AUDITING – ACC ACCT T 2161 Interteaching Topic 2 Ethics, Legal liability an client acceptance The p!rpose o" this topic is to pro#ie an o#er#ie$ o" the c!rrent a!it en#iron%ent ðics, a!itor inepenence, inepenence, legal liability to client an thir parties, a!itor's client acceptance(contin!ation)* acceptance(contin!ation)*
Learning Objectives: A"ter st!ying this chapter chapter yo! sho!l sho!l be able to+
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Describe the "!na%ental principles o" pro"essional ethics
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Eplain the relationship bet$een an a!itor an -ey gro!ps they ha#e a pro"essional lin$ith !ring the a!it engage%ent
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Eplain the a!itor's a!itor's legal liability to their client client an the concept o" contrib!tory contrib!tory negligence
De"ine a!itor inepenence* Eplain the threats to a!itor inepenence an eplain the sa"eg!ars to re!ce the ris- o" those threats*
Eplain the etent to $hich an a!itor is liable to thir parties* Ienti"y $hy a!itors nee to o a care"!l client acceptance an contin!ance process an the "actors to consier client acceptance an contin!ance ecision* ecision*
et reaings "or this topic Chapter 2 – oroney, Ca%pbell an 3a%ilton – 1 st Eition* A4E 115 115 Coe o" Ethics "or 4ro"essional 4ro"essional Acco!ntants Acco!ntants section 275 Inepenence Inepenence an section .55*8 to .55*18
9hat yo! nee to o this $ee1* :ea this Topic Topic Guide 2* Co%plete the set reaing "or this topic "ro% oroney, Ca%pbell an 3a%ilton $ith re"erence to the liste learning ob;ecti#es o" the topic* a-e s!re yo! achie#e ALL the liste learning ob;ecti#es a"ter reaing the chapter* .* Co%plete the Interteaching !ire to present yo!r ans$ers care"!lly in $riting* =o!r notes $ill be echange $ith other gro!p %e%bers to be rea an co%%ente at the beginning o" yo!r gro!p isc!ssion in the t!torials* The secon part o" the gro!p isc!ssion $ill be "oc!se on iss!es raise by gro!p %e%bers "or isc!ssion or %ore eplanation* To prepare "or this part, !ring yo!r preparation at ho%e yo! sho!l note o$n all the points that &yo! are not s!re or not "!lly !nerstan) yo! $ant to see- "!rther clari"ication "ro% yo!r gro!ps* =o! are s!ppose to ha#e gaine %ost &i" not all) !nerstanings !nerstanings o" the t he topic a"ter the t!torials* I" there is(are are any re%aining iss!es that cannot be sol#e in the gro!p isc!ssion, yo! sho!l note o$n as >!estions to be aresse in the lect!res* In the Interteaching Session yo! $ill also be epecte to apply the in"or%ation yo! ha#e learnt "ro% yo!r reaing to aress a real $orl iss!e*
Interteaching
1) The textbook often refers to the term “members of professional bodies”? Who does it refer to? What are the professional bodies? Members of the professional bodies here mean the professional accountants (among those are the external auditors). The professional bodies are those organisations that are oerseeing the accounting profession. There are three such organisations in !ustralia" including #$! !ustralia" %#!! and &%!. ') %n hat circumstance(s) does the auditor commit a legal liabilit? Who are the potentiall liable to? %f the auditor fails to exercise due care hen conducting the audit" the ma be sued and be charged ith negligent. When found to be negligent" the auditor ma be asked to compensate for damages suffered as a conse*uence of the negligence. The parties that the audit ma oe the legal liabilit to include the client and the third parties ho hae used the financial statements and suffered the losses. +) Who must compl ith the fundamental ethical principles included in the !$,- 11? The professional accountants (e.g public accountants such as auditors) /) What does “independence” mean for auditors? %ndependence is re*uired beteen hich parties?
