Ch.3: Professional Ethics and Legal Liability

Audit BU477

Ethics

set of moral principles or values

• We use these values to guide us in how we should act in various situations

Professional Ethics

The morally permissible standards of conduct that apply to the members of a particular profession

• Given their position of trust, professionals are expected to conduct themselves at a higher level than most other members of society

Fundamental Ethical Principles - What is the goal/what is the purpose

According to the CPA code of Professional Conduct, these ethical principles are aimed

1. at serving the public interest, and

2. aimed at achieving orderly and courteous conduct within the profession

The 5 Ethical Principals:

1. Professional Behaviour

2. Integrity

3. Objectivity

4. Professional Competence and Due Care

5. Confidentiality

Framework for Resolving Ethical Dilemmas (6 Steps):

1. Gather relevant facts and identify the problem

2. Identify the fundamental ethical principles

3. Identify the ethical issues involved

4. Identify the relevant parties

5. Consider and evaluate the courses of action

6. Determine the course of action

Professional Guidance on Ethical Conduct

The professional accounting associations harmonized all of their rules of professional conduct so that generally the same set of rules applies to all public accountants in Canada and serves both members and the public

Rules of Public Protection - what do they ensure?

Section 200 of the Code of Professional Conduct represents the standards of conduct that ensure the protection of the public interest and the maintenance of the professional’s reputation

Rule 201: Maintenance of Good Reputation of the Profession/Professional Behaviour

• Members should behave in the best interest of their profession and the public

  • This means accountants should not take advantage of the trust placed in them

  • A member should not be critical of a colleague without giving the colleague a chance to explain his or her actions first.

Rule 202: Integrity, Due Care, and Objectivity

• The rules of conduct for professional accountants require members to act with integrity and due care

Due Care - What does it mean?

the application by a professional of a level of care and skill in accordance with what would reasonably be expected of a person of his or her rank and training.

Rule 203: Professional Competence

• The rules of conduct require practitioners to maintain competence

  • Professional accountants are required to attend a certain number of continuing professional education courses per year

  • An auditor should not undertake an audit of a client unless that auditor has knowledge of both of that clients business and industry and of the technical aspects of the audit

Rule 204: Independence

• The most critical of all principles when an auditor is engaged to perform an audit

  • The auditor must have both Independence in fact and independence in appearance

• The auditor must be independent when conducting an audit or review level assurance engagement

Independence in Fact (Independence)

• Actual mental state of objectivity

  • The auditor is truly unbiased and exercises professional judgement without being influenced by any interests, relationships or pressures

  • Not directly observable

  • Real impartiality

    • Ex: Auditor does not let personal financial interests or relationships influence audit conclusions

Independence in Appearance (Independence)

• How independence is perceived by a reasonable third party

  • Independence is considered impaired if a knowledgeable outsider would doubt the auditors objectivity, even if the auditor is actually unbiased.

  • Perceived impartiality

  • Based on a ‘reasonable and informed third party’ test

    • Ex: Auditor has a close family member in a key management position at the client therefore, outsiders would question objectivity, so appearance is impaired.

Distinction: Independence in Fact VS. Independence in Appearance

Fact = Actual absence of bias in judgement

Appearance = absence of circumstances that would lead a reasonable third party to believe bias exists

Threats to Independence (5)

1. Self-Interest Threat

2. Advocacy Threat

3. Self-Review Threat

4. Familiarity Threat

5. Intimidation Threat

Self-Interest Threat (Threats to Independence)

• When the member has a financial interest in the client or in the financial results of the client

  • The firm or auditor owns shares in, or has a loan to, the client

  • The client’s fees are significant in relation to the total fee base of the public accountant or of the firm

Advocacy Threat (Threats to Independence)

• When the firm or member is perceived to promote (or actually does promote) the client’s position

  • The auditor is acting as an advocate in resolving a dispute with a major creditor of the client

  • The firm or auditor is promoting the sale of shares or other securities for the client, or is receiving a commission for such sales

Self-Review Threat (Threats to Independence)

• When the firm or member is perceived to be auditing their own work

  • The auditor has assisted the client in designing an information system that calculates costs for an inventory system

    • However, during the design phase, the auditor neglected to put in controls to highlight when a system creates a negative inventory situation, either due to clerical or programming error

    • Perhaps the auditor would be less likely to point out this error to the client in a management letter because it would simply imply that the auditor did not perform their work properly during the system design

    • Alternatively, the auditor might not detect the system inadequacy during their analysis of internal controls, as they may believe that it is already a good system, and that they do not need to complete a detailed analysis of internal controls

Familiarity Threat (Threats to Independence)

• When it is difficult to behave with professional skepticism during the engagement

  • There is a long association of senior staff with the client

    • e.g. being on the same engagement for 10 years

  • A former partner of the firm is now the CEO of the client

Intimidation Threat (Threats to Independence)

• When the client intimidates the firm or staff with respect to the content of the financial statements or with respect to the conduct of the audit

  • The client threatens to replace the audit firm over a disclosure agreement

  • The client places a maximum upon an audit fee that is unrealistic with respect to the amount of work that needs to be completed

What should we do once we receive these threats?

