7/31/2019 20100115171401_02 as AA Workbook Chapter 1
1/16
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
2/16
Professional practice and ethics
2
Professional practice and ethics
Introduction
This section of the A&A syllabus reintroduces the concepts of audit and
assurance, then considers the legal and ethical framework for theprofession. Although many of the topics covered here have beencovered in your earlier studies, the questions at Advanced Stage areless likely to be clear cut, so you will need to exercise more judgement.
ICAEW Chapter 1 Role and context of modern auditing
Much of the background knowledge here is revision from ProfessionalStage.
ICAEW Chapter 2 Ethics
Ethical issues are likely to be embedded in questions throughout the Advanced Stage papers, and the problems and solutions may be lessobvious than in your previous studies.
ICAEW Chapter 3 Governance
Corporate Governance is a topical issue, and has a real impact on theway businesses are run. It is therefore of significance to the auditor when they assess the control environment, and if you are faced with aquestion dealing with a listed company you should always consider theimpact of Governance.
This section also revises Sarbanes Oxley.
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
3/16
chapter 1
3
1 Role and context of modern auditing
Overview of the audit process
Client acceptance / continuance
Establish engagement terms
Plan the audit
Develop the audit approach
Obtain audit evidence
Evaluate results
Issue audit report
Auditors responsibilities (CA 2006)
Form opinion on truth and fairness of the financial statements
Confirm financial statements adequately prepared in accordancewith Companies Act
Confirm that directors report is consistent with the financialstatements
Report by exception on
Returns from branches not visited received
Accounts agree with the underlying records
Proper accounting records kept
Information and explanations received
Directors transactions properly disclosed
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
4/16
Professional practice and ethics
4
Directors responsibilities (CA 2006)
Responsibility Comments
Enlightened shareholder value Promote the success of the company
for the benefits of the members as awhole
Duty of skill and care
Conflicts of interest To be avoided. If the company suffersloss as result of a directors conflict of interest the director is personally liableto the company.
Fraudulent and wrongfultrading
See Insolvency section.
Theft If company deceives with consent of directors then both company anddirectors will be liable.
Keep adequate accountingrecords
Prepare and file annualaccounts
Safeguard assets Implement system of internal controls.
Directors loans and other transactions (CA 2006)
The aim of CA 2006 is to prevent directors abusing their position, byrequiring disclosure to, and approval by, the members of the companywhen significant loans or other transactions between the company andits directors take place (otherwise transactions voidable by company).
Audit risk high due to:
Materiality
Complexity of rules
Potential lack of formal documents
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
5/16
chapter 1
5
All companies Relevant companies (plc or member of plc group)
Loans >10,000 todirectors must be
approved by membersof company (need to begiven details of loan andpurpose)
Advances for legitimatebusiness expensesallowed but must notexceed 50,000(approval of membersnot required)
Rules extended to connected persons(spouse, minor children, business
partner, company of which director owns >20% voting power)
The following transactions with adirector or connected person requiremember approval:
Loans >10,000
Credit transactions >15,000
Quasi-loans >10,000
Disclosure of directors transactions
For all transactions:
Statement that loan etc. made / existed in year
Name of director / connected person
Principal terms
Amount of loan and any amount repaid
Other transactions and contracts
Directors interests in contracts
Declare interests to board
Substantial property transactions between company anddirectors require approval by members
o Value at least 100,000 or
o Value at least 10% of companys net assets (de minimis5,000)
Directors interests must be disclosed in the financialstatements if material
Long service contracts must be approved by members (>2 years)
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
6/16
Professional practice and ethics
6
2 Ethics
Sources of ethical guidance
IFAC Code of Ethics governs audits carried out under ISAs
ICAEW Code of Ethics to be followed by ACAs, but ispractically identical to the IFAC code
APB Ethical Standards
Fundamental principles
IFAC Code of Ethics (in ISA 200)
Integrity
Objectivity
Professional competence and due care
Confidentiality
Professional behaviour
General threats to objectivity
Self-interest
Self-review
Management
Advocacy
Familiarity or trust
Intimidation
Detailed guidance
APB Ethical Standards
ES1 Integrity, Objectivity and Independence
ES2 Financial, Business, Employment and PersonalRelationships
ES3 Long Association with the Audit Engagement
ES4 Fees, Remuneration and Evaluation Policies, Litigation,Gifts and Hospitality
ES5 Non-Audit Services Provided to Audit Clients
ES Provisions Available for Small Entities (ESPASE)
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
7/16
chapter 1
7
ICAEW Code of Ethics
Confidentiality
Conflicts of interest
Changes in professional appointment
ES1 Integrity, Objectivity and Independence
Sets out requirement for firms to have policies and proceduresrelating to ethics.
