Professional Ethics and ACCA’s Code of Ethics and Conduct

Professional Ethics and ACCA’s Code of Ethics and Conduct

Contents:

Session 1: Code of Ethics for Professional Accountants
Session 2: Five Fundamental principles
Session 3: Threats to objectivity
Session 4: Managing ethical threats in different situations

Referenced syllabus:

Syllabus A Audit framework and regulation: 4 Professional ethics and ACCA’s Code of Ethics and Conduct (a)-(d)

Referenced standards:

ACCA’s Code of Ethics and Conduct

Exam focus:

Section B in the exam usually provides a scenario requiring students to evaluate ethical issues. The following steps could be applied:

Step 1 – State threats from the case;

Step 2 – Level of threats and whether per code of ethics, this is banned;

Step 3 – Recommend actions or safeguards.

Session 1: Code of Ethics for Professional Accountants

Sketch - Code of Ethics and Conduct:

The International Ethics Standards Board for Accountants (IESBA) (from IFAC) developed an International Code of Ethics for Professional Accountants.

The ACCA Code of Ethics and Conduct is included in Section 3 of the ACCA’s Rulebook.

ACCA members, fellow members, affiliates and students need to follow this.

Overview:

Session 2: Five Fundamental principles:

Professional behaviour: (Mnemonics: CCD)

Principles:

Comply with law - An auditor should comply with relevant laws and regulations.

With courtesy - An auditor shall behave with courtesy and consideration towards all with whom the auditor comes into contact in a professional capacity.

Not discredit profession - should avoid any action that discredits the profession, ie make exaggerated claims for services or qualifications they can offer or have; make unsubstantiated comparisons to others’ work.

Integrity:

Principles:

Straightforward and honest - An auditor should be straightforward and honest in all professional and business relationships, ie declare potential conflicts of interests to clients and how safeguards are applied; protect client’s information and will not use this for private gains.

Do not lie in the audit report – If client’s accounts are materially misstated, auditor’s report shall reflect this, otherwise, auditor is lacking integrity.

Professional competence and due care:

Principles:

Knowledge and experience - An auditor has a continuing duty to maintain professional knowledge and skill at the level required to ensure that a client or employer receives competent professional service based on current developments in practice, legislation and techniques, ie

An auditor should not accept an audit appointment if the auditor does not have necessary expertise or resource to perform the audit effectively.

An auditor should ensure sufficient and competent audit professionals are assigned to carry out the audit.

CPD - The maintenance of professional competence requires a continuing awareness and an understanding of relevant technical, professional and business developments. Continuing professional development (CPD) enables professional accountant to develop and maintain the capabilities to perform competently within the professional environment.

Act per the standard - An auditor should act diligently and in accordance with applicable technical and professional standards when providing professional services. Diligence encompasses the responsibility to act in accordance with the requirements of an assignment, carefully, thoroughly and on timely basis.

A specific area - Opinion shopping (second opinion) - when client approaches a new audit firm to ask to provide a second audit opinion. New auditor shall gather all facts about this through professional clearance procedures, otherwise, it creates threats to professional competence and due care.

Confidentiality:

Principles:

Confidential information: no personal or 3^rd party advantage - Auditors shall not use client’s confidential information for personal advantage or for third party’s advantage; and

Confidential information: no disclosure - Auditors shall not disclose client’s confidential information to third party.

Disclosure of confidential information (obligatory)– when client involves in terrorist offences, money laundering activities or other situations required by laws.

Disclosure of confidential information (voluntary) – defend in court, situations in conflict with public’s interest such as client’s activities damaging the environment.

Objectivity:

Objectivity: An auditor should not allow bias (self interest, review, familiarity, management threats to objectivity), conflict of interest or undue influence of others (intimidation threat to objectivity) to override professional or business judgments.

Independence: Objectivity is a state of mind but in certain roles the preservation of objectivity has to be shown by the maintenance of independence from those influences which could impair objectivity.

Independence in mind: when an auditor issues an audit opinion, the auditor should keep independence in mind, ie following standards to do the work and remain integrity. For instance, when making professional judgment, the auditor considers the facts and the evidence and does not allow personal relationship or emotion to unduly influence the judgment.

Independence in appearance: Relationships that bias or unduly influence the professional judgment of the member should be avoided. For instance, an auditor should not audit a company’s accounts if the chief accountant responsible for the accounts is an immediate family member.

Conflicts of interest:

Situation 1. Conflicts between members' and clients' interests - A conflict between members' and clients' interests might arise if members compete directly with a client, or have a joint venture or similar with a company that is in competition with the client. This may threaten the member's objectivity.

Situation 2. Conflicts between the interests of different clients - Conflicts of interest can arise when a firm has two (or more) audit clients (usually competitors), both of which have reason to be unhappy that their auditors are also auditors of the other company.

Auditor should not accept audit appointment unless the conflicts of interests can be managed in the following ways:

Inform the potential client and the existing client of the conflict of interests.

Obtain consent to act from the both the potential client and client.

Assign two different audit teams with two different audit engagement partners to perform audit.

Implement control procedures to ensure client’s confidential information is adequately protected, including:

Physical and password controls to ensure audit working paper are segregated such that one audit team will not be able access the working papers for the audit for another client.

Emphasise the need for protecting client’s confidential information including refraining from discussing client’s matters with members outside the audit team.

Requiring audit engagement team to sign confidentiality agreement.

Session 3: Threats to objectivity:

Any threats to objectivity must be avoided or reduced to an acceptably low level.

1. Self-interest threat - occur as a result of the financial or other interests of an auditor or of an immediate or close family member.

Auditor’s interest - The fear of losing fee income may cause auditor to issue an unqualified opinion (ie the financial statements are true and fair) when in fact the financial statements contained material misstatements.

Close family member’s interest (job security) - If the auditor’s immediate family member is the finance manager of an audit client, the auditor may not report material misstatements detected to protect the career of the immediate family member.

