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Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
19-1
Chapter Nineteen Professional Ethics, Independence,
and Quality Control
Chapter Nineteen Professional Ethics, Independence,
and Quality Control
Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
19-2
Ethics and Professional Behaviour
Ethics
Professionalism
Refers to a system or code of conduct based on moral duties and obligations that indicate how an individual should
behave in society.
Refers to the conduct, aims, or qualities that characterize or mark a profession or
professional person.
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Theories of Ethical Behaviour
Utilitarianism
Rights-Based Approach
Justice-Based Approach
Recognizes that decision making involves trade-offs between the benefits and burdens
of alternative actions and focuses on the consequences and individuals affected.
Assumes that individuals have certain rights and other individuals have a duty to
respect those rights when making decisions.
Is concerned with issues such as equity, fairness and impartiality.
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Development of Moral Judgment
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Conceptual Framework Approach to Independence
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Conceptual Framework Approach to Independence
• The definitions of independence in the frameworks acknowledge that independence only indirectly affects the ultimate goal of auditor objectivity, i.e. to make unbiased audit decisions.
• Independence is considered a relatively observable trait of an auditor that should be correlated with the relatively unobservable trait of objectivity.
• Consequently, auditor independence is viewed as the main mean to ensure and demonstrate auditor objectivity and independence has therefore been in regulatory focus.
Independence of mind relates to the fact of independence, i.e. if the auditor actually behaves without being affected by interests than may impair objectivity.
Independence in appearance relates to perception of independence, i.e. if third parties perceive that auditor interests that may impair objectivity do not exist.
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Conceptual Framework Approach to Independence
Threats to auditor independence are pressures and other factors that impair or are perceived to impair an auditor’s
objectivity.
Safeguards to auditor independence are controls that mitigate the effects of the threats.
Independence risk is the likelihood that auditor’s objectivity would be compromised or reasonably would appear to be
compromised to informed investors and other users of the audit report.
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Conceptual Framework Approach to Independence
• Self-interest threats arise from the auditors favouring or is perceived to favour self-interests over their interest in performing an unbiased audit.
• Self-review threats arise from auditor’s difficulty to evaluate without bias one’s own work, or that of one’s firm.
• Advocacy threats arise from auditors acting biased in promoting or advocating for or against the auditee.
• Familiarity threats arise from auditors compromising objectivity due to being influenced by a close relationship with the auditee.
• Intimidation threats arise from auditors deterred from acting objectively because they are being, or believing that they are being, overtly or covertly coerced by auditees or by other interested parties.
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19-9
Conceptual Framework Approach to Independence
Safeguards created and maintained within the auditee.
Safeguards created by the profession, legislation, or
regulation. Safeguards within the
auditor’s and audit firm’s own system and procedures.
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IFAC Code of Ethics for Professional Accountants
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IFAC Code: Fundamental Principles and Conceptual Framework
Part A of the Code establishes the fundamental principles for professional accountants’
behaviour and the conceptual framework for applying those principles.
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IFAC Code: Fundamental Principles and Conceptual Framework
A professional accountant in public practice is defined as a professional accountant that provides professional services in
a firm.
• Professional services are defined as services requiring accountancy or related skills performed by a professional accountant including accounting, auditing, taxation, management consulting, and financial management services.
• A firm is defined as a sole practitioner, partnership, or corporation of professional accountants; an entity that controls such parties, and an entity controlled by such parties.
A professional accountant in business is defined as a professional accountant employed or engaged in an executive or
non-executive capacity in such areas as commerce, industry, service, the public sector, education, the not-for-profit sector,
regulatory bodies or professional bodies, or a professional accountant contracted by such entities.
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IFAC Code: Fundamental Principles and Conceptual Framework
Integrity Objectivity
Professional Competence & Due Care
ConfidentialityProfessional
Behaviour
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IFAC Code: Fundamental Principles and Conceptual Framework
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19-15
IFAC Code: Fundamental Principles and Conceptual Framework
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IFAC Code: Conduct of Professional Accountants in Public Practice
Part B Professional Accountants in Public Practice illustrates how the conceptual framework contained in Part A is to be applied by professional accountants in public practice in specific situations.
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IFAC Code: Conduct of Professional Accountants in Public Practice
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19-18
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IFAC Code: Conduct of Professional Accountants in Public Practice
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19-20
Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
19-21
IFAC Code: Conduct of Professional Accountants in Public Practice
Professional Appointment
Second Opinions
Fees & Other Types of Remuneration
Marketing Professional Services
Gifts & Hospitality
Custody of Client Assets Objectivity – All Services
Conflicts of Interest
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19-22
IFAC Code: Independence - Assurance Engagements
Assurance Engagement
An engagement in which a professional accountant in public practice expresses a conclusion designed to
enhance the degree of confidence of the intended users other than the responsible party about the outcome of
the evaluation or measurement of a subject matter against criteria.
Independence of Mind
The state of mind that permits the expression of a conclusion without being affected by influences that
compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity,
and professional scepticism.
The avoidance of facts and circumstances that are so significant that a reasonable and informed third party, having knowledge of all relevant information, including
safeguards applied, would reasonably conclude a firm’s, or a member of the assurance team’s, integrity, objectivity, or professional scepticism had been
compromised.
