any professional
reason w hy the audit should not be accepted. The procedure should be as follows:

(a) 3URSRVHG QHZ DXGLWRU UHTXHVWV KLV SURVSHFWLYH FOLHQW·V SHUPLVVLRQ WR FRP PXQLFDWH
with the existing auditor, and on receipt of permission requests the existing auditor to
make available all information necessary to enable him to decide whether he can
accept nom ination.

(b) 7KH H[LVWLQJ DXGLWRU DVNV KLV FOLHQW IRU KLV DJUHHPHQW WKDW KH PD\ GLVFXVV WKH FOLHQW·V
affairs freely with the proposed new auditor, and on receipt of permission discloses
fully all relevant information needed.

If the client refuses his consent to free comm unication, the proposed new auditor should
decline nomination.

Having established satisfactory answers to each of the above questions, the auditor is in a
position to accept the appointment. Once the appointment has been accepted the auditor
should confirm that the regulations of the relevant statute relating to appointment of auditors
have been complied with by inspecting the appropriate minutes.

3.2 The contract

W hen an auditor holds office he undertakes to carry out a service for the company. In any
contract there are generally terms that are expressly agreed between the parties and those
which are implied. The express WHUPV RI DQ DXGLWRU·V FRQWUDFW FDQ EH H[SUHVVHG LQ ZULWLQJ E\
sending the client an engagement letter. This is discussed more fully in the next section. The
impliedWHUPVRIDQDXGLWRU·VFRQWUDFWDUHDOVR ZRUWK\ RI QRWH  0 RVW DXGLWRUV ZRXOG UHFRJQLVH
these as:

(a) SUHVHUYLQJWKHFOLHQW·VFRQILGHQWLDOLW\
(b) taking reasonable care of any documents entrusted to them;
(c) being aware of any rules of law affecting their appointment.

The last point refers not only to w hat is reasonable skill and care but also to the duty of care that
is owed not only to the client but also to any third party w ho may suffer injury through the
DXGLWRU·V QHJOLJHQFH $Q DXGLWRU PXVW EH DZDUH RI WKH VFRSH DQG OLPLWV RI KLV UHVSRQVLELOLWLHV
and must ensure that the client understands them also.

3.3 The engagem ent letter

Introduction

It is now regarded as an essential part of audit practice to send to the client an engagement
letter which sets out the terms under which the assignment is to be carried out.

The requirement to send an engagement letter to every client (audit or non-audit) is set out in
ISA 210 Terms of Audit Engagements w hich should be followed as a guide to best professional
practice. If such a letter is sent the chances of misunderstandings occurring between client and
auditor are minimised.

´7KHDXGLWRUDQGWKHFOLHQWVKRXOGDJUHHRQWKHWHUPVRIWKHHQJDJHPHQW7KHDJUHHGWHUPV
ZRXOGQHHGWREHUHFRUGHGLQDQDXGLWHQJDJHPHQWOHWWHURURWKHUVXLWDEOHIRUPRIFRQWUDFWµ
(ISA 210).

40
 Chapter 3 Ethics and code of conduct

The features of the engagement letter

Introduction and purpose

On accepting any appointm ent an auditor should write a letter to the client as soon as possible,
with the purpose of defining clearly the extent of his responsibilities. The engagement letter
achieves this purpose by documenting and confirming:

(a) WKHDXGLWRU·VDFFHptance of his appointment;

(b) the objective and scope of the audit;
(c) WKHH[WHQWRIWKHDXGLWRU·VUHVSRQVLELOLWLHV
(d) the form of his report.

7KH FOLHQW VKRXOG QRUPDOO\ UHSO\ WR WKLV OHWWHU FRQILUPLQJ WKH DXGLWRU·V XQGHUVWDQGLQJ RI WKH
above matters; agreement will happen more readily if the contents of the letter have been
SUHYLRXVO\GLVFXVVHGEHWZHHQWKHDXGLWRUDQGWKHFOLHQW·VPDQDJHPHQW

Principal contents

(a) Introduction paragraph confirming the appointment.

