Ethical Issues in Accounting

Course Code: ACT 4102

Threats and safeguards

Integrity: This means that an accountant must be straightforward and

honest. It implies fair dealing and truthfulness.
a

Objectivity: This is a state of mind that excludes bias, prejudice and

compromise and that gives fair and impartial consideration to all matters
that are relevant to the task in hand, disregarding those that are not.
a

Independence is related to and underpins objectivity – it is freedom from

situations and relationships that make it probable that a reasonable and
informed third party would conclude that objectivity either is impaired or
could be impaired.
Self-interest threat

a. Financial interests:
The following safeguards will therefore be relevant:
 Disposing of the interest
 Removing the individual from the team if required
 Keeping the client's audit committee informed of the situation
 Using an independent partner to review work carried out if
necessary
b. Close business relationships:
Appropriate safeguards are therefore to end the assurance provision or to
terminate the (other) business relationship.
If an individual member of an assurance team had such an interest, he
should be removed from the assurance team.
Purchasing goods and services from an assurance client in the ordinary
course of business on an arm's length basis does not constitute a threat to
independence. However, if there are a substantial number of such
transactions, there may be a threat to independence and safeguards may
be necessary.
Self-interest threat (Cont.…)

c. Employment with assurance client:

Various safeguards might be considered:
a. Modifying the assurance strategy
b. Ensuring the assurance engagement is assigned to someone of
sufficient experience as compared with the individual who has left
c. Involving an additional professional accountant not involved with the
engagement to review the work done
d. Carrying out a quality control review of the engagement
a
 There is a significant threat to objectivity if a partner of an audit firm
accepts a key management position at a client of the firm.
 When any former member of an engagement team joins an audit client
as director/key management within a short length of time of being
involved with the audit, the firm should consider whether the
composition of the audit team is appropriate.
Self-interest threat (Cont.…)

c. Employment with assurance client (Cont.…):

 An individual who has moved from the firm to a client should not be
entitled to any benefits or payments from the firm unless these are
made in accordance with pre-determined arrangements. The individual
should not continue to participate (or appear to) in the firm's business
or professional activities. If money is owed to the individual, it should
not be so much as to compromise the independence of the assurance
engagement.
 A firm should have quality control procedures setting out that an
individual involved in serious employment negotiations with an audit
client should notify the firm and that this person would then be
removed from the engagement.
Self-interest threat (Cont.…)

d. Partner on client board:

It may be acceptable for a partner or an employee of an assurance firm to
perform the role of company secretary for an assurance client, if the role is
essentially administrative.
e. Family and personal relationships:
When an immediate family member of a member of the assurance team is
a director, an officer or an employee of the assurance client in a position to
exert direct and significant influence over the subject matter information
of the assurance engagement, the individual should be removed from the
assurance team.
The firm should also consider whether there is any threat to independence
if an employee who is not a member of the assurance team has a close
family or personal relationship with a director, an officer or an employee
of an assurance client.
If a firm inadvertently violates the rules concerning family and personal
relationships they should consider applying additional safeguards, such as
undertaking a quality control review of the assurance engagement and
discussing the matter with the audit committee of the client, if there is
one.
Self-interest threat (Cont.…)

f. Gifts and hospitality: Unless the value of a gift is clearly insignificant, or

hospitality, is reasonable in terms of its frequency, nature and cost, a firm
or a member of an assurance team should not accept them.
g. Loans and guarantees:
If a lending institution client lends an immaterial amount to an audit firm
or member of assurance team on normal commercial terms, there is no
threat to independence. If the loan was material it would be necessary to
apply safeguards to bring the risk to an acceptable level. A suitable
safeguard is likely to be an independent review (by another partner or a
partner from another office/firm).
Loans to members of the assurance team from a bank or other lending
institution client are likely to be material to the individual, but provided
that they are on normal commercial terms, these do not necessarily
constitute a threat to independence.
An assurance firm or member of the assurance team should not enter into
any loan or guarantee arrangement with a client that is not a bank or
similar institution.
Self-interest threat (Cont.…)

h. Overdue fees:
In a situation where there are overdue fees, the assurance provider runs
the risk of, in effect, making a loan to a client, whereupon the guidance
above becomes relevant.
Firms should guard against fees building up and being significant by
discussing the issues with those charged with governance (more
specifically, the audit committee), and, if necessary, the possibility of
resigning if overdue fees are not paid.
i. Percentage or contingent fees:
A firm should not enter into any fee arrangement for an assurance
engagement under which the amount of the fee is contingent on the result
of the assurance work or on items that are the subject matter of the
assurance engagement.
Self-interest threat (Cont.…)

j. High percentage of fees:

