Chapter 3
Ethics, independence and
corporate governance
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-1
Learning objective 1:
The nature and importance of
professional ethics
• Ethics are concerned with the requirements
for the general well-being, prosperity, health
and happiness of people.
• It requires knowledge of moral principles and
skills in applying them to problems and
decisions.
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PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-2
Ethical rules
• The establishment of ethical codes and disciplinary
rules does not necessarily create an ethical culture
or ensure the moral integrity of employees.
• APES 110 'Code of Ethics for Professional
Accountants', issued by the Accounting Professional
and Ethical Standards Board (APESB), indicates
that members are expected to comply with the spirit
as well as the letter of the rules.
• Ethics are principally attitudes of mind rather
than compliance with written rules of conduct.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-3
Learning objective 2:
Ethical theory
• Teleological ethics: deal with the consequences
or outcomes of actions
–
Generally, if the benefits of a proposed action outweigh the
costs, the decision is morally correct.
• Deontological ethics: based on duties and rights
–
Duties and rights set down in rules that must be followed.
• Virtue ethics: focus on personal qualities, such
as the integrity of the decision maker.
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PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-4
Learning objective 3:
Accounting bodies’ codes of ethics
•
•
•
APES 110 sets out main ethical pronouncements
that relate to the undertaking of an audit. [Revised
version issued December 2010; effective July 2011]
ASA 200.14/ISA 200.14 and ASA 102.5 require that
auditors comply with relevant ethical requirements.
APES 110 consists of three sections:
1.
2.
3.
•
Part A: General Application of the Code
Part B: Members in Public Practice
Part C: Members in Business
There are also a number of APES standards
and miscellaneous Professional Statements
promoting ‘competence’.
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PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-5
Purpose of the code of ethics
• Code of ethics: formal, systematic statement of
rules and principles developed by a community
to promote its well-being and punish undermining
behaviour.
• The code therefore:
–
–
–
Makes explicit the values implicitly required
Indicates how members should act towards
one another
Provides an objective basis for sanctions.
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PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-6
Virtues of an auditor
Distinguishing mark of accountancy profession
is its acceptance to act in the public interest, defined
as 'the collective well-being of the community of
people that the members serve'.
(APES 110, s 100.1)
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PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-7
Fundamental principles
•
Five fundamental principles contained
in the code of ethics:
1.
2.
3.
4.
5.
•
Integrity
Objectivity
Professional competence and due care
Confidentiality
Professional behaviour (APES 110, s 100.5 [Previously
100.4]).
Specific guidance on independence requirements
for assurance engagements provided in APES
110, s 290.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-8
Learning objective 4:
Applying ethics
• Sound ethical decision making is dependent on:
–
Knowledge of the basic principles on which moral
values and rules are based
–
Competence in decision-making skills
–
The ability to choose appropriate policies and decision
procedures in different situations.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-9
Ethical decision models
•
There are three main models:
1.
American Accounting Association Model
2.
Mary Guy Model
3.
Laura Nash Model
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-10
Learning objective 5:
Corporate governance
• Corporate governance: system by which
companies are directed and managed.
• Covers the conduct of the Board of Directors and
the relationship between the Board, management
and shareholders.
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PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-11
Corporate Governance – OECD
• In 1998 the OECD developed a set of corporate
governance standards covering six key areas –
Principles of Corporate Governance
–
–
–
–
–
–
Ensuring an effective corporate governance framework
Rights of shareholders and key ownership functions
Equitable treatment of shareholders
Role of stakeholders in corporate governance
Disclosure and transparency
Responsibilities of the board.
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3-12
Corporate Governance – The UK
• In 1999 the Institute of Chartered Accountants in
England and Wales issued what is known as the
Turnbull Report, specifying the accountability of
company directors and management.
–
–
–
Principle D.2 states that ‘the board should maintain a
sound system of internal control to safeguard
shareholders’ investment’.
Provision D.2.1 states that ‘the directors should, at least
annually, conduct a review of the effectiveness of the
group’s system of internal control’.
