Ethics and Independence in Accountancy Profession
Mohammed Humayun Kabir FCA
1.0 Background
Accounting is a very valuable knowledge and important component for a market economy. No
economic activity would be possible without accountancy. It provides information on financial
position and profitability of operations. It is the foundation of countries’ fiscal, monetary &
financial systems and plays a key role in ‘governance’ towards establishing accountability and
transparency in the economies. The accountancy profession comprises individual accountants,
firms of accountants and accountancy bodies. Members of professional accountancy bodies
engage in a broad range of professional activities that are all classified as accounting/
accountancy work. This includes: the traditional external audit function; other professional firm
services; such as tax and corporate finance advice; finance, accounting and treasury functions in
industry and commerce; and general management roles including those of chief executive,
chairman and member of boards of directors The Institutes of Accountants and their members
have been subject to increasing public scrutiny and criticisms. These criticisms are ranging from
the failure of accounting documents to reveal a more accurate reflection of the financial wellbeing/ill health of organizations and the collusion of accountants in the preparation and
validation of those documents, to the failure of the accountancy profession satisfactorily to take
account of the public interest in the determination of the future of accounting and auditing
practice.
High profile corporate collapses and fraud, with which accountants have been associated as
auditors, executives and directors, have prompted searching questions to be asked as to the
integrity of the professional accountants involved. These collapses or systemic failures, as the
broad range of financial scandals exposed in the early years of the 21st century have been
labeled, have brought into sharp focus and over a more concentrated timescale, issues of longstanding debate including: audit and accounting regulation; auditor independence; earnings
management; and audit and audit firm quality controls. The crisis of credibility being faced by
the profession because society perceived accountants have lost their commitment to public
service. The credibility of the profession is threatened when the ideals of integrity, independence,
public service and ethical standards come under suspicion. The ideal of the profession is public
service. Self-interest can thwart this ideal.
The financial scandals at the start of the 21st century, including the expeditious demise of one of
the then Big Five global accountancy firms, have brought the question of professional ethics in
the context of accountancy into focus. This is not surprising, given that regulators and the public
assume that the underlying problems [of the recent financial reporting scandals] are corruption
and criminality of unethical accountants falsifying numbers to protect equally unethical clients.
Ethics have been shown to have assumed an increased importance in organizations, which are
now subject to scrutiny and criticism from the media, regulators, and public interest groups.
Accountants and their professionalism have been criticized in the past, and some of the
professions responses to this criticism have been criticized as being self-serving. For example,
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concerns expressed outside the profession were simply reconstituted by accounting institutions
as a problem of misguided expectations. However, the scandals of the early 21st century
provided evidence that the commercial interests of large firms of accountants had overwhelmed
the allegiance to professional integrity.
Similar to the medical and legal professions, society grants public accountants an exclusive right
to perform certain activities and it expects something in return. Professional practitioners are
expected to act in the best interests of society when resolving issues that arise within the scope of
their franchised practice.
The core issue in the context of the accountancy profession is the statutory audit monopoly
privilege enjoyed by public accounting practitioners and the accountability that is demanded by
that privilege. This monopoly is defended by the profession on the grounds of the professions
superior qualities of independence, integrity, and of serving the public interest. The relationship
of these characteristics to ethical behavior is central too much of the criticisms leveled at the
profession over the past 30 years.The accountancy profession has claimed to be both moral and
ethical throughout the 20th century, but this assertion has been questioned by the regulators /
legislators / investors / stakeholders. This code of ethics also were have undergone changes over
time.
2.0 What are ethics & Its need
Ethics can be defined broadly as a set of moral principles or values. Each of us has such a set of
values, although we may or may not have considered them explicitly. Philosophers, religious
organizations and other groups have defined in various ways ideal sets of moral principles or values.
Examples of prescribed sets of moral principles or values at the implementation level include laws
and regulations, religious doctrine, codes of business ethics for professional and industry groups,
and codes of conduct within individual organizations. It is common for people to differ in their
moral principles or values. These differences result from our relationships with and opinions of
others, including parents, teachers, friends and colleagues; and our life experiences, including life
successes and failures, politics, sports and the media.
Ethical behavior is necessary for a society to function in an orderly manner. Ethics is one of the
forces that hold a society together. Imagine, for example, what would happen if we couldn't depend
on the people we deal with to be honest. If parents, siblings, teachers, employers, co-workers and
friends all frequently lied, it would be almost impossible for effective communication to occur. The
need for ethics in society is sufficiently important that many commonly held ethical values are
incorporated into laws. However, many of the ethical values of a society cannot be incorporated into
law because of the judgmental nature of particular values. It is practical to have laws that deal with
cheating, stealing, lying or deceiving others. It is far more difficult to establish meaningful laws that
deal with principles such as integrity, loyalty and the pursuit of excellence. That does not imply that
these principles are less important for an orderly society. Nor does the establishment of a code of
ethics ensure that individuals will always act ethically or that a broadly ethical culture will develop in
a firm or professional body.
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3.0 Ethics in Accountancy Profession
Michael Hammer (1996) identifies three words characterizing the worldview of a professional:
customer, result, and process. The professional sees himself or herself as responsible to the
customer; the mission is to solve the problem of the customer, to create the value that the customer
requires. If that value is not created, if problem is not solved, the professional has not done his or
her job. It is only by producing the result that customer requires- by performing the entire process
that yields that result-that the professional discharges his or her responsibility.