Other examples:

A financial interest in a client or jointly holding a financial interest with a client;

Undue dependence on total fees from a client (should not exceed 15% income of the firm);

A close business relationship with a client;

Client’s potential employment;

Contingent fees relating to an assurance engagement;

A loan to or from an audit client or any of its directors.

2. Self-review threat - when members review their own work or advice as part of an assurance engagement, ie auditor prepares accounting records or Financial Statements, and then audits them.

3. Advocacy threat - occur when an auditor promotes a position or opinion to the point that subsequent objectivity may be compromised.

Examples:

Auditor promoting shares in a listed entity when that entity is a financial statement audit client.

Auditor attending an audit client’s meeting with potential investors to discuss a potential listing of the shares on a stock exchange will give the impression that the auditor supports the listing.

Auditor acting as an advocate on behalf of an audit client in litigation or disputes with third parties.

4. Familiarity threat - due to a long or close relationship with a client or employer, a professional accountant will be too sympathetic to their interests or too accepting of their work

Examples:

A member of the engagement team having a close or immediate family relationship with a director, or key management of the client;

A former audit partner of the firm becomes finance director or key management in accounting of the client;

Auditor accepting gifts from client, unless the value is clearly insignificant (this could be deemed as self interest threat);

Long association of senior personnel (ie audit partner or manager) with the audit client.

5. Intimidation threat - occur when an auditor may be deterred from acting objectively by actual threats or perceived threats from audit client.

Examples:

Auditor being threatened with dismissal, or replacement in relation to an audit engagement;

Auditor being threatened with litigation;

Auditor being pressured to reduce inappropriately the extent of work performed in order to reduce fees;

Management’s aggressive behaviour towards auditor.

6. Management threat - auditors assume management responsibilities.

Examples of management responsibilities:

Determine strategy;

Authorise transactions;

Report to those charged with governance on management’s behalf;

Prepare Financial Statements;

Design and maintain internal control system.

Audit firm makes a management decision on behalf of the client’s company may run a risk that the client’s company would fail. To reduce the liability to this, audit firm may issue an audit opinion which is not objective.

Session 4: Managing ethical threats in different situations:

Overall principles:

Before accepting clients, auditors must assess any ethical threats and either put appropriate safeguards in place or resign / reject appointment.

During the audit, ethical threats to objectivity shall be considered all the time with appropriate safeguards being put in place.

Cases/Situations:

Case 1: Auditor owning shares in audit client

Case 2: Auditor having indirect financial interests in audit client

Case 3: Loan from/to audit client

Case 4: Close business relationship

Case 5: Buying goods or services from audit client

Case 6: Family or close personal relationship

Case 7: Audit partner or manager becomes audit client

Case 8: Auditor seeking employment with audit client

Case 9: Audit client senior personnel joins audit firm

Case 10: Auditor serving as audit client director

Case 11: Auditor is invited to attend board’s meetings or board level committee meetings on a regular basis

Case 12: Long association of senior personnel with audit clients

Case 13: Providing non-audit services

Case 14: Preparing Accounting Records and Financial Statements

Case 15: Provision of Internal Audit Services to Financial Statement Audit clients

Case 16: Designing accounting system

Case 17: Temporary staff assignment to audit client (also known as seconding staff or secondment of staff)

Case 18: Valuation service

Case 19: Corporate finance service

Case 20: Auditor attending audit client’s meetings with potential investors

Case 21: Recruitment service

Case 22: Too dependent on audit client for fee income

Case 23: Overdue fee

Case 24: Low balling in audit tender

Case 25: Contingent fee (prohibited)

Case 26: Gift and hospitality

Case 27: Actual or Threatened Litigation

Case 1: Auditor owning shares in audit client:

Issue:

Own shares - If audit team member or its immediate family member own shares in the audit client - significant self-interest threat.

Safeguards to remove the threat:

Removal - Remove the member from the audit engagement, ie assign another person to the audit team.

Case 2: Auditor having indirect financial interests in audit client:

Issue:

If audit team member or its immediate family member own shares in the company which controls the client - significant self-interest threat.

Safeguards to reduce or remove the threat:

Sell shares - Dispose of the indirect financial interest in total or dispose of a sufficient amount of it so that the remaining interest is no longer material prior to the individual becoming a member of the audit team; or

Removal - Remove the member from the audit engagement.

Case 3: Loan from/to audit client:

Issues:

Situation 1 - Loan from an audit client that is a bank – self interest threat but can be managed:

A bank providing loan is normal course of business. A loan to the firm from an audit client that is a bank or a finance company, would not create a threat to independence if:

the loan is made under normal lending procedures, terms and requirements and;

the loan is immaterial to both the firm and the audit client.

Safeguards: do not obtain loan from audit client (bank) if:

The amount is material; or

The loan is not based on commercial term.

Situation 2 - Loan from audit client that is not a bank - Significant self-interest threat which can not be managed:

Safeguard: do not give loan to an audit client. i.e. loan to audit client is prohibited by the ACCA Code.

Case 4: Close business relationship:

Issues: (Self-interest threat because of financial interest)

Situation 1 - Joint venture - having a material financial interest in a joint venture with the audit client.

Situation 2 - Joint marketing – in promoting products or services, with reference to both parties.

Situation 3. Distributorship – firm acts a distributor of client’s product or services.

Safeguards: avoid or remove the threat. Do not start business relationship with audit client.

Case 5: Buying goods or services from audit client:

Issue:

If the purchase of goods or services is in the normal course of business; and with standard commercial term (no special discounts to firm), this is not a threat to objectivity.

Safeguards:

Do not buy goods or services from audit client if the transactions are NOT in the normal course of business, and there are significant discounts.

Case 6: Family or close personal relationship:

Issues:

Family and personal relationships between a member of the audit team and a director, or senior personnel in accounting of the audit client may create self-interest, familiarity or intimidation threats.

1. Immediate family:

Situation 1: Immediate family member of the auditor works for the audit client as a director or key management involved in accounting.

Safeguard: remove the auditor from the audit team and assign another auditor in the firm.

