Chapter 3
Ethics, Independence and
Corporate Governance
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-1
Learning Objective 1:
The Nature and Importance of Professional
Ethics
•
Ethics:
–
–
Concerned with the requirements for the general wellbeing, prosperity, health and happiness of people.
Requires knowledge of moral principles, and skills in
applying them to problems and decisions.
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Revised PPTs t/a Auditing and Assurance Services in Australia 3e 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.
• A.1 of the Joint Code of Professional Conduct (CPC) of
ICAA and CPA Australia (from 1 July 2006 reference is
to Section A of APES 110 “Code of Ethics for Profession
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.
• Failure to observe expected standards can result in
disciplinary procedures and sanctions.
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-3
Learning Objective 2:
Ethical Theory
•
Teleological ethics – deals with consequences or
outcomes of actions
–
•
Deontological ethics – based on duties and rights
–
•
generally, if benefits of proposed action outweighs costs,
the decision is morally correct.
duties and rights set down in rules which must be
followed.
Virtue ethics – focus on personal qualities, such as the
integrity of the decision-maker.
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-4
Learning Objective 3:
Accounting Bodies’ Code of Ethics
•
•
•
Joint CPC (APES 110) sets out main ethical
pronouncements that relate to the undertaking of an
audit.
AUS 202 (ISA 200) requires that auditors comply with
ethical rules.
Joint CPC consists of six sections, including:
–
–
Section B: Fundamental Principles of Professional
Conduct;
Section F: Professional Statements, including F1
Professional Independence, and F7 Incompatible
Business
(APES 110 covers similar issues to the CPC, but in a
different structure)
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Revised PPTs t/a Auditing and Assurance Services in Australia 3e 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 the community to promote
its well-being and punish undermining behaviour.
• The code therefore:
•
–
–
–
makes explicit the values implicitly required;
indicates how members should act toward one another;
provides basis for sanctions.
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-6
CPC Section B (APES 110
Section 100): Fundamental Principles
Eight fundamental principles contained in the codes of
ethics:
1.
2.
3.
4.
5.
6.
7.
8.
Public interest
Integrity
Objectivity
Independence
Confidentiality
Compliance with technical and professional standards
Professional competence and due care
Ethical behaviour
(Part A of APES 110 includes integrity, objectivity, professional
competence and due care, confidentiality and professional
behaviour).
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
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3-7
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; and
the ability to choose appropriate policies and decision
procedures in different situations.
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-8
Ethical decision models
•
Three main models:
–
–
–
American Accounting Association Model
Mary Guy Model
Laura Nash Model.
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
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3-9
Learning Objective 5:
Corporate Governance
•
Corporate Governance — system by which companies
are directed and controlled. Concerned primarily with
management and stewardship issues including:
–
–
–
–
corporate strategy
succession planning
integrity of internal control structure and
remuneration policy.
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3-10
Parties in corporate governance
•
Board of directors
• Management
• Auditors
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3-11
Groups advocating improved corporate
governance
•
•
•
•
•
The business community
Investors
Australian Stock Exchange (ASX)
Australian Securities and Investments Commission
(ASIC)
CPA Australia and Institute of Chartered Accountants
Australia (ICAA)
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Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-12
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;
Principle 5: Make timely and balanced disclosure.
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
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3-13
ASX Corporate Governance Council’s Principles
of Good Corporate Governance (Cont.)
•
•
•
•
•
Principle 6: Respect the rights of shareholders;
Principle 7: Recognise and manage risks;
Principle 8: Encourage enhanced performance;
Principle 9: Remunerate fairly and responsibly; and
Principle 10: Recognise the legitimate interests of
stakeholders.
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Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
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3-14
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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Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
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3-15
Functions of audit committees
•
•
•
•
•
•
•
Assist the board of directors;
Add to credibility and objectivity of financial reports;
Enhance auditor independence and effectiveness;
Consider appropriateness of accounting policies;
Consider policies for unethical or illegal activities;
Consider internal and management controls; and
Communication link between management, board and
auditors.
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
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3-16
Learning Objective 6:
Whistleblowing in Australia
•
s. 311 of the Corporations Act imposes a responsibility
on auditors to inform the ASIC of any significant
contraventions of the Act discovered in the normal
course of their duties, and any other contraventions
which 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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Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
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3-17
Whistleblowing defined
•
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.’