The need for certain norms of behavior, responsibility and attitude of professional accountant
cannot be overemphasized as modern view of a professional is someone who is responsible for
achieving a result than performing a task. A professional is an independent human being. Once
provided with knowledge and clear understanding of goal, professional can be expected get there on
their own. To be a professional a person needs education as well as training and a professional does
not work according to explicit instructions. Technically, the professional accountants should carry
out professional services in accordance with the relevant technical and professional standards. The
professional accountants have a duty to carry out with care and skill, the instructions of the client or
employer in so far as they are compatible with the requirements of integrity, objectivity and, in the
case of professional accountants in public practice, independence. In addition, they should conform
to the technical and professional standards promulgated by:
(a) International Federation of Accountants (IFAC) on International Standards of Auditing
(ISA);
(b) International Accounting Standards Committee (IASC);
(c) In line with the instructions of professional accounting body of the country; and
(d) Incompliance with requirements of corporate laws and relevant regulatory bodies and
legislation.
IFAC considers fundamental principles by which an accountant should be governed in the conduct
of his professional relations with others are integrity, objectivity, professional Competence and due
care, Confidentiality, Professional behavior and Technical Standards.
4.0 Ethical conduct in professions
Our society has attached a special meaning to the term 'professional'. Professionals are expected to
conduct themselves at a higher level than most other members of society. For example, when the
press reports that a medical practitioner, lawyer, CPA or chartered accountant has been indicted for
a crime, most people feel more disappointment or dismay than when the same thing happens to
people who are not labeled as professionals. The term professional implies a responsibility for
conduct that extends beyond satisfying people's responsibilities to themselves and beyond the
requirements of our society's laws and regulations. CPAs and chartered accountants, as
professionals, recognize a responsibility to the public, to clients and to fellow practitioners that
includes honorable behavior, even if that means personal sacrifice.
The underlying reason for a high level of professional conduct by any profession is the need for
public confidence in the quality of service by the profession, regardless of the individual providing it.
For the CPA or chartered accountant, it is essential that management and external financial
statement users have confidence in the quality of audits and other services. If users of services do
not have confidence in physicians, judges or public accountants, the ability of those professionals to
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serve clients and the public effectively is diminished. It is not practical for users to evaluate the
quality of the performance of most professional services because of their complexity. A patient
cannot be expected to evaluate whether an operation was properly performed. A financial statement
user cannot be expected to evaluate audit performance. Most users have neither the competence nor
the time for such an evaluation. Public confidence in the quality of professional services is enhanced
when the profession encourages high standards of performance and conduct on the part of all
practitioners.
In recent years, increased competition has made it more challenging for public accountants and
many other professionals to conduct themselves in a professional manner. Increased competition
sometimes has the effect of making public accounting firms more concerned about keeping clients
and maintaining profits than with providing high quality audits for users. Because of the increased
competition, many public accounting firms have implemented philosophies and practices that are
frequently referred to as improved business practices. These include such things as: improved
recruiting and personnel practices to lower recruiting and training costs and increase productivity;
better office management to increase efficiency; and more effective advertising and other
promotional methods to retain or increase revenues. Firms are also attempting to become more
efficient in doing audits through the more sophisticated use of technology and more effective audit
planning. Such changes are desirable provided they do not interfere with the conduct of auditors as
professionals.
5.0 Difference between auditors and other professionals
Auditors' relationship with users of financial statements is different from the relationship most other
professionals have with the users of their services. Lawyers, for example, are typically engaged and
paid by a client and have primary responsibility to be an advocate for that client. Auditors are
effectively engaged and paid by the company issuing the financial statements but the primary
beneficiaries of the audit are statement users. Frequently, the auditor doesn't know or have contact
with the statement users, but has frequent meetings and ongoing relationships with auditee
personnel.
It is essential that users regard public accounting firms as competent and unbiased. If users were to
believe that auditors do not perform a valuable service (by reducing information risk), the value of
the independent audit and other attestation reports would be reduced, and the demand for audits
would thereby also be reduced. There is therefore considerable incentive for public accounting firms
to conduct themselves at a high professional level.
6.0 Ways in which auditors are encouraged to conduct themselves professionally
There are several ways the public accounting profession and society encourage CPAs and chartered
accountants to conduct them appropriately and to do high-quality audits and related services. Figure
1 shows the most important ways. Professional Institutes promulgate auditing standards and their
interpretations, the professional bodies' programs and examinations, quality control, peer review
requirements and continuing education. Also, the regulators oversight functions in relation to
auditors can stimulate greater attention to professional ethics. The ability of individuals separately or
together to sue public accounting firms also exerts considerable influence on the way practitioners
conduct themselves and audits. Legal liability of practicing accountants Code of Professional
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Conduct also has a significant influence on practitioners. The Code is intended to provide minimum
standards of conduct for members.
Figure 1: Ways in which the profession and society encourage auditors to conduct themselves at a
high level
Conduct of
audit firm
personnel
Auditing
standards
and
pronouncemen
ts
Continuing
education
requirements
Tertiary
study
requirement
s
Legal
liability
Each firm’s
quality
control
mechanisms
Auditor
registratio
n and
regulatory
oversight
Ethical
codes
Professiona
l programs
and
examination
s
In addition to the Code and other professional body pronouncements, guidance on any matter of
professional conduct can be sought from the professional bodies. All the Institutes have a national
advisory facility for members to obtain advice on ethical problems.
7.0 The Code of Professional Conduct
Generally, a code of ethics can consist of general statements of ideal conduct, or specific rules that
define unacceptable behavior. The advantage of the general statements is the emphasis on positive
attitudes and activities that encourage a high level of performance. The disadvantage is the difficulty
of enforcing general ideals, because there are no minimum standards of ideal behavior. The
advantage of carefully defined specific rules is the enforceability of minimum behavior and
performance standards. The disadvantage is the tendency of some practitioners to define the rules as
maximum rather than minimum standards. The professional bodies, probably in response to this
potential problem, state that the Code provides 'authoritative guidance on minimum acceptable
standards of professional conduct' (emphasis added). It is expected that members will achieve a level
of professionalism in excess of such minimum requirements.