Situation 2: Immediate family member of the auditor works for the audit client, but NOT as a director or key management involved in accounting.

Safeguard: None, as the ethical threat is not significant.

2. Close personal relationship:

Close personal relationship between senior personnel, ie audit partner and finance director are close friends there will be significant familiarity threat. The auditor may not maintain professional scepticism because of the close friendship.

Safeguard: assign another auditor to the team.

Case 7: Audit partner or manager becomes audit client:

Issue:

If a member of the audit team or partner has joined the audit client, familiarity or intimidation threats will be created.

Familiarity threat：

The ex-audit partner or ex-audit manager is familiar with the firm’s audit methodology.

The ex-audit partner or ex-audit manager has close relationship with the audit team.

Intimidation threat:

The junior members of the audit team may be intimidated by the seniority and authority of the ex-audit partner or ex-audit manager.

Safeguards:

Adjust the audit plan to make the audit procedures less predictable to reduce familiarity threat;

Assigning an audit team that is of sufficient experience to reduce intimidation threat.

Case 8: Auditor seeking employment with audit client:

Issue:

A self-interest threat is created when a member of the audit team participates in the audit engagement while knowing, or having reason to believe, that he or she is to, or may, join the audit client some time in the future.

Safeguards:

Remove the individual from the audit engagement.

Perform an independent review of any significant judgments made by that individual while on the engagement.

Case 9: Audit client senior personnel joins audit firm:

Issue:

Client’s finance director joined the audit firm as audit partner. Self-review and familiarity threats may be created if this person is assigned to the audit the company he just left.

Self-review threat: He will be auditing the financial statements he was involved in the preparation.

Familiarity threat: He has friendship or close personal relationship with his ex-colleagues.

Safeguards: Such individuals should not be assigned to the audit team that audit his ex-employer, for at least 2 years after he left the audit client.

Case 10: Auditor serving as audit client director:

Issue:

Auditor who is a director of his audit client will be performing management duty.

The self-review and self-interest threats created would be so significant no safeguards could reduce the threats to an acceptable level.

Safeguard: auditor should not be a director of his audit client

Case 11: Auditor is invited to attend board’s meetings or board level committee meetings on a regular basis:

Issue:

This represents a self-interest threat as the audit firm may be perceived as performing the role of management by attending these meetings and this threatens objectivity.

Safeguard: do not accept such invitation.

Case 12: Long association of senior personnel with audit clients:

Issues:

Using the same engagement partner or the same individual responsible for the engagement quality control review on a financial statement audit over a prolonged period may create a familiarity threat.

Situation 1 - Audit client is a listed entity:

Safeguards:

The engagement partner and the individual responsible for the engagement quality control review should be rotated after serving in either capacity for a pre-defined period, normally no more than seven years; and

Such an individual rotating after a pre-defined period should not participate in the audit engagement until a further period of time, normally two years, has elapsed.

Situation 2 - Audit client is not a listed entity:

ACCA Code does not specify how many years of service will trigger a rotation.

Audit partner rotation is based on the audit firm’s professional judgement on how long the audit partner has been responsible for the audit.

Case 13: Providing non-audit services:

Issues:

Threats - Providing non-audit services to audit client will create self-review threat, advocacy threat, or self-interest threat, depending on the type of service provided.

Situation 1: Non audit services involve management decision – not allowed.

Situation 2: Non audit services do not involve management decision – safeguards to be put in place, ie using separate team, one for audit and one for non-audit work.

Case 14: Preparing Accounting Records and Financial Statements:

Issue:

Help prepare client’s accounts and then audit them.

Situation 1 - Financial Statement Audit Clients that are not listed entities – allowed as long as safeguards to be put in place.

Safeguards to reduce the threat to an acceptable level:

Assign two separate teams - the team that performs the accounting service shall not be involved in the audit

No management decisions - The team that provides accounting service shall not make any managerial decisions on behalf of the audit client.

Situation 2 - Financial Statement Audit Clients that are listed entities -not allowed.

Case 15: Provision of Internal Audit Services to Financial Statement Audit clients:

Issue:

A self-review threat may be created when an audit firm provides internal audit services to a financial statement audit client unless the internal audit services are unrelated to the internal accounting controls, financial systems or financial statements.

1. Audit client is a listed entity – not allowed.

2. Audit client is not a listed entity – allowed if sufficient safeguards are put in place:

Assign two separate teams: The internal audit services should be provided only by personnel not involved in the financial statement audit engagement and with different reporting lines within the firm.

Case 16: Designing accounting system:

Issue:

The provision of services by an audit firm to a financial statement audit client that involve the design and implementation of financial information technology systems that are used to generate information forming part of a client’s financial statements may create a self-review threat.

Situation 1 - Audit client is a listed entity – not allowed.

Situation 2 - Audit client is not a listed entity – allowed as long as sufficient safeguards are put in place.

Assign two separate teams: accounting system services should be provided only by personnel not involved in the financial statement audit engagement and with different reporting lines within the firm.

Case 17: Temporary staff assignment to audit client (also known as seconding staff or secondment of staff):

Issue:

The lending of staff by an audit firm to a financial statement audit client may create a self-review threat when the individual is in such a position to influence the preparation of a client’s accounts or financial statements.

Safeguards:

Not involved in audit - The staff providing the assistance should not be involved in the audit of the client to avoid self-review threat; and

Not involved in management decisions - The staff providing the assistance should not be involved in managerial decision or duty.

Case 18: Valuation service:

Issue:

A self-review threat may be created when a firm performs a valuation service for a financial statement audit client that is to be incorporated into the client’s financial statements.

Situation 1 - Audit clients that are not listed:

In the case of an audit client that is not a listed entity, if the valuation service has a material effect on the financial statements and the valuation involves a significant degree of subjectivity, no safeguards could reduce the self-review threat to an acceptable level. Accordingly, a firm shall not provide such a valuation service to an audit client.

Situation 2 - Audit clients that are listed entities:

Valuation that is material – not allowed.