!uditors are re*uired b both the la (the #orporations !ct '1) and the #ode of ,thics to be independent . The are re*uired to be independent from their client heneer the carr out and engagement. 0eing independent means that the auditor needs to make a decision that is free from bias" personal belief and client pressures. The auditor is re*uired to be independent in mind (actuall independent) and also independent in appearance" meaning that the need to alas be seen b others as independent from their client. Practical application 1:
! 2 is a small" rapidl groing audit firm. %ts success is largel due to the groth of seeral clients that hae been ith the firm for more than fie ears. 3ne of these clients" Taramine #ompan 4td" is no listed on the !-5 and must compl ith additional reporting regulations. Taramine #ompan 4td6s rapid groth has meant that it is financiall stretched and its accounting sstems are struggling to keep up ith the groth in business. The client continuance decision is about to be made for the next financial ear. The managing partner of ! 2" #hristine -teenson" has recognised that the audit firm needs to make some changes to deal ith the issues created b the charging circumstances of its ma7or client and the audit firm6s oerall groth. -he is particularl concerned that the audit firm could be legall liable if Taramine #ompan 4td6s financial situation orsens and it fails. Required a) What actions should A&Y takes to avoid the potential threat of litigation if Taramine Company Ltd fails
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!) What should Christine consider "hen making the client continuance decision for Taramine Company Ltd for the ne#t financial year
-olution8 (a) -teps to take to aoid the threat of litigation (in addition to the client continuation decision issues in part b belo) include8
hiring competent staff training staff and updating their knoledge regularl ensuring compliance ith ethical regulations ensuring compliance ith auditing regulations %mplementing policies and procedures that ensure8 appropriate procedures are folloed hen accepting a ne client o appropriate staff are allocated to clients o ethical and independence issues are identified and dealt ith on a timel basis o all ork is full documented o ade*uate and appropriate eidence is gathered before forming an opinion o meeting ith a client6s audit committee to discuss an significant issues identified as part of the audit folloing up on an significant eaknesses in the client6s internal control procedures in a preious ear6s audit dealing ith priit letter re*uests in accordance ith the guidance proided in !9- 11/ $rivity Letter Requests
(b) The client continuation decision is critical. #hristine should ealuate and document the firm6s abilit to serice the ma7or client" Taramine #ompan 4td" and an other ma7or clients for the coming ear. !$,- +' :ualit #ontrol for ;irms and !-:# 1 proide guidance on the procedures to be folloed hen making the client acceptance or continuance decision. The ke factors to be ealuated are client integrit and an threats to the auditor6s compliance ith the fundamental principles of professional ethics (integrit" ob7ectiit" professional competence and due care" confidentialit and professional behaiour). !lthough Taramine #ompan has been a client of the firm for seeral ears" its integrit must still be reealuated.
. Taramine should also be concerned about the firm6s abilit to use professional competence and due care in audits for rapidl groing clients at a time hen the audit firm is groing rapidl and the client is undergoing ma7or changes to its reporting re*uirements. oes the audit firm hae the expertise to audit listed clients? What sort of auditing difficulties are likel to be created b the stretched financial sstems at Taramine? The client continuation decision must be properl documented and the engagement letter drafted to reflect the responsibilities of both parties.
Practical Application 2
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1. 2ou are a manager in the audit firm of !li #o@ and this is our first time ou hae orked on one of the firm6s established clients" -tark #o. The main actiit of -tark #o is proiding inestment adice to indiiduals regarding saing for retirement" purchase of shares and securities and inesting in tax efficient saings schemes. -tark is regulated b the releant financial serices authorit. 2ou hae been asked to start the audit planning for -tark #o" b Mr -on" a partner in !li #o. Mr -on has been the engagement partner for -tark #o" for the preious nine ears and so has excellent knoledge of the client. Mr -on has informed ou that he ould like his daughter Aoe to be part of the audit team this ear@ Aoe is currentl studing for her first set of fundamentals papers for her !##! *ualification. Mr -on also informs ou that Mr ;ar" the audit senior" receied inestment adice from -tark #o during the ear and intends to do the same next ear. %n an initial meeting ith the finance director of -tark #o" ou learn that the audit team ill not be entertained on -tark #o6s acht this ear as this could appear to be an attempt to influence the opinion of the audit. %nstead" he has arranged a balloon flight costing less than oneBtenth of the expense of using the acht and hopes this ill be acceptable. The director also states that the fee for taxation serices this ear should be based on a percentage of tax saed and trusts that our firm ill accept a fixed fee for representing -tark #o in a dispute regarding the amount of sales tax paable to the taxation authorities.
Required% i) '#plain the ethical threats "hich may affect the auditor of (tark Co ii) or each ethical threat* discuss ho" the effect of the threat can !e mitigated Solution Ethical threat Mr -on" the engagement partner has been inoled ith the client for the last nine ears. This means he ma be too familiar ith the client to be able to make ob7ectie decisions due to this long association. There is no ethical rule hich stops Mr -on recommending Aoe for the audit" or letting Aoe take part in the audit. Coeer" there ma be the impression of lack of independence as Aoe is related to the engagement partner. Aoe could be tempted not to identif errors in case this pre7udiced her father6s relationship ith the client. !s long as Mr ;ar paid a full fee to -tark #o for the inestment adice" then there is no ethical threat. This ould be a normal commercial transaction and Mr ;ar ould not gain an benefit. Coeer" continued use of client serices could impl a lack of independence especiall if Mr ;ar is not paing a full fee and therefore receiing a benefit from the client. The audit team hae been offered a balloon flight at the end of the audit. !cceptance of gifts from a client" unless of an
Mitigation of threat Mr -on should be rotated from being engagement partner. Ce can still contact the client but should not be in the position of signing the audit report.