(b) Definition of the audit: this should cover both the objective of an audit as per ISA 200
and, in the case of a company audit, an outline of the basic requirements of the relevant
statute.

(c) Scope of the audit: the letter should deal with (inter alia):

(i) the ascertainment of system s;

(ii) the evaluation of controls;

(iii) the need to obtain adequate evidence;

(iv) reporting to members;

(v) reporting to management of any significant weaknesses;

(vi) any special arrangements concerning eg, internal auditors, divisions,

subsidiaries;

(vii) the responsibility of the client, not the auditor, to institute and maintain
adequate systems and controls, and to prepare financial statements;

(viii) areas where the auditor does not intend to rely on the internal controls.

(d) Detection and prevention of errors and fraud: it m ust be stressed that this is not the main
SXUSRVHRIWKHDXGLWVLQFHLWLVWKHUHVSRQVLELOLW\RIWKHFOLHQW·VPDQDJHPHQWEXWWKDW
the auditor w ill plan his audit so that he has a reasonable expectation of detecting
material misstatements in the financial statements.

(e) Management representations: w here appropriate, the auditor should confirm that prior to
completion of his audit he may seek management representations on certain matters
affecting the financial statements.

(f) Accounting and taxation services: the auditor may undertake services for his client in
addition to his statutory duties as auditor; the letter should outline clearly the
DFFRXQWDQW·VDQGWKHFOLHQW·VUHVSRQVLELOLWLHVLQUHODWLRQWRWKHVHVHUYLFHVDQGWRWKHGD\
to-day bookkeeping, the maintenance of all accounting records and the preparation of
financial statements.

(g) Fees: mention should normally be made of fees and the general basis on w hich they are
computed and rendered.

An example of a letter of engagement complying w ith ISA 210 can be found below.

41
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH,QWHUQDWLRQDO

Specimen engagement letter

H C Andersen
Chartered Certified
Accountant

2222 Regents Park Road

London NW99

The Directors
Ice Queen Refrigerator Ltd
Colindale Business Park
London NW97

Dear Sirs

Terms of engagement for the audit of Ice Queen Refrigerator Ltd

The purpose of this letter is to set out the basis on which we (are to) act as auditors of
the company (and its subsidiary undertakings) and the respective areas of
responsibility of the directors and of ourselves.
Responsibilities of directors and auditors
1.1 As directors of the above company, you are responsible for ensuring that the
company maintains proper accounting records and for preparing financial
statements which give a true and fair view and have been prepared in
accordance with the relevant statutory requirements. You are also
responsible for making available to us, as and when required, all the
FRPSDQ\·V DFFRXQWLQJ UHFRUGV DQG DOO RWKHU UHOHYDQW UHFRUGV DQG UHODWHG
LQIRUPDWLRQ LQFOXGLQJ PLQXWHV RI DOO PDQDJHPHQW DQG VKDUHKROGHUV·
meetings.
1.2 We have a statutory responsibility to report to the members whether in our
opinion the financial statements give a true and fair view and whether they
have been properly prepared in accordance with statute. In arriving at our
opinion, we are required to consider the following matters, and to report on
any in respect of which we are not satisfied:
(a) whether proper accounting records have been kept by the company
and proper returns adequate for our audit have been received from
branches not visited by us;
(b) ZKHWKHU WKH FRPSDQ\·V EDODQFH VKHHW DQG LQFRPH VWDWHPHQW DUH LQ
agreement with the accounting records and returns;
(c) whether we have obtained all the information and explanations
which we consider necessary for the purposes of our audit; and
(d) ZKHWKHU WKH LQIRUPDWLRQ JLYHQ LQ WKH GLUHFWRUV· UHSRUW LV FRQVLVWHQW
with the financial statements.
In addition, there are certain other matters which, according to the
circumstances, may need to be dealt with in our report. For example, where
WKH ILQDQFLDO VWDWHPHQWV GR QRW JLYH GHWDLOV RI GLUHFWRUV· UHPXQHUDWLRQ RU RI
their transactions with the company, statute requires us to disclose such
matters in our report.
1.3 We have a professional responsibility to report if the financial statements do
not comply in any material respect with applicable accounting standards,
unless in our opinion the non-compliance is justified in the circumstances. In
determining whether or not the departure is justified we consider:
(a) whether the departure is required in order for the financial
statements to give a true and fair view; and
(b) whether adequate disclosure has been made concerning the