Valuation that is not material – allowed as long as appropriate safeguards are in place:

Assign separate teams - the personnel providing valuation service shall not be involved in the audit

Case 19: Corporate finance service:

Issue:

The provision of corporate finance services advice or assistance to an assurance client may create advocacy threat so the audit firm is seen to be promoting the interests of the audit client.

1. Corporate finance services that are prohibited – underwriting client’s shares or the preparation of prospectus.

2. Corporate finance services that are not prohibited – allowed if this is not promoting client’s shares (such as advising on financing options, developing corporate strategies, ownership structure advice, identify possible targets to be acquired), and safeguards need to be put in place:

Individuals assisting the audit client shall not make managerial decisions on behalf of the client;

Individuals providing the corporate finance service to the audit client shall not be involved in the audit.

Case 20: Auditor attending audit client’s meetings with potential investors:

Issue:

This will create advocacy threat as the audit firm is seen as promoting the audit client’s interests.

Safeguards: auditor shall NOT attending audit client’s’ meetings with potential investors.

Case 21: Recruitment service:

Issue:

The recruitment of senior management for an audit client, such as those in a position to affect the financial reporting may create current or future self-interest, familiarity and intimidation threats.

1. A firm shall not provide the following recruiting services to an audit client that is a listed entity with respect to a director or officer of the entity or senior management in a position to exert significant influence over the preparation of the client’s accounting records or the financial statements:

searching for or seeking out candidates for such positions; and

undertaking reference checks of prospective candidates for such positions.

2. Other positions: The firm could generally provide such services as:

reviewing the professional qualifications of a number of applicants

providing advice on their suitability for the post

producing a short-list of candidates for interview based on criteria specified by the audit client.

The firm should not make management decisions and the decision as to whom to hire should be left to the client.

Case 22: Too dependent on audit client for fee income:

Issue:

When the total fees generated by an audit client represent large proportion of a firm’s total fees, the dependence on that client or client group and concern about the possibility of losing the client may create a self-interest threat. The audit client may threaten to change auditor which gives rise to intimidation threat.

Safeguards:

Reducing the dependency on the client, ie do not accept any additional assignments from the audit client.

Where an audit client is a public interest entity and, for two consecutive years, the total fees from the client represent more than 15% of the total fees received by the firm expressing the opinion on the financial statements of the client, the firm shall:

Safeguards:

disclose to those charged with governance of the audit client the fact that the total of such fees represents more than 15% of the total fees received by the firm, and

discuss which of the safeguards below it will apply to reduce the threat to an acceptable level, and apply the selected safeguard:

Prior to the issuance of the audit opinion on the second year’s financial statements, a professional accountant, who is not a member of the firm expressing the opinion on the financial statements, performs an engagement quality control review of that engagement or a professional regulatory body performs a review of that engagement that is equivalent to an engagement quality control review (“a pre-issuance review (hot review)”); or

After the audit opinion on the second year’s financial statements has been issued, and before the issuance of the audit opinion on the third year’s financial statements a professional accountant, who is not a member of the firm expressing the opinion on the financial statements, or professional regulatory body performs a review of the second year’s audit that is equivalent to an engagement quality control review (“a post-issuance review (cold review)”).

Case 23: Overdue fee:

Issue:

A self-interest threat may be created if fees due from an audit client for professional services remain unpaid for a long time, especially if a significant part is not paid before the issue of the assurance report for the following year.

The firm should also consider whether the overdue fees might be regarded as being equivalent to a loan to the client which is prohibited.

Generally the payment of such fees should be required before the report is issued.

Safeguard:

Arrange with the audit client so that significant proportion of the unpaid fee is collected before progressing further with this year’s audit.

Case 24: Low balling in audit tender:

Issue:

Charging low audit fee is allowed. However, audit fee that is too low creates a self-interest threat affecting professional competence and due care. In order for the audit engagement to be profitable despite a low audit fee, the auditor may inappropriately:

assign inexperienced audit staff;

reduce extent of audit procedures performed

Safeguards:

Ensure the audit engagement team collectively has the necessary competence and experience to perform audit effectively.

Ensure the audit is carried out according to International Standards on Auditing.

Case 25: Contingent fee on audit (prohibited in audit):

Contingent fees are fees calculated on a predetermined basis relating to the outcome of a transaction or the result of the work performed.

A contingent fee charged by a firm in respect of an audit engagement creates self-interest and advocacy threats that cannot be reduced to an acceptable level by the application of any safeguard.

Audit fee should be based on the time spent and the level of worked performed.

However, contingent fee is allowed in non-audit engagements.

Case 26: Gift and hospitality:

Issues:

Accepting gifts or hospitality from an audit client may create self-interest and familiarity threats.

When a firm or a member of the audit team accepts gifts or hospitality unless the value is clearly insignificant, the threats to independence cannot be reduced to an acceptable level by the application of any safeguard.

Safeguard:

A firm or a member of the audit team should not accept gifts or hospitality that is not clearly insignificant in value.

Case 27: Actual or Threatened Litigation:

Issue:

When litigation takes place, or appears likely, between the firm or a member of the audit team and the audit client, a self-interest or Intimidation threat may be created.

Safeguards:

Disclosure - Disclosing to the audit committee, or others charged with governance, the extent and nature of the litigation;

Removal - If the litigation involves a member of the audit team, removing that individual from the audit team; or

Withdraw - If such safeguards do not reduce the threat to an appropriate level, the only appropriate action is to withdraw from, or refuse to accept, the audit engagement.

Exam rehearsal question

Auditors have a professional duty of confidentiality under ACCA’s Code of Ethics and Conduct; voluntary disclosure of information may be necessary in certain situations.

For which TWO of the following situations should an auditor make VOLUNTARY disclosure?

(1) If an auditor knows or suspects his client is engaged in money laundering

(2) Where disclosure is made to non-governmental bodies

(3) Where it is in the public interest to disclose

(4) If an auditor suspects his client has committed terrorist offences

A 1 and 4

B 1 and 3

C 2 and 4

D 2 and 3

Answer: D

In the case of situations 1 and 4, the auditor has an obligation to disclose details of their clients’ affairs to third parties. Situations 2 and 3 are ones where voluntary disclosure should be made.