•
United States Civil Service Reform Act of 1978
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Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-18
Auditor’s responsibilities regarding
whistleblowing
•
Auditor does not have to actively look for contraventions
of the Corporations Act;
• Decision to blow the whistle is not easy for an auditor;
• AUS 210/ASA 240 (ISA 240) also provide guidance.
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-19
Learning Objective 7:
The Importance of Audit Independence
•
Independence is a very key characteristic of an audit or
assurance service provider;
• In order that auditors can add credibility to financial
report or other subject matter, they needs to remain
independent;
• One of the eight fundamental ethical requirements of
CPC (APES 110); and
• Test for independence is a reasonable person test –
would a reasonable person having access to all facts
consider that the auditor was independent?
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-20
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.
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
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3-21
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 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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3-22
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 identifying all non-audit services provided
by an audit firm, fee, and explanation why provision of
service did not impair independence.
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3-23
Auditor’s 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, auditor is
aware of relationship and does not take all reasonable steps to
discontinue audit.
S 324CH(1) relationships include:
–
–
–
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Auditor or immediate family member being an officer or auditcritical 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 more than $5,000 to a client (unless a
housing loan on normal terms).
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3-24
Auditors removal and resignation
Removal – Difficult to remove auditor.
• S 329 – Requires a resolution of company at a general
meeting of which special notice is given. Auditor entitled
to make written representation and speak at general
meeting. A copy of notice must be sent to ASIC.
• Resignation – Auditor can resign. Must have written
consent from ASIC. Application outlines reason, and
ASIC must approve the reason. Designed to ensure
independence and integrity of audit function is
maintained.
•
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3-25
Right of access to records and reasonable
fees
•
Section 310 provides further protection to the auditor by
giving the 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.
• Section 331 states that the 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, as far as possible a suitable
environment for an audit process that is free from
undue influence and obstruction.
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-26
Independence – ethical requirements
Emphasises both:
–
–
perceived independence – how others will view the
auditor; and
actual independence – state of mind of the auditor.
Whether the auditor can actually eliminate bias and
personal interest from their decisions, and not succumb to
any pressures or influences.
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-27
Learning Objective 8:
Recent Developments in Auditor
Independence
•
•
•
•
•
•
Ramsay Report (Aust) – issued October 2001
IFAC independence rules – adopted in Australia in CPC
F.1 – 2002.
Sarbanes-Oxley Act (USA) – 2002.
Joint Committee of Public Accounts and Auditors
(Australia) – 2002
HIH Royal Commission – 2003
Corporate Law Economic Reform Program (CLERP 9)
(Australia) – 2002-4.
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-28
CPC F1/ APES 110 Section 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
their 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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Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
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3-29
CPC F1 /APES 110 Section 290: Safeguards
Safeguards fall into three broad categories. For an auditor
these are:
–
–
–
–
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, corporate governance structures.
Safeguards within the audit firm – quality control, policies
and procedures.
The safeguards are aimed at reducing or resolving
circumstances that pose threats.
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3-30
Learning Objective 9:
Major Threats to Auditor Independence
•
Auditor employment relationships
• Financial and business relationships
• Provision of non-audit services, including:
–
–
–
–
–
–
•
preparing financial reports
taxation
internal audit
design of systems
legal services
corporate finance
These threats are major reasons for recent changes to
legislation
Copyright  2006 McGraw-Hill Australia Pty Ltd
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3-31
Learning Objective 10:
Suggestions for Improving Auditor
Independence
•
•
•
•
•
•
Establishment of a Public Oversight Board, to reduce
the perception of auditors setting standards for their
own profession;
In Australia, the FRC now acts as a Public Oversight
Board;
Strengthening the role of audit committee;
Rotation of audit partners and audit firms;
Audit firm independence boards;
Client policies, such as restricting other services
provided by audit firm.
Copyright  2006 McGraw-Hill Australia Pty Ltd
Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
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3-32
Learning Objective 11:
Fee Determination
•
Audit fees should be commensurate with service
provided. Thus, should reflect time taken to audit, and
knowledge, skills and expertise required.
• Auditor should not enter into fee arrangements that may
compromise independence.
• Fees for a period should not be dependent on fees from
provision of future audits or other services.
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3-33
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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Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett
3-34