The firm should appoint an ethics partner.
For listed clients, compliance with ethical standards should bereviewed by an independent partner.
Matters that bear on the auditors objectivity and independenceshould be communicated to client management.
Detailed guidance in ES 2-5
Ethicalstandard
Specificthreats
Safeguards
2 Beneficialinterest inshares
Audit partner and staff cannot hold sharesin audit client.
2 Mutualbusinessinterest
Should not go into business with auditclient.
2 Staff movingfrom auditfirm to client
Partner becomes client management within2 years of being involved in the audit firmshould resign as auditors.
Other staff firm must consider implicationsfor independence.
All partners and staff should discloseintention to move to client and be removedfrom the audit team.
2 Client staff joining auditfirm
Should not be allowed to work on the auditfor 2 years.
3 Acting for aprolongedperiod for
Rotate staff as follows:
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
8/16
Professional practice and ethics
8
Ethicalstandard
Specificthreats
Safeguards
listed clients Engagement partner 5 years
Key audit partners and senior staff 7 years
3 Acting for aprolongedperiod for non-listedclients
Rotate staff as follows:
Engagement partner 10 years
Rules more relaxed might be ableto make a case that partner shouldremain for longer
4 Dependence
on client
Fees for services to clients should not
exceed following % of firms fee income: Listed: 10% (review at 5%)
Non-listed: 15% (review at 10%)
4 Loans, etc. Not allowed loans or guarantees.
Overdue fees akin to a loan.
4 Hospitality or other benefits
Firm should have a policy.
Basic idea is that they should be modest.4 Litigation Firm should resign as auditor if there is
actual or potential litigation between auditfirm and client.
5 Other services
Consider the impact of non-audit services.
Establish safeguards to counter anythreats.
Communicate with those charged with
governance.Document rationale for decisions taken.
Do not help PLCs prepare accounts exceptin an emergency.
Do not carry out IA / IT / Valuation workwhere the external audit opinion will placeheavy reliance upon this other work.
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
9/16
chapter 1
9
ICAEW Guidance Confidentiality
Auditors should keep client information confidential unless there is aright or duty to disclose.
Right to disclose Duty to discloseClient permission obtained Money laundering
Public interest Ordered to by a court
To defend the audit firm Required by a regulator
ICAEW Guidance Conflicts of interest
Firm vs client E.g. where the auditor recommends another service to a client
and receives a commission for doing so
Disclose to client
Obtain client consent
Client vs client
E.g. the firm audits clients who are competitors
Main issue is confidentiality
Separate teams with separate reporting lines
Maintain confidentiality (Chinese walls)
Independent partner review
If sufficient safeguards cannot be implemented, consider resigning / refusing to act
ICAEW Guidance Changes in Professional Appointment
Outgoing auditor
Reply to requests for information from incoming auditor assuming client gives permission
Incoming auditor
Write to client asking for permission to contact the previousauditors
If client declines, do not accept engagement
If client allows, write to previous auditor asking them aboutmatters that may be relevant to acceptance
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
10/16
Professional practice and ethics
10
Follow up if no reply
Consider reply e.g. unpaid fees, disagreements about accountingtreatment
If no reply, can accept the engagement but be scepticalDuty to report misconduct
ICAEW members have duty to report possible misconduct of other members:
To ICAEW Professional Conduct Directorate
In writing
May wish to seek legal advice first
No need to investigate before reporting, but need facts rather than just suspicion
Examples of when to report
Committed offence involving dishonesty, fraud, or cheating
Breach of regulations e.g. IA86, Money laundering
Gross incompetence
Failure to report is grounds for disciplinary action
Current issues in ethics
The following issues are being considered as part of a consultationpaper on revisions to the Ethical Standards:-
Rotation period for the audit engagement partner should it be 5or 7 years?
Potential conflict of interest when auditor also providesrestructuring advice
Existing financial interests of potential new partners which aredifficult to dispose of, that may currently restrict the ability of firms to appoint new partners externally
Clarification of the definition in ES4 of the 'audit team' whenconsidering remuneration and evaluation policies
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
11/16
chapter 1
11
3 Governance
Underlying concepts of Corporate Governance
Concept Explanation
Fairness Decisions / systems of co should be fair to allstakeholders.
Transparency Financial statement and other, voluntary, disclosurehelps shareholders understand the company.
Independence Independent non-execs promote the interests of shareholders and other stakeholders bychallenging the executive.
Honesty Dont mislead stakeholders.
Responsibility System in place that penalises mismanagementand takes corrective action.
Accountability Board accountable to shareholders who shouldalso exercise their voting rights and take someresponsibility.