8.0 IFAC Code of Ethics Featuring New Independence Rules
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The International Federation of Accountants (IFAC) has released its updated Code of Ethics for
Professional Accountants featuring new rules on independence. This international Code is
intended to serve as a model on which to base national ethical guidance for accountants.
The Code includes principles that are applicable to all professional accountants, and
distinguishes between those that affect professional accountants in public practice and those that
are applicable to other accountants employed in business and industry. The Accountancy
profession throughout the world operates in an environment with different cultures and
regulatory requirements. The IFAC Code states the fundamental principles that should be
observed by professional accountants to meet their responsibility to protect the public interest.
Changes in the global the economy, technology developments, and the expanding services
performed by the accountancy profession have necessitated updating the independence rules. The
new rules of independence set out a conceptual framework that focuses on the factors that pose a
threat to independence for all assurance engagements and the safeguards those auditors should
put in place to preserve their independence. In addition, the updated Code provides examples of
situations on how the conceptual approach to independence is to be applied to specific
circumstances and relationships.
9.0 Independence
The rules of conduct are permeated with requirements intended to enhance independence. It deals
with both general and specific issues affecting independence. General considerations include
freedom to plan and conduct the audit, report findings, and express an opinion free from external
influence; considerations in accepting an engagement; charging for services; and fee dependency.
More specific considerations encompass the provision of other services to auditees, quality control
considerations, and opinion shopping. Some selected issues affecting independence are discussed
below in this section.
Independence in auditing means taking an unbiased viewpoint (i) in the performance of audit tests;
(ii) in the evaluation of the results; and (iii) in the issuance of the audit report. If the auditor is an
advocate for or influenced by an employee or the management of the auditee, a particular creditor or
anyone else, the auditor cannot be considered independent or objective.
Independence is one of the auditor's cost vital characteristics. The reason that many users are willing
to rely upon the external auditors' reports as to the truth and fairness of financial statements is their
expectation of an unbiased viewpoint. It highlights three personal attributes essential to maintaining
an independent frame of mind: integrity, objectivity and strength of character. Not only is it essential
that auditors maintain an independent attitude in fulfilling their responsibility, but it is also
important that the users of financial statements have confidence in that independence. These two
objectives are frequently identified as independence in fact and independence in appearance.
Independence in fact exists when the auditor actually maintains an unbiased attitude throughout the
audit, whereas independence in appearance is the result of others' interpretations of the situation. If
auditors are independent in fact but users believe them to be advocates for the auditee, most of the
value of the audit function will be lost.
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In each professional assignment undertaken, a member in public practice must both be and be seen
to be free of any interest which is incompatible with objectivity. This is self-evident in the exercise
of the reporting function but also applies to all other professional work. In determining whether a
member in public practice is or is not seen to be free of any interest which is incompatible with
objectivity, the criterion should be whether a reasonable person, having knowledge of the relevant
facts and taking into account the conduct of the member and the member's behaviour under the
circumstances, could conclude that the member has placed himself or herself in a position where his
or her objectivity would or could be impaired.
Some argue that eliminating everything affecting either independence in fact or in appearance is too
extreme. They argue that this position is likely to restrict significantly the services offered to clients,
the freedom of public accountants to practice in the traditional manner, and the ability of public
accounting firms to hire competent staff. Many regulators, social commentators and others,
however, argue that the breadth of services offered by public accounting firms impairs independence
to the extent that public confidence in the audit function loses much of its value. At this point, it is
helpful to examine some conflicts of independence that have arisen, evaluate their significance and
determine how the profession has addressed them.
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Independence of Mind
– The state of mind that permits the expression of a conclusion without being affected
by influences that compromise professional judgment, thereby allowing an individual
to act with integrity and exercise objectivity and professional skepticism.
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Independence in Appearance
– The avoidance of facts and circumstances that are so significant that a reasonable
and informed third party would be likely to conclude, weighing all the specific facts
and circumstances, that a firm’s, of a member of the audit team’s, integrity,
objectivity or professional skepticism has been compromised.
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Audit and review engagements for purposes of Section 290 include a:
– Complete set of financial statements; and
– Single financial statement.
Modification of the independence requirements that apply to audit and review engagements
is permitted where the audit or review report includes a restriction on use or distribution,
provided certain conditions are met.
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Conceptual Framework – Threats
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Self-interest
– The threat that a financial or other interest will inappropriate influence the
professional accountant’s judgment or behavior.
Self-review
– The threat that a professional accountant will not appropriately evaluate the results
of a previous judgment made or service performed on which the accountant will rely
when forming a judgment as part of providing the current service.
Advocacy
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The threat that a professional accountant will promote a client’s position to the point
that the accountant’s objectivity is compromised.
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Familiarity
– The threat that due to a long or close relationship with a client, a professional
accountant will be too sympathetic to their interests or too accepting of their work.
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Intimidation
– The threat that a professional accountant will be deterred from acting objectively
because of actual or perceived pressures, including attempts to exercise undue
influence over the accountant.
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Safeguards fall into two broad categories:
– Those created by the profession, legislation or regulation; and
– Those in the work environment.
Network firms are required to be independent of audit clients of other firms within the
network
Network is defined as a larger structure that is:
– Aimed at co-operation; and
– Clearly aimed at profit or cost sharing or shares common ownership, control or
management, common quality control policies and procedures, common business
strategy, the use of a common brand-name, or a significant part of professional
resources.
