Week 1

Lecture # 2

Chapter 3

Professional Ethics,
Independence
 Objectives

• Explain the role and duties of the professional

accountant
• Discuss the basic ethical principles for auditors
• Explain the conceptual principles of the Code of Ethics
for Professional Accountants
• Describe the regulatory and conceptual framework of
professional independence and the key guidelines
• Discuss the impact of the Corporate Law Economic
Reform Program on audit reform and corporate
disclosure
• State the importance of technical and ethical
competence to enhance audit quality
• Describe the essential disciplinary measures for auditors
 5 elements of a Profession
Systematic
theory
Professional
authority &
expertise
Culture

Regulative Community
& Ethical sanction
codes
 Concept of a profession

• Duties of a profession:
– Competence in the field of expertise and knowledge
– Integrity in client dealings
– Objectivity in offering services
– Confidentiality in client matters
– Discipline over members
• Duties to sustain a fiduciary relationship
– Behaviour that espouses responsible values
– Attention to requirements of clients and stakeholders
– Acquire & maintain required skills and knowledge
– Maintain credible reputation
– Maintain acceptable personal reputation
 Duties of a professional
accountant

• Rights of a profession includes:

– To represent oneself as a professional
– To be involved in the development of accounting and audit
practice
– To establish entrance standards and examine candidates
– To require self-regulation and discipline of members of the
profession based on specified codes of conduct.
– To have access to areas of accounting and auditing activity.
• Values required to carry out duties and maintain rights
includes:
– Assumes a commitment to put the public, client, the profession
and employer ahead of any self-interest
– Public interest is the overriding responsibility
 VIRTUES OF AN AUDITOR

INTEGRITY

OBJECTIVITY

HONESTY

DUE CARE

CONFIDENTIALITY

PROFESSIONAL BEHAVIOUR

COMPETENCE
 Fundamental aspects of auditing

ETHICS

3 – Key
inter-related
terms

CORPORATE
INDEPENDENCE
GOVERNANCE
 An understanding of ethics and ethical
issues
• The word ‘ethics’ is derived from the Greek word ethos, meaning
‘character’ and how people act. What is ‘right/wrong’
• Whereas morality focuses on the ‘good’ and ‘bad’ of human behaviour.
• Focuses on a study of choices, standards and behaviour
• Ethics - general well-being, prosperity, health, happiness, moral
principles, and skills of people.
• Ethics is concerned with the evaluation of choices where options are not
clear or where there is no absolute right or wrong
• Code of Ethics
• Professional ethics is foundation left to the profession
• Principles-based. The fundamental principles are:
– Public interest is overriding responsibility
– Integrity
– Objectivity
– Professional competence & due care
– Confidentiality
– Professional behaviour
 Ethical theories

Teleological
Teleological Deontological
Deontological Virtue
Virtue Ethical
Ethical
ethics
ethics ethics
ethics ethics
ethics relativism
relativism
 Ethical decision models

• There are three main models:

– American Accounting Association Model
– Mary Guy Model
– Laura Nash Model.

Ethical Decision Making – AAA Model

1. What are the facts of the case?
2. What are the ethical issues in the case?
3. What are the norms, principles and values related to the case?
4. What are the alternative courses of action?
5. What is the best course of action that is consistent with the norms,
principles and values identified in step 3?
6. What are the consequences of each possible course of action?
7. What is the decision?
 Code of Ethics for professional
accountants
• Issued June 2006 by the Accounting Professional and Ethical Standards
Board (APESB)
• Part A – Fundamental principles
• Parts B and C – illustrate how conceptual framework is to be applied
• Changes from 1 January 2011
– Independence requirements extended
– Requirements for members joining public interest audit clients
– Extending partner rotation
– Provisions regarding non-assurance services
– Pre or post issuance review
– Non-assurance services provided to clients
 Threats to compliance with code of
ethics
• Self-interest threats:
– financial interest in a client; Loans to or from a client
– Potential employment with a client
– Acceptance of clients with illegal dealings
– Acceptance without competence of knowledge in that industry
– Temptation to accept gifts offered by clients
– Conflict of interest
• Self-review threats:
– may occur when a previous judgement needs to be re-evaluated
– Reporting on systems designed by auditors
– Client being past employer
• Advocacy threats:
– Promoting shares in a listed audit client-compromising objectivity
– Acting as a advocate on behalf of client in resolving disputes
 Threats to compliance with code of
ethics
• Familiarity threats:
– May occur because of family relationship with a director or client officers- a
member becomes too sympathetic to others interests
– Former partner of the firm being the director now
– Accepting gifts or preferential treatment, unless value is insignificant
• Intimidation threats:
– Being threatened with dismissal; litigation
– Being threatened to reduce work in order to reduce fees
– Accepting gift
• Public practice behaviour:
– threats may occur as a result of inappropriate marketing of professional
services and products
– Acceptance of inappropriate clients.
 Professional independence