Reputation Co reputation is often very valuable so should bepromoted.
Judgement Board should make decisions that enhance thecompanys prosperity.
Integrity Straightforward dealing, which requires personalhonesty and professionalism.
The Combined Code
UK incorporated companies listed on the main LSE mustdisclose in their annual reports how they have complied with theCode
Overseas companies listed on the main LSE must disclose anysignificant differences between their corporate governancepractice and those of the Code
Reduced compliance allowed for companies below the FTSE350
Does not apply to non-listed companies (including AIM) althoughprovides measure of best practice for all companies
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
12/16
Professional practice and ethics
12
The main provisions of the Combined Code
Directors Effective Board should lead and control thecompany
Chair and CEO roles should be separate public justification required for combiningroles
Balance of executive and non-executive
Majority of non-executives independent
Formal and transparent procedure for Board appointment
Regular re-election
Directorsremuneration
Enough to attract high calibre candidates
Not excessive
Proportion linked to performance
Formal and transparent procedure for fixingremuneration
Annual report states remuneration policyand details of remuneration of eachdirector
Service contracts of more than 12 monthsrequire careful consideration
Relations withshareholders
Companies should be prepared to enter into a dialogue with institutional investors
Board should use the AGM tocommunicate with private investors
Accountability andaudit Annual report should show a balanced andunderstandable assessment of the
companys position and prospects
Maintain a good system of controls tosafeguard shareholders investments
Establish an Audit Committee
Institutionalshareholders
Have a responsibility to use their votes
Should be prepared to enter into a dialoguewith companies
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
13/16
chapter 1
13
Combined Code Disclosure Requirements
Requirement Location in annual report
Statement of compliance with CC CG statement or directors report
Assessment of position / prospects Chairmans statement, OFR, or directors report
Combining Chairman / CEO CG statement or directors report
Identify Chairman, CEO, other directors and committee members
CG statement or directors report
Directors responsibilities Immediately before the auditreport
Auditors responsibilities Audit reportDirectors statement on goingconcern
OFR
Auditors review of statement oncompliance with CC
Audit report
Turnbull report
Key points Disclosures
Guidance on how to applyCC with regards to internalcontrols
Encourages a risk basedapproach
Directors should consider
Control environment Risk assessment
Information systems
Control procedures
Monitoring
Statement in annual reportdisclosing that there is aprocess for identifying,evaluating and managingrisks
Additional information onthe ICS may be given
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
14/16
Professional practice and ethics
14
Audit Committees
Smith Report Guidance as follows:
At least 3 members all independent non-executive directors
At least 1 member with relevant financial experience
All to be trained
Review ICS
Monitor and review IA effectiveness
Monitor and review EA independence, objectivity andeffectiveness
Report in the directors report APB advice on the relationship between auditors and the auditcommittee:
Should be open communication
Should be discussion at the end of the audit about
Non-compliance with laws and regulations
Control environment
Significant adjustments to the financial statements
How differences between management and EA wereresolved
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
15/16
chapter 1
15
Sarbanes-Oxley Act 2002
Principles Key provisions from audit pointof view
Audit committeeresponsible for FR andaccuracy
Increases FS disclosures
Required companies tohave internal code of ethics
Imposes restrictions onshare trading by companyofficers
New regulator to setstandards, with disciplinarypower (Public Company
Accounting OversightBoard)
Auditing standardstightened
Provision of other servicesseverely restricted (ban on
IA, bookkeeping, valuation;all others subject to auditcommittee review)
Auditor to discussaccounting policies,management letter andunadjusted differences withaudit committee
Increased whistleblower protection in case of fraud
Auditors responsibilities with regards to CorporateGovernance
The auditor is required to review parts of the directors statement on thecombined code.
APB Bulletin 2006/5 identifies procedures to perform:
General On the Board review and reporton effectiveness of ICS
Review board minutes
Review supportingdocuments prepared for the Board
Make enquiries of directors
Attend meetings of theaudit committee at whichthe annual report isconsidered
Concentrate on the reviewcarried out
Review the statement bydirectors, make enquiries,review supportingdocumentation
Communicate anyweaknesses found duringaudit promptly
7/31/2019 20100115171401_02 as AA Workbook Chapter 1
16/16
Professional practice and ethics
16
Reporting responsibilities
Bulletin 2006/5 recommends the following wording in the auditreport: We are not required to consider whether the boardsstatement on internal controls covers all risks and controls, or
form an opinion on the effectiveness of the companys corporategovernance procedures or its risk and control procedures.
Report by exception if problems arise e.g. Board have notconducted annual review of ICS
Report will be an additional paragraph headed Other matterafter the opinion paragraph an emphasis of matter as the auditopinion is not affected
Top Related