Independence in Appearance
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IFAC Code: Independence - Assurance Engagements
Financial Statement Audit Engagements
Other Assurance Engagements
Listed Entities Engagement Period
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IFAC Code: Independence
• Financial interests. • Loans and guarantees.• Close business relationships with the assurance
clients.• Family and personal relationships.• Employment with assurance clients.• Recent service with assurance clients.• Serving as an officer or director on the board of
assurance clients.• Long association of senior personnel with assurance
clients.• Provisions of non-assurance services to assurance
clients.
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IFAC Code: Provisions of Non-Assurance Services – Types of Services
• Preparing accounting records and financial statements.• Valuation services.• Provisions of taxation services to audit clients.• Provisions of internal audit services to audit clients.• Provisions of IT systems services to audit clients.• Temporary staff assignments to audit clients.• Provisions of litigation support services to audit clients.• Provisions of legal services to audit clients.• Recruiting senior management.• Provisions of corporate finance services to audit clients.• Fees, pricing and partner compensation.• Gifts and hospitality.• Actual or threatened litigation.
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IFAC Code: Provisions of Non-Assurance Services – Examples of Prohibited Activities
Acting in the capacity of management by authorizing, executing or consummating
a transaction.
Making decisions on behalf of management.
Reporting in a management role to those charged with
governance.
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19-27
IFAC Code: Provisions of Non-Assurance Services – Examples of Safeguards
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19-28
Summary of Code Provisions for Selected Non-Assurance Services to Audit Clients
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19-29
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19-30
Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
19-31
IFAC Code: Conduct of Professional Accountants in Business
A professional accountant in business is an accountant holding
membership in an IFAC body and is employed or engaged in an executive
or non-executive capacity in an organization other than an audit firm.
Professional accountants in business must comply with the IFAC Code’s fundamental principles and apply
the conceptual framework when threats to the principles exist.
Threats:• Potential conflicts.• Preparation and reporting of
information.• Acting with sufficient expertise.• Financial interests.• Inducements.
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19-32
EU Rules on Auditor Independence
From European Commission, Recommendation on Statutory Auditors’ Independence in the EU: A Set of Fundamental Principles (2002):
“A principles-based approach to statutory auditors' independence is preferable to one based on detailed rules because it creates a robust structure within which statutory auditors have to justify their actions. It also provides the audit profession and its regulators with the flexibility to react promptly and effectively to new developments in business and in the audit environment. At the same time, it avoids the highly legalistic and rigid approach to what is and is not permitted which can arise in a rules-based regime. A principles-based approach can cater for the almost infinite variations in individual circumstances that arise in practice and in the different legal environments throughout the EU. Consequently, a principles-based approach will better serve the needs of European capital markets, as well as those of SMEs (small and medium sized enterprises).”
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EU Rules on Auditor Independence
Threats to Independence:• Preparing of accounting records and financial statements.• Design and implementation of financial information technology systems.• Valuation services.• Participating in the audit client’s internal audit.• Acting for the audit client in the resolution of litigation.• Recruiting of senior management.• Audit and non-audit fees (contingent fees, relationship between total fees
and total revenue, overdue fees and pricing).• Litigation.• Senior personnel acting for a long period of time.
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19-34
Quality Control Standards
ISQC 1 Quality Control for Firms That Perform Audits and Reviews of Historical Financial Information and Other Assurance and Related
Services Engagements
• Leadership responsibilities for quality within the firm.
• Ethical requirements.• Acceptance and continuance of client
relationships and specific engagements.• Human resources.• Engagement performance.• Monitoring.
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Elements of Quality Control
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Selected Quality Control Policies and Procedures
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Monitoring Quality Control
Provide an evaluation of:
(1) Adherence to professional standards and regulatory and legal requirements.
(2) Whether the quality control system has been appropriately designed and effectively implemented.
(3) Whether the firm’s quality control policies and procedures have been appropriately applied, so that reports that are issued by the firm or engagement partners are appropriate in the circumstances.
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Monitoring Quality Control
Procedures for monitoring include:
• Inspection procedures of a selection of completed engagements.
• Analysis of— New professional standards and regulatory and legal requirements.— Written confirmation of compliance with policies and procedures on
independence.— Continuing professional development, including training.— Decisions related to acceptance and continuance of client
relationships and specific engagements.• Determination of any corrective actions to be taken and improvements to
be made in the system.• Communication to appropriate firm personnel of weaknesses identified in
the system, in the level of understanding of the system, or compliance with it.
• Follow-up by appropriate firm personnel to ensure that any necessary modifications are promptly made to the quality control policies and
procedures.
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19-41
Quality Assurance Programmes of Firms’ Practices
• Mandatory or voluntary review.
• Firms and auditors covered by reviews.
• Selection and qualities of reviewers.
• Scope and thoroughness of reviews.
• Frequencies of reviews.
• Sanctions initiated as a result of negative outcomes of reviews.
• Public reporting of outcomes of reviews and sanctions imposed.
• Public oversight of programs.
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Quality Assurance Programmes of Firms’ Practices - Regulations
IFAC SMO 1 Quality Assurance
EU 8th Directive
European Commission, Recommendation on
Quality Assurance for the Statutory Audit in the EU:
Minimum Requirements
PCAOB
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End of Chapter 19