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10.0 Public Interest Entities
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Public interest entities defined as:
– Listed entities; and
– Entities
• defined by regulation or legislation as a public interest entity, or
• for which the audit is required by regulation or legislation to be conducted in
compliance with the same independence requirements that apply to the audit
of listed entities.
11.0 Related Entities
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Related entities of the audit client are defined as:
– An entity that has direct or indirect control over the client if the client is material to
such entity;
– An entity with a direct financial interest in the client if that entity has significant
influence over the client and the interest in the client is material to such entity;
– An entity over which the client has direct or indirect control;
– An entity in which the client, or an entity over which the client has direct or indirect
control, has a direct financial interest that gives it significant influence over such
entity and the interest is material to the client and its related entity; and
– Listed entities
– References to “audit client” include its related entities
– Independence is required from all related entities.
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Non-listed entities
Independence is required from related entities over which the audit client has direct
or indirect control.
When the audit team knows, or has reason to believe, a relationship or circumstance
involving a related entity is relevant to the evaluation of the firm’s independence,
that related entity shall be included in the evaluation of independence.
An entity which is under common control with the client (a “sister entity”) if the
sister entity and the client are both material to the entity that controls both the client
and the sister entity.
12.0 Those Charged with Governance
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Regular communication with those charged with governance is encouraged.
Communication enables those charged with governance to:
– Consider the firm’s judgments in identifying and evaluating threats to independence,
– Consider the appropriateness of safeguards applied, and
– Take appropriate action.
13.0 Documentation
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The professional accountant shall document conclusions regarding compliance with
independence requirements and the substance of relevant discussions supporting
conclusions:
– When safeguards are required, the nature of the threat and safeguards in place or
applied to reduce threat to an acceptable level shall be documented.
– When a threat required significant analysis to determine whether safeguards were
necessary and the accountant concluded safeguards were not necessary because the
threat was already at an acceptable level, the nature of the threat and rationale for the
conclusion shall be documented.
14.0 Engagement Period
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Independence is required during the engagement period and the period covered by the
financial statements.
The engagement period starts when the audit team begins to perform audit services and ends
when the audit report is issued.
If the engagement is recurring, the period ends at the later of the notification by either party
that the professional relationship has terminated or the issuance of the final report.
15.0 Mergers and Acquisitions
•
When, as a result of merger or acquisition, an entity becomes a related entity of the audit
client, the firm shall:
– Identify and evaluate previous and current relationships that could affect
independence, and
– Take steps necessary by the effective date of the merger or acquisition to terminate
any current interests or relationships that are not permitted.
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If the firm cannot reasonably terminate an interest or relationship by the effective
date, the firm shall:
Evaluate the significance of the threat, and
Discuss the matter with those charged with governance and if those charged with
governance request the firm to continue as auditor, the firm shall do so only if:
The interest or relationship will be terminated as soon as reasonably possible and in
all cases within six months of the effective date;
Any individual with such an interest or relationship is not a member of the
engagement team or the individual responsible for the engagement quality control
review; and
Appropriate transitional measures are applied and discussed with those charged
with governance.
When the firm has completed a significant amount of audit work before the effective
date of the merger or acquisition and can complete the audit in a short period of
time, and those charged with governance request the firm to complete the audit
while continuing with an interest or relationship that would otherwise be prohibited,
the firm shall do so only if :
The firm has evaluated the significance of the threats and discussed such evaluation
with those charged with governance;
The individual with such an interest or relationship is not a member of the
engagement team or the individual responsible for the engagement quality control
review;
Appropriate transitional measures are applied; and
The firm ceases to be the auditor no later than the issuance of the audit report.
In all cases, the firm shall determine whether, even if all the requirements can be met,
the interests or relationships create threats that would remain so significant that
objectivity would be compromised .
The firm shall document any prohibited interests or relationships that will not be
terminated by the effective date of the merger or acquisition, including the:
Reasons why the interest or relationship was not terminated;
Transitional measures applied;
Results of the discussion with those charged with governance; and
Rationale as to why the threats that remain are not so significant that objectivity
would be compromised.
16.0 Other Considerations
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An inadvertent violation of an independence requirement generally will be deemed not to
compromise independence provided:
– The firm has appropriate quality control policies and procedures (equivalent to ISCQ
1) in place to maintain independence; and
– Once discovered, the violation is corrected promptly and any necessary safeguards
are applied to eliminate any threat or reduce it to an acceptable level.
The firm shall determine whether to discuss the matter with those charged with governance.
17.0 Key Independence Provisions
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General Provision
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Financial interests
Loans and guarantees
Business relationship
Family and personal relationships
Employments with an audit client
Temporary staff assignments
Recent service with an audit client
Serving as a director or officer
Long association (including partner rotation)
Provision of non-assurance services
Fees
Compensation and evaluation policies
Gifts and hospitality
Actual of threatened litigation
Reports that include a restriction on use or distribution
18.0 General Provision
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The firm and members of the audit team shall evaluate the implications of similar, but
different, circumstances and relationships and determine whether safeguards can be applied
when necessary to eliminate the threats or reduce them to an acceptable level.
19.0 Financial Interests
•
A firm, a member of the audit team, or an immediate family member shall not have a direct
financial interest or material indirect financial interest in:
– The audit client, or
– An entity that has a controlling interest in the audit client if the client is material to
the controlling entity.
•
Partners, and their immediate family members, shall not have a direct financial interest or
material indirect financial interest in any audit client served by engagement partners located
in the same office.
• Partners and managerial employees who provide non-audit services to an audit client, except
those whose involvement is minimal, or their immediate family members, shall not have a
direct financial interest or material indirect financial interest in such audit client.