It is also necessary to beware of situations where the fees generated by an
assurance client present a large proportion of the revenue of an individual
partner.
Safeguards in these situations might include:
 Discussing the issues with the audit committee
 Taking steps to reduce the dependency on the client
 Obtaining external/internal quality control reviews
 Consulting a third party such as ICAB
Self-interest threat (Cont.…)

j. High percentage of fees:

It is also necessary to beware of situations where the fees generated by an
assurance client present a large proportion of the revenue of an individual
partner.
Safeguards in these situations might include:
 Discussing the issues with the audit committee
 Taking steps to reduce the dependency on the client
 Obtaining external/internal quality control reviews
 Consulting a third party such as ICAB
k. Lowballing:
When a firm quotes a significantly lower fee level for an assurance service
than would have been charged by the predecessor firm, there is a
significant self-interest threat. If the firm's tender is successful, the firm
must apply safeguards such as:
 Maintaining records such that the firm is able to demonstrate that
appropriate staff and time are spent on the engagement
 Complying with all applicable assurance standards, guidelines and
quality control procedures
Self-review threat

a. Service with an assurance client:

The situation where audit staff are temporarily 'loaned' to a client is also a
threat to audit objectivity unless it is not in a management position and
the client acknowledges its responsibility for directing and supervising
that work. The role should not include making management decisions or
exercising discretionary authority to commit the client to a particular
position or accounting treatment. When an audit staff member returns to
the firm after such a secondment, he should not be given a role in the audit
involving any function or activity that he performed/supervised while at
the client.
If an individual had been closely involved with the client prior to the time
limits set out above, the assurance firm should consider the threat to
independence arising and apply appropriate safeguards, such as:
 Obtaining a quality control review of the individual's work on the
assignment
 Discussing the issue with the audit committee
Self-review threat (Cont.…)

b. Preparing accounting records and financial statements:

Assurance firms must analyse the risks arising and put safeguards in place
to ensure that the risk is at an acceptable level. Safeguards include:
 Using staff members other than assurance team members to carry out
work
 Implementing policies and procedures to prohibit the individual
providing such services from making any managerial decisions on
behalf of the assurance client
 Requiring the source data for the accounting entries to be originated by
the assurance client
 Requiring the underlying assumptions to be originated and approved
by the assurance client
The rules are more stringent when the client is listed. SEC notification
dated 20th February, 2006 states that firms should not be involved in
other services, unless there is a good explanation.
Self-review threat (Cont.…)

c. Valuation services:
If the valuation is for an immaterial matter, the audit firm should apply
safeguards to ensure that the risk is reduced to an acceptable level.
Matters to consider when applying safeguards are the extent of the audit
client's knowledge of the relevant matters in making the valuation and the
degree of judgement involved, how much use is made of established
methodologies and the degree of uncertainty in the valuation.
Safeguards include:
 Second partner review
 Confirming that the client understands the valuation and the
assumptions used
 Ensuring the client acknowledges responsibility for the valuation
 Using separate personnel for the valuation and the audit
Self-review threat (Cont.…)

d. Taxation services:
Safeguards to mitigate these threats include:
 Tax services being provided by partners and staff with no involvement
in the audit of financial statements
 Tax services being reviewed by an independent tax partner or senior
tax employee
 Obtaining external independent advice on tax work
 Tax computations prepared by audit staff members being reviewed by
a partner/staff member of appropriate experience who is not a
member of the audit team
 An audit partner not involved in the audit engagement reviews
whether the tax work has been properly and effectively addressed in
the context of an audit of the financial statements
Self-review threat (Cont.…)

e. Internal audit services:

It may be appropriate to use safeguards such as ensuring that an employee
of the client is designated responsible for internal audit activities and that
the client approves all the work that internal audit does.
The key threat in providing internal audit services is self-review.
Appropriate safeguards should be applied to reduce the threat to an
acceptable level.
f. Corporate finance services:
Certain aspects of corporate finance services will create self-review
threats that cannot be reduced to an acceptable level by safeguards.
Therefore, assurance firms are not allowed to promote, deal in or
underwrite an assurance client's shares. They are also not allowed to
commit an assurance client to the terms of a transaction or consummate a
transaction on the client's behalf.
Other corporate finance services, such as assisting a client in defining
corporate strategies, assisting in identifying possible sources of capital
and providing structuring advice may be acceptable, provided that
safeguards, such as using different teams of staff, and ensuring no
management decisions are taken on behalf of the client are in place.
Self-review threat (Cont.…)

g. Information technology services:

