Chp15: Integrity, Objectivity & Independence

• Threats to independence:

  • Self-interest
  • Self-review
  • Advocacy
  • Familiarity
  • Intimidation
  • Management
• Examples of self-interest threat:

  • Financial interests
  • Close business relationships
  • Gifts & hospitality
  • Loans and guarantees
  • Overdue fees
  • High percentage of fees
  • Lowballing
• Assurance firm, partners, audit or non-audit staff and immediate family members of such persons are prohibited from having a direct financial interest in the client
• Financial interest safeguards:

  • Disposing of the interest
  • Removing individual from team
  • Keeping audit committee aware
  • Use engagement quality control reviewer
• Audit firms and their clients should not have close business relationships e.g. joint venture, combining products, leases between parties
• Close business relationship safeguards:

  • Should not participate in venture unless immaterial and insignificant
  • No business relationships (unless at arm's length)
  • Should terminate business relationship
• Gifts and hospitality should not be accepted unless the value of the gift is clearly insignificant in cost and nature
• Gifts & Hospitality Safeguards:

  • Gift acceptance policy
  • Certain members should not accept gifts
• Loans and guarantees examples:

  • Immaterial amounts lent are not a threat to independence
  • If loan was material then safeguards needed
• Loan and guarantees safeguards:

  • Member of engagement should not enter into a loan agreement unless with a bank
  • Independent review of material loan from a lending institution
• Overdue fees may mean that the assurance provider runs the risk of making a 'loan' to the client
• Overdue fees safeguard:

  • Payment of overdue fees should be paid before the assurance report is issued
• High percentage of fees examples:

  • Total audit fees should not be generated from one or few clients
  • Fee should not exceed 10% for a listed company
  • Fee should not exceed 15% for an unlisted company
  • Total non-audit fees must be no more than 70% of the average audit fee from the last 3 years
• High percentage of fees safeguards:

  • Monitor fee income
  • Discussing breaches with audit committees
  • Disclose breaches to ethics partner
  • Taking steps to reduce the dependency on client
  • Obtain internal/external quality control reviews
  • Consulting a third party (e.g. ICAEW)
  • Resignation is a last resort
• IFAC (IESBA) code states that if total firm fees exceed 15% for over 2 consecutive years, the firm must:

  • Disclose to those charged with governance
  • Conduct quality control reviews of those years before/after opinion is issued
• Lowballing examples:

  • When firm charges lower fee than normal
  • Size of fee must not be influenced by the provision of non-audit services to the client
• Lowballing safeguards:

  • Record that appropriate staff and time spent on client
  • Comply with all applicable assurance standards and quality control procedures
• Percentage/contingent fee example:

  • Fee based on the outcome of the audit
• A firm should not enter into any fee arrangement under which the amount of the fee is contingent on the result of the audit work
• Self-review threat examples:

  • Service with an assurance client
  • Internal audit services
  • Preparing accounts & financial statements
  • Valuation services
  • Tax services
• Audit firm members who previously provided services to the client should not be assigned to the engagement team (until 2 years following leaving the client)
• Audit firms cannot provide internal audit services to an audit client (applies to both listed and unlisted companies)
• Audit firms should not prepare account records for listed clients
• Preparing records & financial statements safeguards:

  • Using staff members other than assurance team to carry out work
  • Source data for accounting entries to be originated from audit client
  • Underlying assumptions originated and approved by audit client
• Valuation services safeguards:

  • Second partner review
  • Client understands valuation and assumptions used
  • Client acknowledges responsibility for valuation
  • Use separate personnel for the valuation and the audit
• Tax services examples:

  • Tax return preparation
  • Tax calculations for accounting entries
  • Tax planning
  • Assistance in dispute resolution
• Management must take responsibility for tax returns when tax services are provided (safeguard)
• Separate staff (unlisted companies) to be used for tax calculations for accounting entries but for listed companies this is prohibited if material
• Tax planning is allowed when supported by previous evidence but is not allowed if subjective and material (safeguard)
• Assistance in dispute resolution is allowed if separate personnel are used for unlisted companies but not allowed for listed companies if material
• Advocacy threat safeguards may be using different departments to carry out work and disclosing work to audit committees
• Familiarity threat examples:

  • Long association with assurance clients
  • Family and personal relationships between client/firm
• Long association safeguards:

  • Rotate senior staff on audit engagement
  • Engagement partner shall not act for more than 5 years and only can act again after 5 years have elapsed (listed company)
  • Other key partners should not act for a period greater than 7 years
  • If the partner has been involved for 10 years in an unlisted company then the third-party test is applied
• If there is a family or personal relationship between an audit member and a client member then the individual should not be part of the audit of the client
• FRCs Ethical Standards include the management threat not ICAEW
• Management threat - Audit firm undertakes work involving making judgements and taking decisions that are the responsibility of management
• Others threats considered by audit firm:

  • Illegal activities of the client
  • Apparent dishonesty of the client
  • Questionable accounting practices of the client
• ICAEW framework for resolving ethical conflicts:

  • Relevant facts
  • Relevant parties
  • Ethical issues involved
  • Relevant fundamental principles
  • Established internal procedures
  • Alternative courses of action
• Pressures that may be faced by non-practice accountants:

  • Act contrary to law or regulation
  • Act contrary to technical or professional standards
  • Facilitate unethical or illegal earnings
  • Lie or mislead auditors
  • Associated with material misstatements
• Actions to take when threatened:

  • Resolve internally (if possible) using formal dispute resolution process
  • Obtain advice from ICAEW
  • Seek legal advice
  • Resign (last resort)