Exam rehearsal question - Horti & Co (Case Objective Test Question – 5 Qs)

You are an audit manager at Horti & Co and you are considering a number of ethical issues which have arisen on some of the firm’s long-standing audit clients. Tree Co Horti & Co is planning its external audit of Tree Co. Yesterday, the audit engagement partner, Charlie Thrower, discovered that a significant fee for information security services, which were provided to Tree Co by Horti & Co, is overdue. Charlie hopes to be able to resolve the dispute amicably and has confirmed that he will discuss the matter with the finance director, Percy Marsh, at the weekend, as they are both attending a party to celebrate the engagement of Charlie’s daughter and Percy’s son. Bush Co Horti & Co is the external auditor of Bush Co and also provides other non-audit services to the company. While performing the audit for the year ended 31 October 20X8, the audit engagement partner was taken ill and took an indefinite leave of absence from the firm. The ethics partner has identified the following potential replacements and is keen that independence is maintained to the highest level: Brian Smith who is also the partner in charge of the tax services provided to Bush Co Monty Nod who was the audit engagement partner for the ten years ended 31 October 20X7 Cassie Dixon who introduced Bush Co as a client when she joined the firm as an audit partner five years ago Pete Russo who is also the partner in charge of the payroll services provided to Bush Co Plant Co Plant Co is a large private company, with a financial year to 30 June, and has been an audit client of Horti & Co for several years. Alan Marshlow, a partner of Horti & Co, has acted as the engagement quality control reviewer (EQCR) on the last two audits to the year ended 30 June 20X8. At a recent meeting, he advised that he can no longer be EQCR on the engagement as he is considering accepting appointment as a non-executive director and will sit on the audit committee of Plant Co. The board of directors has also asked Horti & Co if they would be able to provide internal audit services to the company. Weed Co Weed Co, a listed company, is one of Horti & Co’s largest clients. Last year the fee for audit and other services was $1·2m and this year it is expected to be $1·3m which represents 16·6% and 18·1% of Horti & Co’s total income respectively.	Q1: Which of the following statements correctly explains the possible threats to Horti & Co’s independence and recommends an appropriate safeguard in relation to their audit of Tree Co? (1) An intimidation threat exists due to the overdue fee and Tree Co should be advised that all fees must be paid prior to the auditor’s report being signed (2) A self-review threat exists due to the nature of the non-audit work which has been performed and an engagement quality control review should be carried out (3) A self-interest threat exists due to the relationship between Charlie and Percy and Charlie should be removed as audit partner A 1, 2 and 3 B 1 and 2 only C 2 only D 3 only Answer: D In line with ACCA’s Code of Ethics and Conduct, a self-interest threat would arise due to the personal relationship between the audit engagement partner and finance director. A self-interest threat, not intimidation threat, would arise as a result of the overdue fee and due to the nature of the non-audit work, it is unlikely that a self-review threat would arise.

Exam rehearsal question - Horti & Co (Case Objective Test Question – 5 Qs)

You are an audit manager at Horti & Co and you are considering a number of ethical issues which have arisen on some of the firm’s long-standing audit clients. Tree Co Horti & Co is planning its external audit of Tree Co. Yesterday, the audit engagement partner, Charlie Thrower, discovered that a significant fee for information security services, which were provided to Tree Co by Horti & Co, is overdue. Charlie hopes to be able to resolve the dispute amicably and has confirmed that he will discuss the matter with the finance director, Percy Marsh, at the weekend, as they are both attending a party to celebrate the engagement of Charlie’s daughter and Percy’s son. Bush Co Horti & Co is the external auditor of Bush Co and also provides other non-audit services to the company. While performing the audit for the year ended 31 October 20X8, the audit engagement partner was taken ill and took an indefinite leave of absence from the firm. The ethics partner has identified the following potential replacements and is keen that independence is maintained to the highest level: Brian Smith who is also the partner in charge of the tax services provided to Bush Co Monty Nod who was the audit engagement partner for the ten years ended 31 October 20X7 Cassie Dixon who introduced Bush Co as a client when she joined the firm as an audit partner five years ago Pete Russo who is also the partner in charge of the payroll services provided to Bush Co Plant Co Plant Co is a large private company, with a financial year to 30 June, and has been an audit client of Horti & Co for several years. Alan Marshlow, a partner of Horti & Co, has acted as the engagement quality control reviewer (EQCR) on the last two audits to the year ended 30 June 20X8. At a recent meeting, he advised that he can no longer be EQCR on the engagement as he is considering accepting appointment as a non-executive director and will sit on the audit committee of Plant Co. The board of directors has also asked Horti & Co if they would be able to provide internal audit services to the company. Weed Co Weed Co, a listed company, is one of Horti & Co’s largest clients. Last year the fee for audit and other services was $1·2m and this year it is expected to be $1·3m which represents 16·6% and 18·1% of Horti & Co’s total income respectively.	Q2: Taking into account the concern of the ethics partner, which of the partners identified as potential replacements should take over the audit of Bush Co for the year ended 31 October 20X8? A Brian Smith B Monty Nod C Cassie Dixon D Pete Russo Answer: C In order to maintain independence, Cassie Dixon would be the most appropriate replacement as audit engagement partner as she has no ongoing relationship with Bush Co. Appointing any of the other potential replacements would give rise to self-review or familiarity threats to independence.

Exam rehearsal question - Horti & Co (Case Objective Test Question – 5 Qs)

You are an audit manager at Horti & Co and you are considering a number of ethical issues which have arisen on some of the firm’s long-standing audit clients.

Tree Co

Horti & Co is planning its external audit of Tree Co. Yesterday, the audit engagement partner, Charlie Thrower, discovered that a significant fee for information security services, which were provided to Tree Co by Horti & Co, is overdue. Charlie hopes to be able to resolve the dispute amicably and has confirmed that he will discuss the matter with the finance director, Percy Marsh, at the weekend, as they are both attending a party to celebrate the engagement of Charlie’s daughter and Percy’s son.