To sho complete independence" Aoe should not be part of the audit team. Coeer" if Mr -on is no longer the engagement partner then this remoes the ethical threat and Aoe could be included in the audit team.
To sho independence from the client" Mr ;ar could be asked not to use the serices of -tark #o again unless this is first agreed ith the engagement partner.
The balloon flight should not be accepted. %nestigation ould also be needed to find out h hospitalit as accepted in preious ears.
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insignificant amount" is not alloed. The fact that the flight costs less than the acht expense is irreleant" independence could still be impaired. !greeing to accept taxation ork on the The audit firm must confirm that assistance ith percentage of the tax saed is essentiall taxation ork is acceptable" although the fee accepting a contingent fee. must be based on time and experience for the There ill be pressure to gain the highest tax 7ob" not the contingent fee. refund for the client and this could tempt the audit firm to suggest illegal tax aoidance schemes.
Practical Application 3
(a) -tate the ;%E, threats contained ithin the #ode of ,thics for $rofessional !ccountants and for each threat list 3&, example of a circumstance that ma create the threat.
Solutions – Self-interest – Self-review – Advocacy – Familiarity – Intimidation. Examples for each category (Only one example re!ired per threat"# Self-interest – – – – – – –
$nd!e dependence on fee income from one client %lose personal or &!siness relationships Financial interest in a client Incentive fee arrangements %oncern over employment sec!rity %ommercial press!re from o!tside the employing organisation Inappropriate personal !se of corporate assets.
Self-review – – – –
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-'em&er of ass!rance team &eing or recently having &een employed &y the client in a position to in!ence the s!&)ect matter &eing reviewed Involvement in implementation of *nancial system and s!&se!ently reporting on the operation of said system Same person reviewing decisions or data that prepared them An analyst+ or mem&er of a &oard+ a!dit committee or a!dit *rm &eing in a position to exert a direct or signi*cant in!ence over the *nancial reports ,he discovery of a signi*cant error d!ring a re-eval!ation of the wor !ndertaen &y the mem&er erforming a service for a client that directly a/ects the s!&)ect matter of an ass!rance engagement. =
Advocacy – – – –
Acting as an advocate on &ehalf of a client in litigation or disp!tes romoting shares in a listed a!dit client %ommenting p!&licly on f!t!re events in partic!lar circ!mstances 0here information is incomplete or advocating an arg!ment which is !nlawf!l.
Familiarity – – – – –
1ong association with a client Acceptance of gifts or preferential treatment (signi*cant val!e" Over familiarity with management Former partner of *rm &eing employed &y client A person in a position to in!ence *nancial or non-*nancial reporting or &!siness decisions having an immediate or close family mem&er who is in a position to &ene*t from that in!ence.
b) The folloing situations ma iolate the #ode of ,thics for $rofessional !ccountants. !ssume" in each case that the public accountant is a partner 1. 0aker" #!" approaches a ne client and tells the general manager she has an idea that could result in a substantial tax refund in the prior ear6s tax return b application of a technical proision in the tax la that the client had oerlooked. 0aker adds that the fee ill be => of the tax refund after it has been resoled b the !T3. The client agrees to the proposal. '. #ontel" #$!" adertises in the local paper that his firm does the audit of six of the eight largest finance companies in the cit. The adertisement also states that the aerage audit fee" as a percentage of total assets for the companies he audits" is loer than that of an other public accounting firm in the cit. +. ;inigan" #$!" does the audit" tax return" bookkeeping and management serices ork for 9illigan #onstruction $t 4td. Mildred 9illigan follos the practice of calling ;inigan before she makes an ma7or business decision to determine the effect on her compan6s taxes and the financial statement. ;inigan attends continuing education courses in the construction industr to make sure she is technicall competent and knoledgeable about the industr. ;inigan normall attends board of directors meetings and accompanies 9illigan hen she is seeking loans. Milidred 9illigan often 7okingl introduces ;inigan ith this statement8 F% hae m three business partnersB m bankers" the goernment and m accountant@ but ;inn6s the onl one ho is on m side.6 /. Marie Ganes" hile auditing a large car dealer ship compan is being inited to and attends the compan6s annual #hristmas part. When presents are handed out" she is surprised to find her name included. The present has a alue of approximatel H'.