The self-review threat is likely to be too significant to allow the provision
of such services to a financial statement audit client unless appropriate
safeguards are put in place ensuring that:
 The audit client acknowledges its responsibility for establishing and
monitoring a system of internal controls;
 The audit client designates a competent employee, preferably within
senior management, with the responsibility to make all management
decisions with respect to the design and implementation of the
hardware or software system;
 The audit client makes all management decisions with respect to the
design and implementation process;
 The audit client evaluates the adequacy and results of the design and
implementation of the system; and
 The audit client is responsible for the operation of the system
(hardware or software) and the data used or generated by the system.
Self-review threat (Cont.…)

h. Litigation support services:

An example of a litigation support service is acting as an expert witness.
Such services can cause self-review threats if they involve a subjective
estimation of the likely outcome of a pending legal matter material to the
financial statements. In addition, advocacy threats may arise.
Litigation support services that do not involve such subjective estimations
are not prohibited, provided that appropriate safeguards have been
established.
Advocacy threat:

An advocacy threat arises in certain situations where the assurance firm is

in a position of taking the client's part in a dispute or somehow acting as
their advocate. The most obvious instances of this would be when a firm
offered legal services to a client and, say, defended them in a legal case. An
advocacy threat might also arise if the firm carried out corporate finance
work for the client; for example, if the audit firm were involved in advice
on debt restructuring and negotiated with the bank on the client's behalf.
As with the other threats, the firm has to appraise the risk and apply
safeguards as necessary. Relevant safeguards might be using different
departments in the firm to carry out the work and making disclosures to
the audit committee. Remember, the ultimate option is always to withdraw
from an engagement if the risk to independence is too high.
Familiarity threat:

a. Long association of senior personnel with assurance clients:

 It can be a significant threat to independence if senior members of staff
at an audit firm have a long association with a client. All firms should
therefore monitor the relationship between staff and established
clients and use safeguards to independence such as rotating senior
staff off the assurance team, involving second partners to carry out
reviews and obtaining independent (but internal) quality control
reviews. Where appropriate safeguards cannot be applied, the firm
should resign.
 In addition, the Code of Ethics sets out specific rules for listed entities
in this situation. These state that for the audit of listed entities:
The engagement partner and individuals responsible for engagement
quality control review should be rotated after a pre-defined period,
normally no more than seven years, and should not return to the
engagement until a period of two years has elapsed.
 When an entity becomes a listed entity, the length of time the staff
involved with the audit have been involved should be taken into
consideration, but the engagement partner, other key partners and
quality control person should only continue in those positions for
another two years.
Familiarity threat (Cont.…):

b. Recruitment:
Recruiting senior management for an assurance client, particularly those
able to affect the subject matter of an assurance engagement creates
management, familiarity, self-interest and intimidation threats.
Assurance providers must not make management decisions for the client.
Their involvement could be limited to drawing up a shortlist of candidates,
providing that the client has drawn up the criteria by which they are to be
selected, and makes the final decision in respect of who to hire.
Intimidation threat:

a. Actual and threatened litigation:

The following safeguards could be considered:
 Disclosing to the audit committee the nature and extent of the litigation
 Removing specific affected individuals from the engagement team
 Involving an additional professional accountant on the team to review
work
However, if the litigation is at all serious, it may be necessary to resign
from the engagement, as the threat to independence is so great. However
it is not required to resign immediately in circumstances where a
reasonable and informed third party would not regard it in the interests of
the shareholders for it to do so.
Resolving ethical conflicts

The ICAB Code sets out a framework that professional accountants can
follow when seeking to resolve ethical problems. It states that the
professional accountant should consider:
 The relevant facts
 The relevant parties
 The ethical issues involved
 The fundamental principles related to the matter in question
 Established internal procedures
 Alternative courses of action
The accountant should then consider which is the course of action that
most aligns with the fundamental principles.
If the accountant cannot determine the best course of action himself, he
should refer it to the relevant department within his firm for more advice.
It is generally better for firms to come to conclusions 'in-house', but if
needs be, further advice can be sought from ICAB.
Thank you for Today!!!