• Financial interests held by immediate family members of:
– Partners in the office of the engagement partner, or
– Partners or managerial employees who provide non-audit services to the audit client
will not compromise independence if the interest is received as a result of the family
member’s employment rights and safeguards are applied when necessary.
• When the immediate family member has the right to dispose of the interest or, in the case of
stock options, exercise the option, the interest shall be disposed of or forfeited as soon as
practicable.
• Those prohibited from having a direct or material indirect financial interest in an audit client
shall not hold such interest as trustee unless:
• The trustee, or immediate family member, or the firm are not beneficiaries of the
trust;
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The interest in the audit client is not material to the trust;
The trust cannot exercise significant influence over the audit client; and
The trustee, or immediate family member, or the firm cannot significantly influence
any investment decision involving a financial interest in the audit client.
•
A firm, a member of the audit team, or an immediate family member shall not have a
financial interest in an entity that the audit client also has an interest in if the interest is
material to any party and the audit client can exercise significant influence over the entity.
•
If the firm, a partner or employee of the firm, or immediate family member, receives a
financial interest that would not be permitted, for example by way of an inheritance, gift or
as a result of a merger:
– If received by the firm, a member of the audit team, or immediate family member,
the interest shall be disposed of immediately, or if the interest is indirect, a sufficient
amount shall be disposed of such that the remaining interest is immaterial
– If received by an individual who is not a member of the audit team, or immediate
family member, the interest shall be disposed of as soon as possible, or if the interest
is indirect, a sufficient amount shall be disposed of such that the remaining interest is
immaterial
Threats may be created:
– If a member of audit team knows a close family member, or other individuals ,such
as professionals in the firm or close personal friends, holds a direct financial interest
or material indirect financial interest in the audit client
– A firm’s retirement benefit plan holds a direct financial interest or material indirect
financial interest in an audit client
– A firm, a member of the audit team, or immediate family member, has a financial
interest in an entity and a director, officer or controlling owner of the audit client is
also known to have a financial interest in that entity
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20.0 Loans and Guarantees
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A firm, a member of the audit team, or an immediate family member, shall not make or
guarantee a loan to an audit client unless the loan or guarantee is immaterial to both the firm
or member of the audit team and the immediate family member, and the client.
•
Audit clients that are banks or similar institutions
– A firm, a member of the audit team, or immediate family member, may have a loan
or guarantee of a loan provided it is made under normal lending procedures, terms
and conditions.
– If a loan to a firm is permitted under the above and is material to the audit client or
the firm, it may be possible to apply safeguards to reduce the threat to an acceptable
level.
Audit clients that are not banks or similar institutions
– A firm, a member of the audit team, or immediate family member, may have a loan
or guarantee of a loan unless it is immaterial to the firm or member of the audit team
and the immediate family member, and the client.
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21.0 Business Relationships
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A firm shall not have a business relationship with an audit client or its management unless
any financial interest is immaterial and the business relationship is insignificant to the firm
and the client or its management.
If any financial interest from a business relationship between a member of the audit team
and the audit client or its management is material or the relationship is significant to that
member, the individual should be removed from the audit team.
If the business relationship is between an immediate family member of a member of the
audit team and the audit client or its managements, any threat shall be evaluated and
safeguards applied when necessary.
The purchase of goods and services from an audit client by the firm, or a member of the
audit team or an immediate family member, does not generally create threats to
independence if the transaction is in the normal course of business and at arm’s length.
If the nature or magnitude of the transactions is such that a self-interest threat is created,
safeguards shall be applied when necessary
22.0 Family and Personal Relationships
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An individual who has an immediate family member in one of the following positions at an
audit client, or who was in the position during any period covered by the engagement or
financial statements, shall not be a member of the audit team:
– A director or officer; or
– An employee in a position to exert significant influence over the preparation of the
accounting records or the financial statements.
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Threats to independence are created when a member of the audit team has an immediate
family member who is an employee in a position to exert significant influence over the
client’s financial position, financial performance or cash flows.
The significance of the threats shall be evaluated and safeguards applied when necessary.
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Threats to independence are created when a member of the audit team has a close family
member in one of the following positions at an audit client:
– A director or officer; or
– An employee in a position to exert significant influence over the preparation of the
accounting records of the financial statements.
The significance of the threats shall be evaluated and safeguards applied when necessary.
Threats to independence are created if a member of the audit team has a close relationship
with other persons in one of the following positions at an audit client:
– A director or officer; or
– An employee in a position to exert significant influence over the preparation of the
accounting records of the financial statements.
A member of the audit team who has such a relationship shall consult in accordance with
firm policies and procedures.
The significance of the threats shall be evaluated and safeguards applied when necessary.
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23.0 Employment with an Audit Client
•
A former member of audit team or partner of the firm shall not join an audit client as
director or officer or an employee in a position to exert significant influence over the
accounting records or financial statements unless:
– The individual is not entitled to any benefits or payments from the firm, unless made
in accordance with fixed pre-determined arrangements and any amount owed to the
individual is not material to the firm; and
– The individual does not continue to participate, or appear to participate, in the firm’s
business or professional activities.
•
If no significant connection remains between the firm and the former member of the audit
team or partner, the significance of the threats shall be evaluated and safeguards applied
when necessary.
Firm policies and procedures shall require members of the audit team to notify the firm
when entering employment negotiations with an audit client. Safeguards shall be applied
when necessary.
•
•
•
•
•
In the case of public interest entities, independence is compromised if a key audit partner or
the firm’s Senior or Managing Partner joins the audit client as a director or officer or an
employee in a position to exert significant influence over the accounting records or financial
statements unless a specified period has passed.
An exception exists if a former key audit partner or the firm’s Senior or Managing Partner is
in such a position as a result of a business combination, provided certain criteria are satisfied.