42
 Chapter 3 Ethics and code of conduct

departure.

1.4 Our professional responsibilities also include:

(a) LQFOXGLQJLQRXUUHSRUWDGHVFULSWLRQRIWKHGLUHFWRUV·UHVSRQVLELOLWLHV
for the financial statements where the financial statements or
accompanying information do not include such a description; and
(b) considering whether other information in documents containing
audited financial statements is consistent with those financial
statements.
Scope of audit
2.1 Our audit will be conducted in accordance with the International Standards
on Auditing and will include such tests of transactions and of the existence,
ownership and valuation of assets and liabilities as we consider necessary.
We shall obtain an understanding of the accounting and internal control
systems in order to assess their adequacy as a basis for the preparation of the
financial statements and to establish whether proper accounting records have
been maintained by the company. We shall expect to obtain such appropriate
evidence as we consider sufficient to enable us to draw reasonable
conclusions therefrom.
2.2 The nature and extent of our procedures will vary according to our
DVVHVVPHQWRIWKHFRPSDQ\·VDFFRXQWLQJV\VWHPDQGZKHUHZHZLVKWRSODFH
reliance on it, the internal control system, and may cover any aspect of the
EXVLQHVV·VRSHUDWLRQVWKDWZHFRQVLGHUDSSURSULDWH2XUDXGLWLVQRWGHVLJQHG
WR LGHQWLI\ DOO VLJQLILFDQW ZHDNQHVVHV LQ WKH FRPSDQ\·V V\VWHPV EXW LI VXFK
weaknesses come to our notice during the course of our audit which we think
should be brought to your attention, we shall report them to you. Any such
report may not be provided to third parties without our prior written consent.
Such consent will be granted only on the basis that such reports are not
prepared with the interests of anyone other than the company in mind and
that we accept no duty or responsibility to any other party as concerns the
reports.
2.3 As part of our normal audit procedures, we may request you to provide
written confirmation of certain oral representations which we have received
from you during the course of the audit on matters having a material effect on
the financial statements. In connection with representations and the supply of
information to us generally, we draw your attention to the statutory rule
under which it is an offence for an officer of the company to mislead the
auditors.
2.4 In order to assist us with the examination of your financial statements, we
VKDOO UHTXHVW VLJKW RI DOO GRFXPHQWV RU VWDWHPHQWV LQFOXGLQJ WKH FKDLUPDQ·V
VWDWHPHQWRSHUDWLQJDQGILQDQFLDOUHYLHZDQGWKHGLUHFWRUV·UHSRUWZKLFKDUH
due to be issued with the financial statements. We are also entitled to attend
all general meetings of the company and to receive notice of all such
meetings.
2.5 (Where appropriate) We appreciate that the present size of your business
renders it uneconomic to create a system of internal control based on the
segregation of duties for different functions within each area of the business.
In the running of your company we understand that the directors are closely
LQYROYHG ZLWK WKH FRQWURO RI WKH FRPSDQ\·V WUDQVDFWLRQV  ,Q SODQQLQJ DQG
performing our audit work we shall take account of this supervision. Further,
we may ask additionally for confirmation in writing that all the transactions
undertaken by the company have been properly reflected and recorded in the
DFFRXQWLQJ UHFRUGV DQG RXU DXGLW UHSRUW RQ \RXU FRPSDQ\·V ILQDQFLDO
statements may refer to this confirmation.
2.6 The responsibility for safeguarding the assets of the company and for the
prevention and detection of fraud, error and non-compliance with law or
regulations rests with yourselves. However, we shall endeavour to plan our
audit so that we have a reasonable expectation of detecting material
misstatements in the financial statements or accounting records (including
those resulting from fraud, error or non-compliance with law or regulations),