Bush Co

Horti & Co is the external auditor of Bush Co and also provides other non-audit services to the company. While performing the audit for the year ended 31 October 20X8, the audit engagement partner was taken ill and took an indefinite leave of absence from the firm. The ethics partner has identified the following potential replacements and is keen that independence is maintained to the highest level:

Brian Smith who is also the partner in charge of the tax services provided to Bush Co Monty Nod who was the audit engagement partner for the ten years ended 31 October 20X7

Cassie Dixon who introduced Bush Co as a client when she joined the firm as an audit partner five years ago

Pete Russo who is also the partner in charge of the payroll services provided to Bush Co

Plant Co

Plant Co is a large private company, with a financial year to 30 June, and has been an audit client of Horti & Co for several years. Alan Marshlow, a partner of Horti & Co, has acted as the engagement quality control reviewer (EQCR) on the last two audits to the year ended 30 June 20X8. At a recent meeting, he advised that he can no longer be EQCR on the engagement as he is considering accepting appointment as a non-executive director and will sit on the audit committee of Plant Co. The board of directors has also asked Horti & Co if they would be able to provide internal audit services to the company.

Weed Co

Weed Co, a listed company, is one of Horti & Co’s largest clients. Last year the fee for audit and other services was $1·2m and this year it is expected to be $1·3m which represents 16·6% and 18·1% of Horti & Co’s total income respectively.

Q3:

Which of the following correctly identifies the threats to Horti & Co’s independence and proposes an appropriate course of action for the firm if Alan Marshlow accepts appointment as a non-executive director of Plant Co?

	Threats	Course of action
A	Self interest and familiarity	Can continue with appropriate safeguards
B	Self interest and self review	Must resign as auditor
C	Self review and familiarity	Must resign as auditor
D	Familiarity only	Can continue with appropriate safeguards

Answer: B

Exam rehearsal question - Horti & Co (Case Objective Test Question – 5 Qs)

You are an audit manager at Horti & Co and you are considering a number of ethical issues which have arisen on some of the firm’s long-standing audit clients. Tree Co Horti & Co is planning its external audit of Tree Co. Yesterday, the audit engagement partner, Charlie Thrower, discovered that a significant fee for information security services, which were provided to Tree Co by Horti & Co, is overdue. Charlie hopes to be able to resolve the dispute amicably and has confirmed that he will discuss the matter with the finance director, Percy Marsh, at the weekend, as they are both attending a party to celebrate the engagement of Charlie’s daughter and Percy’s son. Bush Co Horti & Co is the external auditor of Bush Co and also provides other non-audit services to the company. While performing the audit for the year ended 31 October 20X8, the audit engagement partner was taken ill and took an indefinite leave of absence from the firm. The ethics partner has identified the following potential replacements and is keen that independence is maintained to the highest level: Brian Smith who is also the partner in charge of the tax services provided to Bush Co Monty Nod who was the audit engagement partner for the ten years ended 31 October 20X7 Cassie Dixon who introduced Bush Co as a client when she joined the firm as an audit partner five years ago Pete Russo who is also the partner in charge of the payroll services provided to Bush Co Plant Co Plant Co is a large private company, with a financial year to 30 June, and has been an audit client of Horti & Co for several years. Alan Marshlow, a partner of Horti & Co, has acted as the engagement quality control reviewer (EQCR) on the last two audits to the year ended 30 June 20X8. At a recent meeting, he advised that he can no longer be EQCR on the engagement as he is considering accepting appointment as a non-executive director and will sit on the audit committee of Plant Co. The board of directors has also asked Horti & Co if they would be able to provide internal audit services to the company. Weed Co Weed Co, a listed company, is one of Horti & Co’s largest clients. Last year the fee for audit and other services was $1·2m and this year it is expected to be $1·3m which represents 16·6% and 18·1% of Horti & Co’s total income respectively.	Q4: You are separately considering Plant Co’s request to provide internal audit services and the remit of these services if they are accepted. Which of the following would result in Horti & Co assuming a management responsibility in relation to the internal audit services? (1) Taking responsibility for designing and maintaining internal control systems (2) Determining which recommendations should take priority and be implemented (3) Determining the reliance which can be placed on the work of internal audit for the external audit (4) Setting the scope of the internal audit work to be carried out A 1 and 3 B 2, 3 and 4 C 1, 2 and 4 D 3 and 4 only Answer: C Assuming a management responsibility is when the auditor is involved in leading or directing the company or making decisions which are the remit of management. Designing and maintaining internal controls, determining which recommendations to implement and setting the scope of work are all decisions which should be taken by management.

Exam rehearsal question - Horti & Co (Case Objective Test Question – 5 Qs)