Provision D.2.2 states that ‘companies which do not
have an internal audit function should from time to time
review the need for one’.
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PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-13
Corporate Governance – The UK
(cont.)
–
Paragraph 12.43A states that ‘in the case of a company
incorporated in the United Kingdom, the following
additional items must be included in its annual report and
accounts:


a narrative statement … providing explanation which
enables its shareholders to evaluate how the principles have
been applied;
a statement as to whether or not it has complied throughout
the accounting period with the Code provisions.’
• Effective monitoring on a continuous basis is an
essential component of a sound system of internal
control.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-14
Corporate Governance – Australia
• The first Australian attempt to set out corporate
governance standards of best practice was
Corporate Practices and Conduct in 1991.
• Corporate governance is primarily the responsibility
of a company’s directors and senior officers,
although accountants have an important role to
play.
– Accountants are concerned with ensuring that
internal control policies and procedures are in
place and working.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-15
Groups in Australia advocating
improved corporate governance
• The business community, including the Australian
Institute of Company Directors (AICD)
• Investors
• Australian Securities Exchange (ASX)
• Australian Securities and Investments Commission
(ASIC)
• The three professional accounting bodies; CPA
Australia, the Institute of Chartered Accountants in
Australia and the National Institute of Accountants.
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PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-16
Improved corporate governance AICD
• The Australian Institute of Company Directors
(AICD) has as one of its goals to ‘be the recognised
advocate for corporate governance and directors’
issues’
• Every member of the AICD is expected to comply
with the AICD’s code of conduct. A director:
–
–
–
Must act honestly, in good faith and in the best interests
of the company as a whole
Has a duty to use care and diligence in fulfilling the
functions of office
Must use the powers of office in the best interest of the
company as a whole
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PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-17
Improved corporate governance –
AICD (cont.)
–
–
–
–
–
–
–
Must recognise that their primary responsibility is to
the company’s shareholders
Must not make improper use of information acquired
as a director
Must not take improper advantage of their position
Must properly manage any conflict of interests
Must not improperly use confidential information
Must not engage in conduct likely to discredit the
company; and
Has an obligation to comply with both the spirit and the
letter of the law and the spirit of the AICD’s code of
conduct.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-18
ASX Corporate Governance Council’s
Principles of Good Corporate
Governance
• Principle 1:
Lay solid foundation for
management and oversight
• Principle 2:
Structure the board to add value
• Principle 3:
Promote ethical and responsible
decision making
• Principle 4:
Safeguard integrity in financial
reporting
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-19
ASX Corporate Governance Council’s
Principles of Good Corporate
Governance (cont.)
• Principle 5:
Make timely and balanced
disclosure
• Principle 6:
Respect the rights of shareholders
• Principle 7:
Recognise and manage risks
• Principle 8:
Remunerate fairly and responsibly
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3-20
Audit committees
• Sub-committee of board of directors, which should
consist mainly of non-executive directors.
• Auditor’s major dealings with the board of directors
are normally through this sub-committee.
• Important component of corporate governance,
with most listed companies in Australia having
an audit committee.
• Top 500 companies on ASX now required
to have an audit committee.
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PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-21
Effective audit committees
•
Take an active role in overseeing company’s accounting and
financial reporting
•
Maintain a direct line of communication between the board of
directors and the auditors
•
Discuss sensitive matters with auditors such as controversial
accounting issues, disagreements with management, and
deficiencies in internal control
•
Discuss general scope and timing of external audit work
•
Involve themselves in nomination of external auditor, review
reasonableness of audit fees, consider how provision of nonaudit services affects auditor independence
•
Strengthen auditor independence by being independent
communication link between management and auditors
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-22
Learning objective 6:
Whistleblowing
Defined in United States Civil Service Reform Act 1978
as:
• A person ‘who discloses information he (or
she) reasonably believes evidences a violation
of any law, rule, or regulation, or mismanagement, a
gross waste of public funds, an abuse of authority,
or a substantial or specific danger
to public health or safety’ is a whistleblower.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-23
Whistleblowing responsibility
In Australia the Corporations Act 2001, s 311,
imposes a responsibility on auditors to inform
ASIC of any significant contraventions of the Act
discovered in the normal course of their duties,
and any other contraventions that cannot be
remedied by comment in the audit report or by
bringing the matter to the attention of directors.