Key audit partners include the:
• Engagement partner;
• Individual responsible for the engagement quality control review; and
• Other audit partners on the engagement team who make key decisions or judgments
on significant matters with respect to the audit.
Specified period
• In the case of key audit partners, the client has issued audited financial statements
covering a period of not less than twelve months and the partner was not a member
of the audit team with respect to the audit of those financial statements.
24.0 Serving as a Director or Officer
•
•
A partner or employee of the firm shall not serve as a director or officer of an audit client.
A partner or employee may serve as Company Secretary if:
– The practice is specifically permitted under local laws and professional rules of
practice;
– Management makes all relevant decision;
– The duties are routine and administrative; and
– The significance of the threats are evaluated and safeguards applied when necessary
25.0 Long Association of Senior Personnel
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•
•
•
•
•
•
Using the same senior personnel on an audit engagement over a long period of time creates
threats to independence, which should be evaluated and safeguards applied when necessary.
In the case of audit clients that are public interest entities, key audit partners shall rotate after
seven years and shall not be a member of the engagement team or a key audit partner for the
client for two years.
Where continuity is especially important to audit quality, key audit partners may, in rare cases
due to unforeseen circumstances outside of the firm’s control, be permitted one additional
year as long as threats to independence can be eliminated or reduced to an acceptable level
by applying safeguards.
The time served as a key audit partner is taken into account when the audit client becomes a
public interest entity.
• An additional year is permitted only when the individual has served as a key audit
partner for six or more years when the audit client becomes a public interest entity.
During the two year “time out” period, the individual shall not:
• Participate in the audit of the entity;
• Provide quality control for the engagement;
• Consult with the engagement team or the client regarding technical or industryspecific issues, transactions or events; or
• Otherwise directly influence the outcome of the engagement.
Rotation is not required if:
• The firm has only a few people with the necessary knowledge and experience to
serve as a key audit partner;
• An independent regulator has provided an exemption from rotation in such
circumstances;
• The independent regulator has specified alternative safeguards; and
• The alternative safeguards are applied.
26.0 Provision of Non-assurance Services
•
•
•
•
•
Before the firm accepts an engagement to provide a non-assurance service to an audit client,
a determination shall be made whether providing the service creates a threat to
independence.
The firm shall not provide the service if the threats cannot be reduced to an acceptable level
by the application of safeguards.
A firm may provide a non-assurance service that would otherwise be restricted to the
following related entities, provided the results of the services will not be subject to audit
procedures:
• An entity that has direct or indirect control over the audit client;
• An entity with a direct financial interest in the audit client if that entity has significant
influence over the client and the interest in the client is material to the entity; or
• An entity under common control with the audit client.
The significance of any threats shall be evaluated and safeguards applied when necessary.
A non-assurance service provided to the audit client before the client becomes a public
interest entity does not compromise the firm’s independence if:
• The service was permissible for audit clients that are not public interest entities;
• The service that is not permitted for public interest entities is terminated before or as
soon as practicable after the client becomes a public interest entity; and
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•
Safeguards are applied when necessary.
27.0 Management Responsibilities
• A firm shall not assume a management responsibility for an audit client.
• To avoid the risk of assuming a management responsibility, the firm shall be satisfied that a
member of management is responsible for:
– Making the significant judgments and decisions that are the proper responsibility of
management;
– Evaluating the results of the service; and
– Accepting responsibility for the actions to be taken from results of the service.
28.0 Preparing Accounting Records and Financial Statements
 Audit Clients that are not Public Interest Entities
• The firm may provide services related to the preparation of accounting records and financial
statements where the services are of a routine or mechanical nature and any threat is
evaluated and safeguards applied when necessary. Examples include:
– Providing payroll services based on client-originated data;
– Recording transactions for which client has determined or approved the appropriate
account classification;
– Posting client-coded transactions to the general ledger;
– Posting client-approved entries to the trial balance; and
– Preparing financial statements based on the trial balance.
 Audit Clients that are Public Interest Entities
• Except in emergency situations, a firm shall not provide accounting and bookkeeping
services, including payroll services , to an audit client or prepare financial statements on
which the firm will express an opinion or financial information which forms the basis of
financial statements.
• A firm may provide services of a routine and mechanical nature for divisions or related
entities if the personnel providing the service are not on the audit team and:
– The divisions or related entities are collectively immaterial; or
– The services relate to matters which are collectively immaterial to the financial
statements of the division or related entity.
 Emergency Situations
• In emergency or other unusual situations when it is impractical for the audit client to make
other arrangements, accounting and bookkeeping services that would otherwise be
prohibited may be provided if:
– Those who provide the services are not on the audit team;
– The services provided only for a short period of time and are not expected to recur;
and
– The situation is discussed with those charged with governance.
29.0 Valuation Services
 General Provisions
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•
Valuation services may create a self-review threat, which shall be evaluated and safeguards
applied when necessary.
 Audit Clients that are not Public Interest Entities
• A firm shall not perform a valuation service if the valuation service has a material effect on
the financial statements and the valuation involves a significant degree of subjectivity.
 Audit Clients that are Public Interest Entities
• A firm shall not provide valuation services if the valuations would have a material effect,
separately or in the aggregate, on the financial statements.
30.0 Taxation Services
 Tax Return Preparation
• Providing tax return preparation services does not generally create a threat to independence
if management takes responsibility for the returns and any significant judgments made.
 Tax Calculations – Audit Clients that are not Public Interest Entities
• Preparing calculations of current and deferred tax liabilities (or assets) for purpose of
preparing accounting entries that will be subsequently audited by the firm creates a selfreview threat.
• The significance shall be evaluated and safeguards applied when necessary.