You are an audit manager at Horti & Co and you are considering a number of ethical issues which have arisen on some of the firm’s long-standing audit clients. Tree Co Horti & Co is planning its external audit of Tree Co. Yesterday, the audit engagement partner, Charlie Thrower, discovered that a significant fee for information security services, which were provided to Tree Co by Horti & Co, is overdue. Charlie hopes to be able to resolve the dispute amicably and has confirmed that he will discuss the matter with the finance director, Percy Marsh, at the weekend, as they are both attending a party to celebrate the engagement of Charlie’s daughter and Percy’s son. Bush Co Horti & Co is the external auditor of Bush Co and also provides other non-audit services to the company. While performing the audit for the year ended 31 October 20X8, the audit engagement partner was taken ill and took an indefinite leave of absence from the firm. The ethics partner has identified the following potential replacements and is keen that independence is maintained to the highest level: Brian Smith who is also the partner in charge of the tax services provided to Bush Co Monty Nod who was the audit engagement partner for the ten years ended 31 October 20X7 Cassie Dixon who introduced Bush Co as a client when she joined the firm as an audit partner five years ago Pete Russo who is also the partner in charge of the payroll services provided to Bush Co Plant Co Plant Co is a large private company, with a financial year to 30 June, and has been an audit client of Horti & Co for several years. Alan Marshlow, a partner of Horti & Co, has acted as the engagement quality control reviewer (EQCR) on the last two audits to the year ended 30 June 20X8. At a recent meeting, he advised that he can no longer be EQCR on the engagement as he is considering accepting appointment as a non-executive director and will sit on the audit committee of Plant Co. The board of directors has also asked Horti & Co if they would be able to provide internal audit services to the company. Weed Co Weed Co, a listed company, is one of Horti & Co’s largest clients. Last year the fee for audit and other services was $1·2m and this year it is expected to be $1·3m which represents 16·6% and 18·1% of Horti & Co’s total income respectively.	Q5: Which of the following actions should Horti & Co take to maintain their objectivity in relation to the level of fee income from Weed Co? (1) The level of fee income should be communicated to those charged with governance (2) Separate teams should be used for the audit and non-audit work (3) Request payment of the current year’s audit fee in advance of any work being performed (4) Request a pre-issuance review be conducted by an external accountant A 1 and 4 only B 3 and 4 only C 2 and 3 only D 1, 2, 3 and 4 Answer: A Weed Co is a listed company and the fees received by Horti & Co from the company have exceeded 15% of the firm’s total fees for two years. As per ACCA’s Code of Ethics and Conduct, this should be disclosed to those charged with governance and an appropriate safeguard should be implemented. In this case, it would be appropriate to have a pre-issuance review carried out prior to issuing the audit opinion for the current year.

Exam rehearsal question - Buffon & Co (Case Objective Test Question – 5 Qs)

You are an audit manager of Buffon & Co, responsible for the audit of Maldini Co and you have become aware of the following information:

The audit engagement partner who is responsible for the audit of Maldini Co, a listed company, has been in place for approximately eight years and her son has just been offered a role with Maldini Co as a sales manager. This role would entitle him to shares in Maldini Co as part of his remuneration package.

Internal audit function

Maldini Co’s board of directors is considering establishing an internal audit function, and the finance director has asked your firm about the differences in the role of internal audit and external audit. If the internal audit function is established, the board has suggested that they may wish to outsource this to Buffon & Co.

Auditor characteristics

Following management’s request for information regarding the different roles of internal and external auditors, the audit assistant has collated a list of key characteristics.

(1) Appointed by audit committee

(2) Reports are publicly available to shareholders

(3) Review effectiveness of internal controls to improve operations

(4) Express an opinion on the truth and fairness of the financial statements

Fees

The finance director has suggested to the board that if Buffon & Co is appointed as internal as well as external auditors, then fees should be renegotiated with at least 20% of all internal and external audit fees being based on the profit after tax of the company as this will align the interests of Buffon & Co and Maldini Co. This fee income would be significant to Buffon & Co.

Q1:

From a review of the information above, your audit assistant has highlighted some of the potential risks to independence in respect of the audit of Maldini Co.

(1) Length of time the audit engagement partner has been in position

(2) Maldini Co’s request for advice regarding internal audit

(3) Possible provision of internal audit services

(4) Basis of fee

Which of the following options correctly identifies the valid threats to independence and allocates the threat to the appropriate category?

	Self interest	Self review	Familiarity
A	1 only	2 and 3	4 only
B	1 only	2 only	4 only
C	2 only	3 and 4	1 only
D	4 only	3 only	1 only

Answer: D

Statement 1 – Partner has been in role for eight years, contravenes ACCA’s Code of Ethics and Conduct and represents a familiarity threat. Statement 3 – Providing internal audit services raises a self-review threat as it is likely that the audit team will be looking to place reliance on the internal control system reviewed by internal audit. Statement 4 – This represents fees on a contingent basis and raises a self-interest threat as the audit firm’s fee will rise if the company’s profit after tax increases. Statement 2 – Is not a threat to independence and therefore D is the correct answer.

Exam rehearsal question - Buffon & Co (Case Objective Test Question – 5 Qs)

You are an audit manager of Buffon & Co, responsible for the audit of Maldini Co and you have become aware of the following information: The audit engagement partner who is responsible for the audit of Maldini Co, a listed company, has been in place for approximately eight years and her son has just been offered a role with Maldini Co as a sales manager. This role would entitle him to shares in Maldini Co as part of his remuneration package. Internal audit function Maldini Co’s board of directors is considering establishing an internal audit function, and the finance director has asked your firm about the differences in the role of internal audit and external audit. If the internal audit function is established, the board has suggested that they may wish to outsource this to Buffon & Co. Auditor characteristics Following management’s request for information regarding the different roles of internal and external auditors, the audit assistant has collated a list of key characteristics. (1) Appointed by audit committee (2) Reports are publicly available to shareholders (3) Review effectiveness of internal controls to improve operations (4) Express an opinion on the truth and fairness of the financial statements Fees The finance director has suggested to the board that if Buffon & Co is appointed as internal as well as external auditors, then fees should be renegotiated with at least 20% of all internal and external audit fees being based on the profit after tax of the company as this will align the interests of Buffon & Co and Maldini Co. This fee income would be significant to Buffon & Co.	Q2: In relation to the audit engagement partner holding the role for eight years and her son’s offer of employment with Maldini Co: Which of the following safeguards should be implemented in order to comply with ACCA’s Code of Ethics and Conduct? A The audit engagement partner should be removed from the audit team B An engagement quality control reviewer should be appointed C A third party such as a professional body should be consulted on key audit judgements D Buffon & Co should resign from the audit Answer: A If the engagement partner’s son accepts the role and obtains shares in the company, it would constitute a self-interest threat but as the partner has already exceeded the seven-year relationship rule in line with ACCA’s Code of Ethics and Conduct, the partner should be rotated off the audit irrespective of the decision made by her son. As Maldini Co is a listed company, an engagement quality control reviewer should already be in place. It is unlikely that the firm needs to resign from the audit (due to stated circumstances) as the threats to objectivity can be mitigated.