• These threats must be documented, and the threat eliminated or reduced to what is called an accetably low level

• If the threat cannot be elimintaed or reduced to an acceptably low level, the auditor must decline or withdraw from the engagement

Rule 205: False and Misleading Documents and Oral Representations/Association with False and Misleading Information

• No members, whether in public accounting or industry, can sign or associate with false or misleading information

  • This includes letters, reports, and written or oral statements

• OR fail to reveal material omissions from financial statements

Rule 206: Compliance with Professional Standards

• Public Accountants are required to comply with professional standards when preparing and auditing financial statements - especially account standards with GAAS as set out in the CPA Handbook

Rule 208: Confidentiality of Information

• The rules of conduct for Public Accountants state that members shall not disclose any confidential information or employer information without specific consent of the client or employer

• The rules also prohibit using confidential or inside information to earn profits or benefits

• Ordinarily, the public accountant firm’s working papers can be provided to someone else only with the express permission of the client

  • This includes telling people within the same firm

Rule 210: Conflict of Interest

• If the auditor is asked to provide assurance services for two or more clients who are competitors, then the auditor needs to obtain consent from each client and must also use procedures to protect confidential information

Rule 211: Duty to report breaches of the CPA Code

• Members who are aware of another member’s breach of the rules are required to report to the profession’s discipline committee after first advising the member of the intent to make a report

Rule 214: Fee Quotations and Billings

• Must obtain adequate information (conduct appropriate assessment of the client’s accounting policies and internal controls) before providing a fee quotation

Rule 215: Contingent Fees

• Charging of a fee based on the outcome of an audit is prohibited for audits, reviews, compilations, and any other engagements that required the auditor to be objective

  • Applies to non-assurance services

    • Doing an extra tax reviews

Rule 216: Commission Arrangements

• A member or firm shall not directly or indirectly pay or receive any compensation in relation to or in respect of:

(a) Obtaining an assurance client

(b) the referral of an assurance client to others

(c) the referral of products or services of others to an assurance client

(d) the provision of other professional services to an assurance client

Rule 217: Advertising, Solicitation, Endorsements

• Members should not solicit one another’s clients or engage in advertising that is overly aggressive, self-laudatory, or critical of other members or that makes claims that cannot be sustained

  • This rule is basically saying that professionals or members of an organization must market themselves ethically and respectfully.

  • Refer to notes if you do not understand*

Rule 218: Retention of Documentation and Working Papers

• Public Accountants must retain documents for a reasonable amount of time. What is reasonable varies with circumstances

  • Without documentation, a member’s or firm’s ability to outline and defend professional work is seriously impaired

  • Some documentation may need to be retained indefinitely (Permanent file)

  • Helps protects against law suits down the line

Rules of Professional Colleagues

• Section 300 should guide collegial relations: that client interests are placed ahead of the interest of the member or firm and that professional courtesy and cooperation are expected at all times

Rule 302: Communication with Predecessor

• Prior to accepting an appointment as auditor, the successor auditor must communicate with the incumbent auditor to inquire if the incumbent is aware of any circumstances that might preclude the successor from accepting the engagement

• Successor would ask the potential client to authorize the incumbent to provide the information requested

  • WHY?

• The incumbent should respond promptly to the successors request and be candid in responding

Rule 303: Provision of Client Information

A predecessor should supply with reasonable information about the client

Safeguards by the Profession: Prohibitions for ALL Assurance Engagements

• Members of the engagement team (and immediate family members) may not have a direct or material indirect financial interest in the entity

• The firm or members of the engagement team may not have a loan from or a loan guaranteed by the entity (except in normal course of business)

• The firm and members of the engagement team cannot have a close business relationship with the entity or management

• Members of the engagement team may not have an immediate family member who is an officer or director of the client, who is in a position to exert significant influence, or who has an accounting role or financial reporting oversight role

• A member of the engagement team must not serve as a director or officer during the period covered by the assurance report

• Members and firms are prohibited from performing management functions (unless the entity’s management directs and supervises their work)

• Members of the engagement team must obtain client approval for making journal entries and accounting classifications

  • The creation of original or source documents such as cheques and invoices are prohibited

• Members and students on the engagement team and the firm may not accept other than insignificant gifts or hospitality from the assurance client

• Key audit partners cannot be evaluated or compensated based on selling non-assurance services

• A member or firm cannot charge a fee that is significantly lower than market

  • (referred to as "low balling")

In General, firms cannot provide the following services to their assurance clients

• Accounting and bookkeeping

• Valuation services

• Internal audit services

• Financial information systems design or implementation

• Litigation support services

• Legal services

• Corporate finance services

• Tax-planning and related advisory services

Prohibitions Specific to Listed Entities / Public Companies

• A member or firm can