43
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH,QWHUQDWLRQDO

but our examination should not be relied upon to disclose all such material
misstatements or frauds, errors or instances of non-compliance as may exist.

2.7 (Where appropriate) We shall not be treated as having notice, for the
purposes of our audit responsibilities, of information provided to members of
our firm other than those engaged on the audit (eg information provided in
connection with accounting, taxation and other services).
2.8 Once we have issued our report we have no further direct responsibility in
relation to the financial statements for that financial year. However we expect
that you will inform us of any material event occurring between the date of
our report and that of the Annual General Meeting which may affect the
financial statements.
Accounting and other services, and taxation services (either included here or set out
in a separate letter)
It was agreed that we should carry out the following services as your agents and on the
basis that you will make full disclosure to us of all relevant information.
Accounting and other services
3.1 Prepare the financial statements based on accounting records maintained by
yourselves;
3.2 Provide assistance to the company secretary by preparing and lodging returns
with the Registrar of Companies;
3.3 Investigate irregularities and fraud upon receiving specific instructions.
Taxation services
4.1 We shall in respect of each accounting period prepare a computation of
profits, adjusted in accordance with the provisions of relevant statute, for the
purpose of assessment to company tax. Subject to your approval, this will
WKHQEHVXEPLWWHGWRWKHWD[DXWKRULWLHVDVEHLQJWKHFRPSDQ\·VIRUPDOUHWXUQ
We shall lodge formal notice of appeal against excessive or incorrect
assessments to tax where notice of such assessment is received by us. Where
appropriate, we shall also make formal application for postponement of tax in
dispute and shall advise as to appropriate payments on account.
4.2 You will be responsible, unless otherwise agreed, for all other returns, more
particularly: the returns of income tax deducted at source, returns relating to
employee taxes and returns of employee expenses and benefits. Your staff
will deal with all returns and other requirements in relation to sales taxes.
4.3 :H VKDOO EH SOHDVHG WR DGYLVH \RX RQ PDWWHUV UHODWLQJ WR WKH FRPSDQ\·V WD[
liability, the implications of particular business transactions and on other
taxation matters which you refer to us.
Fees
5 Our fees are computed on the basis of the time spent on your affairs by the
partners and our staff, and on the levels of skill and responsibility involved.
Unless otherwise agreed, our fees will be charged separately for each of the
main classes of work described above, will be billed at appropriate intervals
during the course of the year and will be due on presentation.
Agreement of terms
6 Once it has been agreed, this letter will remain effective, from one audit
appointment to another, until it is replaced. We shall be grateful if you could
confirm in writing your agreement to these terms by signing and returning
the enclosed copy of this letter, or let us know if they are not in accordance
with your understanding of our terms of engagement.
Yours faithfully

44
 Chapter 3 Ethics and code of conduct

Hans C Andersen

3.4 Tendering for audit work

The relationship of auditor and client is often put under strain due to competitiveness and the
drive to ensure that the corporate audit delivers value for money. Auditors may be asked to
tender for a new audit in competition w ith the existing incumbent. Auditors may also have to
justify their continued appointment as being in the best interest of members. Typical issues
that may arise in this context are set out in the table below.