Required +iscuss "hether these facts in any of the situations indicate violations of the ethical rules ,f so* identify the nature of the violations)
-olution8
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1* Contingent "ee arrange%ents bet$een the p!blic acco!ntant an the client are a #iolation o" the r!les "or clients recei#ing attestation ser#ices* 9hile the Coe inicates that contingent "ees are per%itte "or ser#ices that o not re>!ire inepenence, it also inicates that preparation o" ta ret!rns re>!ires inepenence* 2* A#ertising is per%itte as long as it is not "alse, %isleaing, or ecepti#e* It is probably not acceptable to %a-e co%parison o" those acco!nting "ir%s, !nless they?re base !pon #eri"iable "acts* The in"or%ation o" the a#ertising epressly states t$o "acts+ 6 o" @ o" the largest "inance co%panies are a!ite by their "ir% an secon, the a#erage a!it "ee, as a percentage o" total assets, is lo$er than any o" the other p!blic acco!nting "ir%s in the city* Contel %!st be able to s!pport those "act!al state%ents* Ass!%ing he can, there is no #iolation* .* It is essential that inigan retains both an attit!e o" inepenence in "act an in appearance* It is not possible to eter%ine i" inigan is %aintaining an attit!e o" inepenence in "act, gi#en her in#ol#e%ent in the co%pany, b!t it is certainly possible that she is* inigan is not necessarily #iolating the Coe* he oes the a!it, ta ret!rn, boo--eeping an %anage%ent ser#ices $or- "or the client, b!t that is not a #iolation* It is >!estionable $hether inigan is %aintaining an attit!e o" inepenence in appearance, especially gi#en the co%%ents by Gilligan* It is essential that she %aintain an attit!e o" inepenence thro!gho!t all her $or-* o she %!st be care"!l that she is not on the sie o" Gilligan $itho!t consieration o" her pro"essional responsibilities in con!cting the a!its an in all other aspects o" her pro"essional responsibilities* &c" p75 ?pro#iing acco!nting ser#ices to a!it clients) /* Accepting s!ch a gi"t is li-ely to be a #iolation o" the r!les o" con!ct* That gi"t is reasonably large an $o!l be consiere by %any e%ployees as e>!i#alent to a bon!s* Ieally Bane sho!l not accept the gi"t an state that since she is not an e%ployee, she $o!l pre"er not to ta-e it* I" she belie#es that it $o!l be e%barrassing to the co%pany, she sho!l gracio!sly accept it an ret!rn it $ith an eplanation o" her reasons as soon as practical*
Practical Application 4
,lise allimore is a partner in charge of the audit of Certenstein 4dt" a large listed public compan. ,lise took oer the audit from Mar7orie $latt" ho has recentl retired from the audit firm. Mar7orie as a er experienced auditor and the author of seeral reports into ethical standards in business" but ,lise did not regard her highl for her abilit to gro nonBaudit serice fee reenue. ,lise sees an opportunit to increase the proision for nonBaudit serices to Certenstein 4td and thus increase her reputation ithin the audit firm. Required a) -ive . e#amples of non/audit services that may !e performed !y the audit firm such as 0ertenstein !) Which non/audit services "ould you advise 'lise to avoid trying to sell to 0erstenstein Ltd !ecause of the potential ethical issues for the audit firm1 c) Would it make any difference to your ans"ers if 0erstenstein "as a propriety company* not a listed pu!lic company1
-olution8 J
a) ,xamples of nonBaudit serices include8 0ookkeeping serice (recording transactions" preparation of the financial statements for clients)" consulting serices on arious businessKfinancial matters" tax serice (help clients prepare the tax returns). (b) -ee 'L.1=L of !$,- 11 for a guide to hich serices to aoid. This section states that the auditor should aoid acting as an executie of the client compan. The auditor should not be inoled in transactions" making decisions about the audit firm6s recommendations" management reporting to directors" or acting as manager of the client ithin the preious to ears. s. 'L.1I1 discusses less significant threats" hich should onl be offered after careful consideration because the could create selfBreie or selfBinterest threats. These include haing custod of a client6s assets" superising client emploees" and preparing source documents. The section also discusses examples of safeguards" such as making arrangements so that personnel proiding such serices do not participate in the audit" and gaining additional adice on the impact of such serices. (c) 2es. !uditors can proide more nonBaudit serices to a proprietar compan than to a listed compan. 'L.1J The ;irm" or a &etork ;irm" ma proide an !udit #lient that is not a 4isted ,ntit ith accounting and bookkeeping serices" including paroll serices" of a routine or mechanical nature" proided an selfBreie threat created is reduced to an acceptable leel. ,xamples of such serices include8
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