• Independence is the cornerstone of the auditing profession

• The fact of independence depends on the auditor’s integrity, objectivity
and strength of character
• In order for auditors to add credibility to financial reports or other subject
matter, they need to remain independent.
• One of the fundamental ethical virtues or principles of auditors.
• Independence declaration
– Auditors must give directors a written declaration of their
independence, and this is to be included in the directors’ report.
– Conflict of interest
– not capable of exercising objective and impartial judgment
– non-audit services.
Statutory provisions enhancing
auditor’s independence
• The auditor who conducts an audit of the financial report for a financial
year or half-year must form an opinion about whether the financial report
is in accordance with the Corporations Act
• Includes compliance with accounting standards and showing a true and
fair view of the financial state of affairs of the audited body
• Corporations Act 2001 updated with CLERP Act 2004 to reflect a set of
provisions concerning auditor independence
• Shareholders are permitted to provide written questions to the auditor
within 5 days before the AGM and the auditor must attend to AGM
• Auditors independence declaration required
• Special rules for retiring partners of audit firms and retiring directors
• Rotation obligation required for individual auditors, audit firms and audit
companies
• limited term of 5-7 years for auditors who play a significant role in audit
 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?
• Ethical rules emphasise both:
– Perceived independence (independence in appearance) —
how others will view the auditor
– Actual independence (independence of mind)
— state of mind of the auditor.
Recent developments in auditor independence:
– Ramsay Report (Aust): issued October 2001
– Sarbanes-Oxley Act (USA): 2002
 Independence of mind and
appearance
Independence of mind (Actual Independence)
•State of mind that permits the expression of a conclusion
without being affected by influences that compromise
professional judgement
•Requires accountant to exercise scepticism and act with
integrity and objectivity
Independence in appearance (Perceived Independence)
•The avoidance of facts and circumstances that are so
significant that a reasonable and informed third party, having
knowledge of all relevant information, including safeguards
applied, would reasonably conclude a firm’s or professional
accountant’s integrity, objectivity or professional scepticism had
been impaired
Specific threats to independence

• Financial interests
• Loans and guarantees
• Close business, family and personal relationships
• Employment relationships
• Long association
• Provision of non-assurance services to assurance clients
• Appointment and removal of auditors
• Fees and pricing
• Gifts and hospitality
Suggestions for improving
auditor independence
• Public oversight board
• Strengthening the role of audit committees
• Rotation of audit partners and audit firms
• Audit firm independence boards
• Client policies, such as restricting other
services provided by audit firm
 Whistleblowing role

• Auditors have an obligation to whistleblow!

Defining
• 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.
• Fee determination
• 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.
Auditor’s appointment/removal

• Shareholders are responsible for the appointment of auditor:

• Removal: difficult to remove auditor. Requires a resolution of
company at the AGM.
• Resignation: auditor can resign. Must have written consent from
ASIC. auditor has right of access at all information.
• 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.
Corporate collapses and reform

• Enron – filed bankruptcy in 2001, $35m loss, 1.2b reduction in asset,

overstatement of income 586m, complex debt-hiding schemes, bribes,
Arthur Anderson breached independence (also internal auditor), AA
destroyed Enron documents. USs largest bankruptcy case. CEO
sentenced to 24 yrs imprisonment.
– Lessons learnt: Enron case highlights overriding need for integrity &
honesty. Auditors to be open. Need for independent non-executive
directors.
• Xerox (USA): Xerox falsified its accounts through misleading
accounting schemes.
• Global Crossing (USA): telecom giant filed bankruptcy in 2002. it was
4th largest bankruptcy in US history resulting loss of 9000 jobs –
manipulation of accounting books. AA as accountants and management
consultant.
• Worldcom (USA) – overstated cash flow. Also AA was auditor.
Corporate collapses and reform
• HIH Insurance debacle: one of Australias largest insurance companies.
2001. Auditor AA compromise independence. Overstatement of profits &
understatement of liabilities. Debt of $5b
• Lessons learnt: inherent & business risk
• Parmalat Saga (Italy): fraud & forgery – false paperwork. This scandal
involved a forged letter from Bank of America confirming cash bal of
4billion euros. Owner sentenced for 10 yrs.
• Lessons learnt: domination of family owned business which affects board.
• Akai Holdings (Hongkong): Ernst & Young-settlement of HK$7.8billion.
Hongkongs biggest ever corporate collapse – false accounting.
• Lehman Brothers: (US) balance sheet manipulation. Ernst & Young
negligent.
Corporate collapses and reform

• Satyam (India): 2009. India’s 4th largest IT group.

Overstatement of profits & inclusion of non-existent
assets understatement of liabilities.
– Lessons learnt: powerfull chairman

• NBF (Fiji): 1996. failure to comply with accounting

standards. Hiding massive losses, risks & debts.
Bankrupt with debt of NZ$10m
• Lessons learnt: proper disclosure & risk management