Issue Risk area

)HHV²FOLHQWVSURWHVWDWLQFUHDVHVLQIHHV ´/RZEDOOLQJµ E\ FRPSHWLWRUV LH D FRPSHWLWRU
bids for the audit and is prepared to do the work
for what is an attractively reduced fee. This is a
delicate ethical issue as low-balling may constitute
an incentive and is therefore a breach of the
ethical code.
Disagreements on accounting policies. ´2SLQLRQ VKRSSLQJµ ² WKH FOLHQW WULHV WR ILQG DQ
audit firm with a more sympathetic outlook. This
generally means an unwillingness to qualify the
audit report and a tendency to take a more liberal
stance to interpretation of law and GAAP.
Failure to detect a serious misstatement. Loss of client confidence and another firm is
sought as a replacement.
Third parties such as bankers want a more This is often cited as a reason to dispense with a
prestigious audit firm. ILUP·V VHUYLFHV DQG UHSODFH WKHP ZLWK D ODUJHU
practice.
Lack of technical expertise. The client replaces the firm with one that offers a
range of specialisms such as management
consultancy.
Lack of national or international perspective. The firm is replaced by a large firm with the
facility to supply services on an international
basis.

3.5 ISA 240 - Fraud and error

,W LV WKH GLUHFWRUV· UHVSRQVLELOLW\ WR WDNH VWHSV WR SUHYHQW DQG GHWHFW IUDXG and error. It is not
WKH DXGLWRUV· IXQFWLRQ WR SUHYHQW IUDXG DQG HUURU 7KH IDFW WKDW DQ DXGLW LV FDUULHG RXW PD\
however, act as a deterrent.

Auditors should plan and perform their audit procedures and evaluate and report the results
thereof, recognising that fraud or error may materially affect the financial statements.

Fraud refers to intentional misrepresentations in the financial statements.

Error refers to unintentional mistakes in the financial statements. The auditor is concerned
with both of these since either can cause a misstatement in the financial statements on w hich
the auditor is giving an opinion.

W hen planning the audit the auditors should assess the risk that fraud or error may cause the
financial statements to contain material misstatements.

The risk of fraud or error is increased if the follow ing exist:

¨ Previous incidents that call into question the competence or integrity of management or
other staff.
¨ Particular financial or reporting pressures.

45
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH,QWHUQDWLRQDO

¨ W eaknesses in the accounting and internal control system.

¨ Unusual transactions.
¨ Problems in obtaining sufficient appropriate audit evidence.
¨ Inadequate control in a com puterised environment.

The following list gives specific examples of conditions or events w hich increase the risk of
fraud or error:

¨ M anagement domination by one person (or a small group).

¨ Unnecessarily complex corporate structure.
¨ High turnover rate of staff.
¨ Personnel who do not take holidays.
¨ Understaffed accounts department.
¨ Volatile business environment.
¨ Inadequate w orking capital.
¨ Deteriorating quality of earnings.
¨ Inadequate segregation of duties.
¨ Lack of monitoring of control systems.
¨ Unusual transactions.
¨ Payments for services that appear to be out of proportion to effort.
¨ Significant transactions with related parties.
¨ Inadequate computer system s.

Based on their risk assessment, the auditors should design audit procedures so as to have a
reasonable expectation of detecting m isstatements arising from fraud or error w hich are
material to the financial statements.

7KH DXGLWRU·V MRE LV WR JDWKHU DXGLW HYLGHQFH RQ Z KHWKHU WKH ILQDQFLDO VWDWHPHQWV JLYH D WUXH
and fair view. The auditor should therefore aim to identify all material fraud and error, since
these will directly affect the view given by the statements.

Practice question 1 (The answer is in the final chapter of this book)

Soul

<RX DUH WKH PDQDJHU UHVSRQVLEOH IRU WKH DQQXDO UHYLHZ RI \RXU ILUP ·V DXGLW HQJDJHPHQWV WR
identify situations where independence may be at risk and where the appropriate safeguards
should be applied.