Exam rehearsal question - Buffon & Co (Case Objective Test Question – 5 Qs)

You are an audit manager of Buffon & Co, responsible for the audit of Maldini Co and you have become aware of the following information: The audit engagement partner who is responsible for the audit of Maldini Co, a listed company, has been in place for approximately eight years and her son has just been offered a role with Maldini Co as a sales manager. This role would entitle him to shares in Maldini Co as part of his remuneration package. Internal audit function Maldini Co’s board of directors is considering establishing an internal audit function, and the finance director has asked your firm about the differences in the role of internal audit and external audit. If the internal audit function is established, the board has suggested that they may wish to outsource this to Buffon & Co. Auditor characteristics Following management’s request for information regarding the different roles of internal and external auditors, the audit assistant has collated a list of key characteristics. (1) Appointed by audit committee (2) Reports are publicly available to shareholders (3) Review effectiveness of internal controls to improve operations (4) Express an opinion on the truth and fairness of the financial statements Fees The finance director has suggested to the board that if Buffon & Co is appointed as internal as well as external auditors, then fees should be renegotiated with at least 20% of all internal and external audit fees being based on the profit after tax of the company as this will align the interests of Buffon & Co and Maldini Co. This fee income would be significant to Buffon & Co.	Q3: In line with ACCA’s Code of Ethics and Conduct, which of the following factors must be considered before the internal audit engagement should be accepted? (1) Whether the external audit team have the expertise to carry out the internal audit work (2) If the assignments will relate to the internal controls over financial reporting (3) If management will accept responsibility for implementing appropriate recommendations (4) The probable timescale for the outsourcing of the internal audit function A 1, 2 and 3 B 2 and 3 only C 1 and 4 only D 1, 3 and 4 Answer: B Statement 1 is inappropriate as the external and internal audit team should be separate and therefore consideration of the skills of the external audit team is not appropriate in the circumstances. Statement 4 does not apply in that the timescale of the work is not relevant to consider the threats to objectivity. Statement 2 and 3 are valid considerations – as per ACCA’s Code of Ethics and Conduct providing internal audit services can result in the audit firm assuming a management role. To mitigate this, it is appropriate for the firm to assess whether management will take responsibility for implementing recommendations. Further, for a listed company the Code prohibits the provision of internal audit services which review a significant proportion of the internal controls over financial reporting as these may be relied upon by the external audit team and the self-review threat is too great.

Exam rehearsal question - Buffon & Co (Case Objective Test Question – 5 Qs)

You are an audit manager of Buffon & Co, responsible for the audit of Maldini Co and you have become aware of the following information:

Internal audit function

Auditor characteristics

Following management’s request for information regarding the different roles of internal and external auditors, the audit assistant has collated a list of key characteristics.

(1) Appointed by audit committee

(2) Reports are publicly available to shareholders

(3) Review effectiveness of internal controls to improve operations

(4) Express an opinion on the truth and fairness of the financial statements

Fees

Q4:

Which of the following options correctly allocates the auditor characteristics collated by the audit assistant to the role of internal and external auditors?

	External	Internal
A	2, 3 and 4	1 only
B	1 and 4	2 and 3
C	2 and 4	1 and 3
D	2 only	1, 3 and 4

Answer: C

Internal auditors are appointed by the audit committee (external auditors usually by the shareholders) and it is the role of internal auditors to review the effectiveness and efficiency of internal controls to improve operations. External auditors look at the operating effectiveness of internal controls on which they may rely for audit evidence and a by-product may be to comment on any deficiencies they have found but this is not a key function of the role. Therefore statements 1 and 3 relate to internal auditors. The external auditor’s report is publicly available to the shareholders of the company (internal audit reports are addressed to management/TCWG) and the external auditor provides an opinion on the truth and fairness of the financial statements. Therefore statements 2 and 4 relate to external auditors.

Exam rehearsal question - Buffon & Co (Case Objective Test Question – 5 Qs)

You are an audit manager of Buffon & Co, responsible for the audit of Maldini Co and you have become aware of the following information:

Internal audit function

Auditor characteristics

Following management’s request for information regarding the different roles of internal and external auditors, the audit assistant has collated a list of key characteristics.

(1) Appointed by audit committee

(2) Reports are publicly available to shareholders

(3) Review effectiveness of internal controls to improve operations

(4) Express an opinion on the truth and fairness of the financial statements

Fees

Q5:

If the internal and external audit assignments are accepted, which of the following statements is TRUE regarding the proposed basis for the fee?

A As long as the total fee received from Maldini Co is less than 15% of the firm’s total fee income, then no safeguards are needed

B The client should be informed that only the internal audit fee can be based on profit after tax

C The fees should be based on Maldini Co’s profit before tax

D No safeguards can be applied and this basis for fee determination should be rejected

Answer: D

The proposal in relation to the fees is a contingent fee basis which is expressly prohibited by ACCA’s Code of Ethics and Conduct and therefore no safeguards will be adequate to reduce the threat. The statement that the fee basis must be rejected is true.

Exam rehearsal question

Which of the following statements relating to codes of professional ethics are correct?

(1) Codes of professional ethics are prescriptive ethical rules which professional accountants should consider in every situation

(2) A code of professional ethics allows a professional accountant to apply fundamental ethical principles to a given situation

(3) A code of professional ethics encourages professional accountants to think about more than just legal compliance

(4) Compliance with codes of professional ethics is a legal requirement for professional accountants

A 1 and 2

B 1 and 3

C 2 and 3

D 3 and 4

Answer: C

Codes of professional ethics, including ACCA’s Code of Ethics and Conduct adopt a principles based approach rather than being a prescriptive set of rules. This approach identifies fundamental principles, threats to these principles and safeguards which can be put in place. This approach requires the professional accountant to use professional judgment when applying ethical principles to any given situation. Compliance with codes of professional ethics is a professional requirement.

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Categories: : Audit and Assurance (AA)