 Tax Calculations – Audit Clients that are Public Interest Entities
• Except in emergency situations, a firm shall not prepare tax calculations of current and
deferred tax liabilities (or assets) for the purpose of preparing accounting entries that are
material to the financial statements.
• In emergency or unusual situations when it is impractical for the client to make other
arrangements, a firm may prepare tax calculations if (1) those who provide services are not
on audit team, (2) the services are provided only for a short period of time and are not
expected to recur, and (3) the situation is discussed with those charged with governance.
 Tax Planning and Other Tax Advisory Services
• A self-review threat may be created when advice will affect matters to be reflected in the
financial statements. The threat shall be evaluated and safeguards applied when necessary.
• A firm shall not provide tax advice if the effectiveness of the advice depends on a particular
accounting treatment or financial statement presentation and:
– The audit team has reasonable doubt as to the appropriateness of the related
accounting treatment or presentation; and
– The outcome or consequence of the tax advice would have a material effect on the
financial statements.
 Assistance in the Resolution of Tax Disputes
• An advocacy or self-review threat may be created when the firm assists the audit client with
the resolution of a tax dispute once the tax authorities have notified the client that they have
rejected the client’s arguments and the matter is being referred for determination in a formal
proceeding. The threats shall be evaluated and safeguards applied when necessary.
• A firm shall not act as an advocate for the audit client before a public tribunal or court in the
resolution of a tax matter if the amounts involved are material to the financial statements.
31.0 Internal Audit Services
 General Provisions
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•
•
When providing internal audit services to an audit client, firm personnel shall not assume a
management responsibility, and the firm shall be satisfied that:
– The client designates an appropriate and competent resource to be in charge and
acknowledge responsibility for internal controls;
– Management or those charged with governance review, assess and approve the
scope, risk and frequency of the services;
– Management evaluates the adequacy and results;
– Management decides which recommendations to implement; and
– Management reports to those charge with governance the significant findings and
recommendations.
If the firm provides internal audit services and the results of those services will be used in
conducting the external audit, a self-review threat is created, which shall be evaluated and
safeguards applied when necessary.
 Audit Clients that are Public Interest Entities
• A firm shall not provide internal audit services that relate to:
– A significant part of the internal controls over financial reporting;
– Financial accounting systems that generate information that is, separately or in the
aggregate, significant to the client’s accounting records or financial statements; or
– Amounts or disclosures that are, separately or in the aggregate, material to the
client’s financial statements.
32.0 IT Systems Services
•
The firm may provide the following services provided firm personnel do not assume a
management responsibility:
– Designing or implementing IT systems that are unrelated to internal control over
financial reporting;
– Designing or implementing IT systems that do not generate information forming a
significant part of the accounting records or financial statements;
– Implementation of “off-the-shelf” accounting or financial information reporting
software not developed by the firm if no significant customization is required to
meet the client’s needs; and
– Evaluating and making recommendations on a system designed, implemented or
operated by another or the client.
 Audit Clients that are not Public Interest Entities
• A firm shall only provide services involving the design or implementation of IT systems that:
– Form a significant part of the internal control over financial reporting; or
– Generate information that is significant to the accounting records or financial
statements
if certain specified safeguards are put in place to ensure that the client takes responsibility
for the services. A determination shall be made as to whether other safeguards are necessary.
 Audit Clients that are Public Interest Entities
• A firm shall not provide services involving the design or implementation of IT systems that:
– Form a significant part of the internal control over financial reporting; or
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–
Generate information that is significant to the accounting records or financial
statements.
33.0 Litigation Support Services
• If the firm provides litigation support services involving estimating damages or other
amounts that affect the financial statements, the requirements regarding valuation services
shall be followed.
• For other litigation support services, the significance of any threat created shall be evaluated
and safeguards applied when necessary.
34.0 Legal Services
•
•
•
A firm shall not act in an advocacy role for an audit client in resolving a dispute or litigation
when the amounts involved are material to the financial statements.
A partner or employee shall not act as General Counsel for legal affairs of an audit client.
For other legal services, the significance of any threat created shall be evaluated and
safeguards applied when necessary.
35.0 Recruiting Services
• Providing recruiting services may create threats to independence, which shall be evaluated
and safeguards applied when necessary.
• A firm may generally provide services such as:
– Reviewing the professional qualifications of candidates and providing advice on their
suitability for a position; and
– Interviewing candidates and advising on their competence for financial accounting,
administrative or control positions.
 Audit Clients that are Public Interest Entities
• A firm shall not provide the following services with respect to a director or officer of the
audit client or senior management in a position to exert significant influence over the client’s
accounting records or financial statements:
– Searching for or seeking out candidates for such positions; and
– Undertaking reference checks of prospective candidates for such positions.
36.0 Corporate Finance Services
• Providing corporate finance services may create threats to independence, which shall be
evaluated and safeguards applied when necessary.
• A firm shall not provide corporate finance advice if the effectiveness of the advice depends
on a particular accounting treatment or financial statement presentation and:
– The audit team has reasonable doubt as to the appropriateness of the accounting
treatment or presentation; and
– The outcome or consequence of the tax advice would have a material effect on the
financial statements.
37.0 Fees – Relative Size
19
•
•
Threats are created when fees from an audit client represent a large proportion of the total
fees of the firm or a large proportion of the total revenue of an individual partner or an
individual office of the firm.
The threats shall be evaluated and safeguards applied when necessary.
 Audit Clients that are Public Interest Entities
• If the total fees from the client are more than 15% of the firm’s total fees for two years, the
firm shall discuss which of the following safeguards to apply with those charged with
governance:
– A pre-issuance engagement quality control review performed by a professional
accountant who is not a member of the firm; or
– A post-issuance review equivalent to an engagement quality control performed by a
professional accountant who is not a member of the firm.