)URP\RXUUHYLHZRI\RXUILUP·VILOHVUHODWLQJWR6RXO6KRSSOF\RXDVFHUWDLQWKHIROORZLQJ

The company is expanding rapidly follow ing a number of acquisitions and is preparing to
apply for admission to the Stock Exchange and to offer a proportion of its shares to the public.
As a result of the special investigations undertaken, total fees from Soul Shop plc amount to 17
SHUFHQWRI\RXUILUP·VJURVVSUDFWLFHLQFRPHIRUWKHFXUUHQW\HDU

The company is about to undertake a feasibility study, on a proposal to expand into Europe,
ZKLFK LV WR EH NHSW VHFUHW IURP HPSOR\HHV 7R NHHS WKH LQLWLDO FRVWV RI WKH 6RXO 6KRS WHDP ·V
European travel expenses a secret, a partner (who is not the engagement partner) has offered to
have them put onto his credit card. They w ould then be billed as professional fees.

Required

(a) Explain the risks you w ould consider in deciding w hether or not the appointment
should continue. (8 marks)

(b) Briefly describe the safeguards available. (5 marks)

46
 Chapter 3 Ethics and code of conduct

(c) Come to a conclusion on whether you consider the appointment should continue.
(2 marks)

7RWDO²PDUNV

47
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH,QWHUQDWLRQDO

Approach to the question

Keep your answers relevant to the specific scenario with w hich you are faced.

Do not just list all the risks and threats to independence you can think of. The best approach is
to underline the relevant bits from the scenario ie, the threats to independence particular to
Soul Shop plc.

Also, do not just make a statement. Ensure that you also explain its relevance.

For example, in part (a) you might write:

´(YHQWXDOO\WKHIHHIRUWKHDXGLWZLOODFFRXQWIRUSHUFHQWRIWKHILUP·VJURVVSUDFWLFHLQFRPH
ZKLFKZ RXOGPHDQXQGXHUHOLDQFHRQRQHFOLHQWDQGUHSUHVHQWDWKUHDWWRLQGHSHQGHQFHµ

There is never anything wrong with stating the obvious ie, including a point that appears
ORJLFDO DQG UHDVRQDEOH EXW ZDV QRW LQFOXGHG LQ D VWXGHQW·V ´OLVW RI SRLQWV WR OHDUQµ 6RXO 6KRS
plc is rapidly expanding so it may well be that your audit firm is physically too small to cope
with the audit.

Your conclusion should be based upon your arguments in the first two parts of the question.
There will be no right or wrong answer but there will be marks available for a well-argued
decision.

W e will now look at a full past exam question. It is comm on for exam questions to be divided
up, and here the requirement is in a number of sections w ith separate mark allocations. This
enables the examiner to:

¨ test a number of areas within one overall question.

¨ discover w hether or not students are able to allocate their time efficiently. Students will not
gain a decent overall mark unless they answer all parts of the question so time allocation
within the allotted question time is of the utm ost importance.

Practice question 2 (The answer is in the final chapter of this book)

Phones

You are the partner in charge of a four partner firm of Chartered Certified Accountants. Your
firm has been invited to tender for the audit of Phones Anyw here Limited for the year ended
31 December 20X5.

Phones Anyw here Limited was established tw o years ago, and it provides a mobile phone
service for individuals and businesses. The system being established by the company
comprises the following.

¨ Small portable m obile phones, w hich allow subscribers (users) to contact or be contacted
by any other telephone.

¨ The mobile phones can be used within range of a local relay station, which receives calls
from and sends calls to the m obile phones.

¨ The local relay stations are linked to a central computer which connects the calls to other
XVHUV)UHTXHQWO\WKLVLVWKURXJKDFRPSHWLWRU·VWHOHSKRQHQHWZRUN

¨ Currently, the local relay stations cover one large city w ith a population of about 1,000,000.
W ithin the next year the system will cover all large cities in the region w ith a population of
over 250,000. By the year 20X8, the system will cover all m otorways and cities with a
population of over 100,000. Extending the coverage of the system will involve considerable
capital expenditure on new relay stations and require additional borrowings.