Arguably, this places an obligation on the auditor
to whistleblow.
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PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-24
Auditor’s responsibilities regarding
whistleblowing
• An auditor does not have to actively look for
contraventions of the Corporations Act 2001.
• The decision to blow the whistle is not easy for
an auditor.
• Whistleblowing requires resolution of the
conflict between the principles of independence,
objectivity, integrity and public interest on the
one hand, and client confidentiality on the other.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-25
Auditor’s responsibilities regarding
whistleblowing (cont.)
• ASA 240.A65-66/ISA 240.A65-66 outlines that
where an entity’s governing body fails to take
appropriate action in regard to a fraud, the auditor
may seek legal advice in deciding whether to
report the fraud to a third party.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-26
Learning objective 7:
The importance of audit independence
• Independence is a key characteristic of an audit
or assurance service provider.
• In order for auditors to add credibility to financial
reports or other subject matter, they need
to remain independent.
• Independence is one of the fundamental ethical
virtues or principles required by APES 110.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-27
Independence: Corporations Act 2001
• s 307C: Independence declaration
–
Auditors must give directors a written declaration
of their independence, and this is to be included
in the directors’ report.
• s 324CA: Conflict of interest
–
Auditor must take reasonable steps to ensure conflict
of interest situation ceases to exist. Conflict of interest
is where members of audit team are not capable of
exercising objective and impartial judgment, as
judged by a reasonable person.
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PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-28
Independence: Corporations
Act 2001 (cont.)
• s 300(1)(ca): Former auditors. Directors’ report
is to include names of each officer of client who
was a former partner or director of current auditor.
• s 324CI: Member of audit firm cannot become
director, company secretary or member of senior
management of a client until two years after
ceasing to be with audit firm.
• s 324DA: Rotation of audit partners. Lead or
review partner for five successive years cannot
play a significant role in the audit of that entity
for at least another two successive years.
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3-29
Independence: Corporations Act 2001
(cont.)
• s 300(11)(B): Non-audit services. Boards of
all listed companies are required to provide
a statement in their annual report that identifies
all non-audit services provided by an audit firm,
fees, and explanation why provision of service
did not impair independence.
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3-30
Auditors’ appointment
• s 327B: Shareholders are responsible for the
appointment of auditor:
–
Auditor is in breach of independence requirements
if, while auditing at a time that a s 324CH(1) relationship
exists, the auditor is aware of relationship and does not
take all reasonable steps to discontinue the audit.
• s 324CH(1) Relationships include:
–
–
–
–
Auditor or immediate family member being an officer
or audit-critical member (influencing financial report)
of client
Auditor cannot provide remuneration to officer or
audit-critical employee for acting as consultant
Auditor cannot have an investment in client
Auditor cannot owe money to a client (unless a housing or
commercial loan on normal terms and conditions).
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3-31
Auditors’ removal and resignation
• Removal: Difficult to remove auditor.
• s 329: Requires a resolution of company at a general
meeting of which special notice has been given.
Auditor entitled to make written representation and
speak at general meeting. A copy of notice must be
sent to ASIC.
• Resignation (s 329(9)): Auditor can resign. Must
have written consent from ASIC, if a public company.
Application outlines reason, and ASIC must approve
the reason. Designed to ensure independence and
integrity of audit function is maintained.
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3-32
Right of access to records and
reasonable fees
• s 310: Auditor has right of access at all reasonable
times to the accounting and other records and
registers, and an entitlement to require from any
officer of the company such information and
explanations as required for the purposes of audit.
• s 331: Auditor is entitled to receive reasonable
fees and expenses for the work carried out.