• If the total fees significantly exceed 15% of the firm’s total fees , the firm shall determine
whether the significance of the threat is such that a pre-issuance review is necessary.
38.0 Fees – Overdue
•
•
•
A threat may be created when fees from an audit client remain unpaid for a long time.
Generally, the firm is excepted to require payment of any significant unpaid fees before the
issue of the audit report for the following year.
If fees remain unpaid after the report has been issued, any threat shall be evaluated and
safeguards applied when necessary.
39.0 Contingent Fees
• A contingent fee shall not be charged in respect of an audit engagement.
• A contingent fee shall not be charged for a non-assurance service provided to an audit client
if:
– The fee is charged by the firm and the fee is material or expected to be material to
the firm;
– The fee is charged by a network firm that participates in a significant part of the
audit and the fee is material or expect to be material to the network firm; or
– The outcome of the non-assurance service, and therefore the amount of the fee, is
dependent on a future or contemporary judgment related to the audit of a material
amount in the financial statements.
For other contingent fee arrangements, threats to independence shall be evaluated and safeguards
applied when necessary.
40.0 Compensation and Evaluation Policies
• Key audit partners shall not be evaluated on or compensated for the partner’s success in
selling non-assurance services to their audit clients.
• A threat may be created if other members of the audit team are evaluated on or
compensated for their success in selling non-assurance services to their audit clients. The
threat shall be evaluated and safeguards applied when necessary.
41.0 Gifts and Hospitality
20
•
A firm or member of the audit team shall not accept gifts or hospitality from an audit client
unless the value is trivial and inconsequential.
42.0 Actual or Threatened Litigation
•
•
•
Litigation between the firm or a member of the audit team and an audit client creates a
threat to independence.
The significance of the threat shall be evaluated and safeguards applied when necessary.
If safeguards do not reduce the threats to an acceptable level, the firm shall withdraw from
the audit engagement.
43.0 Reports that Include a Restriction on Use or Distribution
•
•
The Code provides for some modifications to the independence requirements for audit
engagements where the report includes a restriction on use and distribution, unless the audit
is required by law or regulation.
The modifications are permitted if the intended users of the report:
– Are knowledgeable as to the purpose and limitations of the report; and
– Explicitly agree to the application of the modified independence requirements.
44.0 Enforcement
The seriousness of the professional bodies in promulgating these standards of conduct is at least
partly attested to by the fines, suspensions and forfeiture of membership handed down by the
bodies' disciplinary committees.
The potential effectiveness of the enforcement provisions may be criticized in a way common to
most self-regulating professions. In terms of regulating the member's activities, all powers of
enforcement, control or influence cease with the revocation of membership by either the member or
the professional body concerned. However, while expulsion from the Institute would not of itself
prevent anyone from practicing public accountancy, it should certainly be seen as a weighty social
and economic sanction. For example, in Australia, it might also provide a basis for the Companies
Auditors and Liquidators Disciplinary Board (CALDB) to suspend or cancel an auditor's
registration. The CALDB will unhesitatingly suspend or cancel an auditor's registration where the
auditor has failed to follow appropriate standards of practice or behavior, or where the auditor's
actions are sufficiently contrary to expectations of integrity that the CALDB decides the individual is
unfit to be an auditor.
45.0 Conclusion
Independence is considered a benchmark in accounting profession. The insistence on
independence in the auditing process is most significant. But independence can be compromised
by a number of factors including experience or lack thereof, personal relationship, the
profession’s code of ethics, situational and personal differences, among many others. However, it
is unreasonable for auditors to be held legally responsible for every misstatement in the financial
statements. The auditor cannot serve as the insurer or guarantor of financial statement accuracy or
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business health. The audit costs to society that would be required to achieve such high levels of
assurance would exceed the benefits. Moreover, even with increased audit costs, well-planned frauds
would not necessarily be discovered, nor errors of judgment eliminated. It is necessary for the
profession and society to determine a reasonable trade-off between the degrees of responsibility the
auditor should take for fair presentation and the audit cost to society. The individual CAs, the audit
profession, legislators and the courts will have a major influence in shaping the final solution.
Ever since accounting shifted from the cash to accrual accounting, estimates have become a part of
accounting and played a critical role in measuring company profits, particularly for more complex
business in ‘knowledge based economies’. This puts a greater onus on Auditors to focus on the
objectivity and independence of those making the estimates and weed out good estimates from the
hyped ones. Auditors, therefore, should observe the code of ethics and maintain their independence
while certifying and expressing opinion on the financial statements. Accounting profession has
important public responsibilities. There must be a regular monitoring of the ways in which
accounting firms perform their responsibilities. The enforcement of the IFAC code of ethics and
specially bringing the violators to book is today’s priority obligation of the institute for keeping the
image and reputation of the profession high. However, codes may provide a good set of behavioral
guidelines; they almost always have to be generalized and thus often don’t provide personal
solutions to difficult dilemmas. In addition, there is a danger of interpreting codes in such a way that
one might do wrong in the name of adopting one’s behavior to the demands of code. Simply relying
on the law-or a set of professional codes may not be always adequate. Accountancy profession
comes with different sets of powers. A police officer has the right to stop and arrest someone; an
ordinary citizen such as bank manager does not. The determination of the extent to which auditors
should be legally responsible for the reliability of financial statements is relevant to both the
profession and society. Clearly, the existence of legal responsibility is an important deterrent to the
inadequate and even dishonest activities of some auditors. No rational CA would want the
profession's legal responsibility for fraudulent or incompetent performance be eliminated. It is
certainly in the profession's self-interest to maintain public trust in the competent performance of
the accounting profession.
The end
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