48
 Chapter 3 Ethics and code of conduct

¨ The cost of the relay stations and central computer is capitalised and written off over six
years.

¨ The mobile phones are manufactured by other com panies and sold through retailers.
Phones Anyw here does not sell the phones, but it pays $200 to the retailer for each phone
sold and subscription signed by the customer to Phones Anyw here. This payment is
capitalised in the financial statements of Phones Anywhere and written off over four years.

¨ Subscribers are invoiced monthly w ith a fixed line rental and a variable call charge. Other
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computer.

¨ All the shares are ow ned by three wealthy individuals w ho are non-executive directors.
They will receive a fixed salary. They do not plan to make any further investment in the
company.

¨ Establishing the netw ork of relay stations and subscribers will result in the company
making losses for at least three years. Current borrowings are about 20 per cent of
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expected the company will be highly geared by the year 20X8.

¨ As the com pany w ill not be profitable, the non-executive directors have decided that
executive directors should receive a basic salary and a bonus based on the number of
subscribers to the system.

¨ The ow ners plan to float the company on the Stock Exchange in the year 20X8. The
flotation will involve issuing new shares to the general public to provide funds for the
company, and the three non-executive directors selling some of their shares.

You are aware that Phones Anywhere has a number of very large competitors, each of w hich
has a large number of users and comprehensive coverage (ie over 90 per cent of the regional
population are within range of a relay station).

Required

In relation to the audit of Phones Anywhere Limited, you are to:

(a) describe the ethical matters you should consider in deciding whether your audit firm
should accept the audit. This should include considering whether your firm has the
technical and logistical ability to carry out the audit. (8 marks)

(b) come to a conclusion on w hether you w ould advise your firm to accept or decline the
audit, giving your principal reasons for com ing to this decision. (4 marks)

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Approach to the question

Look at the mark allocation carefully and try to decide how many points you are going to
make. For 8 marks you need to do m ore than just write a sentence each for eight different
points. Ensure that you make the most of each point you include.

Keep the follow ing model in mind.

DEFINE Ÿ EXPLAIN Ÿ ILLUSTRATE

Even if you cannot apply this m odel exactly to each point you make, if you understand what it
means, and how to use it, then you w ill produce more complete answers.

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DEFINE Ÿ make a statement

EXPLAIN Ÿ expand the point
ILLUSTRATE Ÿ use an example to clarify the point, preferably an example taken out of the
question scenario.

Here is an example from the scenario above.

¨ Define/state. The ow ners plan to float the com pany on the stock exchange in the year 20X8
so Phones Anywhere is likely to be a rapidly expanding company.

¨ Explain/expand. It is likely that Phones Anywhere will become much larger than it is
already (certainly very large in relation to the size of our audit firm).

¨ Illustrate. W e, as auditors, are likely to find ourselves with the problem of not having
enough staff to adequately complete the audit.

If you adopt this approach w hen producing a list of points, you w ill avoid one-line points
which do not tend to gain good marks.

This model w ill also result in an acceptable volume of w ork for each answer. Both quality and
quantity are important in examinations.

4 Summary
IFAC has published a Code of Ethics for Professional Accountants w hich lays down the
general principles that an accountant should follow.

The ACCA has published m ore detailed Rules of Professional Conduct that students and
members are required to observe.

A key fundamental principle is that ACCA members should strive to maintain objectivity and
independence in their judgements. So, for example, a member should not be unduly
dependent on the fees earned from one audit client, should not ow n shares in audit clients, and
should not accept lavish gifts from audit clients.

Confidential information concerning a client should not normally be disclosed by the auditor
to any third party.

ISA 210 explains how the auditor should send his client an engagement letter to avoid
misunderstandings of the responsibilities of the client and the auditor.

ISA 240 explains how the auditor should plan his audit work in the light of possible fraud and
error in the financial statements.

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