• Collectively, these provisions assist an auditor
to maintain actual and perceived independence,
and attempt to create a suitable environment for
an audit process that is free from undue influence
and obstruction.
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3-33
Independence: ethical requirements
•
Test for independence is a reasonable person test:
Would a reasonable person having access to all facts
consider that the auditor was independent? (APES 110,
s 290.6 [Previously 290.9])
•
Ethical rules emphasise both (APES 110, s 290.6
[Previously 290.8]) :
– Perceived independence (independence in
appearance) — how others will view the auditor
– Actual independence (independence of mind)
— state of mind of the auditor. Whether the auditor
can actually eliminate bias and personal interest
from his or her decisions and not succumb to any
undue pressures or influences. Related to integrity,
objectivity and strength of character.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-34
Learning objective 8:
Developments in auditor
independence
• Ramsay Report (Australia):
• IFAC independence rules: adopted conceptual
approach using a framework for identifying,
evaluating and responding to threats to
independence
• APES 110: based on IFAC independence rules
• Sarbanes-Oxley Act (USA)
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-35
Learning objective 8:
Developments in auditor
independence (cont.)
• Joint Committee of Public Accounts and
Auditors (Australia)
• HIH Royal Commission (Australia)
• Corporate Law Economic Reform Program
(CLERP 9) (Australia)
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3-36
APES 110, s 290: Threats to independence
• Self-interest threats: Auditor could benefit
from a financial interest in the client.
• Self-review threats: Auditor could have
to re-evaluate his or her own work.
• Advocacy threats: Auditor could promote the
audit client’s point of view and compromise
objectivity.
• Familiarity threats: Auditor may become
too sympathetic to the client’s interests.
• Intimidation threats: Auditor may be deterred
from acting objectively by actual or perceived
threats from client.
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3-37
APES 110, s 290: Safeguards
•
Safeguards fall into three broad categories.
For an auditor these are:
1.
2.
3.
•
Safeguards created by the profession, legislation
or regulation — education, professional standards,
monitoring and disciplinary processes, and inspections
and reviews.
Safeguards within the audit client — competent
employees, robust corporate governance structures.
Safeguards within the audit firm — independence and
quality control policies and procedures.
The safeguards are aimed at reducing or
resolving circumstances that pose threats.
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
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3-38
Learning objective 9:
Major threats to auditor independence
• Auditor employment relationships
–
Member of the assurance team cannot be employed
by the client.
• Financial and business relationships, including:
–
–
–
–
Investments in audit clients
Loans to and from clients
Business relationships
Goods and services from clients.
Copyright  2010 McGraw-Hill Australia Pty Ltd
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3-39
Learning objective 9:
Major threats to auditor independence
(cont.)
• Provision of non-audit services, including:
–
–
–
–
–
–
–
–
–
–
Preparing financial reports
Valuation services
Taxation
Internal audit
Design of systems
Temporary staff assignments
Litigation support services
Legal services
Recruiting senior management
Corporate finance
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia 4e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-40
Learning objective 10:
Suggestions for further improving
auditor independence
• Use of an oversight board. In Australia, the FRC
now acts as a public oversight board for the
AUASB (AUASB still has a number of practising
auditors as members)
• Rotation of audit firms
• Audit firm independence boards
• Client policies, such as restricting other services
provided by audit firm.
Copyright  2010 McGraw-Hill Australia Pty Ltd
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3-41
Learning objective 11:
Fee determination and obtaining
clients
• Audit fees should be commensurate with the
service provided. Thus, they should reflect the
time taken to audit, and the knowledge, skills
and expertise required.
• An auditor should not enter into fee arrangements
that may compromise his or her independence.
• Fees for a period should not be dependent
on fees from the provision of future audits or
other services.
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3-42
Obtaining clients
• Advertising, publicity and solicitation are
permitted provided they are not false,
misleading, deceptive or otherwise reflect
adversely on the profession.
• Competing for prospective clients through
tenders is now quite common.
• Auditors should be careful of audit clients
that are opinion shopping.
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3-43