Wk 2: Ethics, legal liability and client acceptance

  1. 5 fundamental ethical principles to accountants and auditors
    1.integrity (honesty)

    2.objectivity (impartiality, unbias, independent)

    3.professional competence and due care (knowledge)


    5.professional behaviour
  2. 1. Integrity
    • All members of the professional bodies be straightforward and honest.
    • A member shall not knowingly be associated with information where the member believes that the info contains materially false or misleading statement
    • Or contains statements or information furnished recklessly.
    • Or omits or obscures info required to be included where such omission or obscurity would be misleading.
  3. 2. Objectivity
    • Not allow personal feelings or prejudices to influence professional judgement.
    • Be unbiased.
    • Not allow conflict of interest or influence of others to impair decision process.
  4. 3. Professional competence and due care:
    • Maintain knowledge and skill at a level required by professional bodies.
    • Keep up-to-date with changes in regulations and standards.
    • Continue education and work experience.
    • Act diligently, taking care to complete each task thoroughly, document all work, finish on a timely basis.
  5. 4. Confidentiality
    • Refrain from disclosing information to people outside the workplace that is learned as a result of employment.
    • Exception if legal requirement to disclose.
    • Not allowed to use confidential information to their advantage or advantage of another person.
  6. 5. Professional behaviour
    • Comply with rules and regulations and do not harm reputation of the profession.
    • Be honest in representations to current and prospective clients.
    • Do not claim to provide services they cannot provide, or qualifications they do not possess, or experience they do not have.
    • Do not undermine reputation of, or quality of work produced by, others.
  7. Roadcap implemented a new IT system. The new system was developed and designed according to the specific needs of Roadcap. Andrew assigned an audit assistant who was a new graduate to examine the new system and document how it operates. Andrew told the audit assistant that since IT systems are much the same as each other, it should not be difficult to document how it operates
    • Breaches professional competence and due care
    • The IT system is tailor made therefore may not be the same as other IT systems
    • The graduate may not have the skill or experience to complete this and there is no mention of supervision
  8. The accounting firm of Peter and Jensen decided to attract more audit clients. They advertised their firm on the newspapaer claiming 'There is no one who can do a real audit besides us'
    • Breaches professional behaviour
    • A blatant lie that undermines the work of other auditors in the industry.
    • Will harm the reputation of the profession
  9. Auditor Independence
    • Independence is the ability to act with integrity, objectivity and with professional scepticism (questioning mind).
    • Lack of auditor independence impacts on credibility and reliability of the financial report.
    • The auditor must be, and be seen to be, independent.
  10. Independence of mind
    • Ability to act independently- Actual independence
    • Ability to make a decision free from bias, personal belief and client pressures.
  11. Independence in appearance
    • belief that independence of mind has been achieved.
    • Perceived independence
  12. Threats to independence




  13. Threats to independence: self-interest threat
    • Can occur if the audit firm or its staff have financial interest in audit client.
    • Examples:
    • Bank account held with the client.
    • Shares owned in the client.
    • A loan to or from the client. (fees still owing from audit year before or staff has a loan from bank)
    • Fee dependence, where the fees from a client form a significant proportion of all fees of the firm. (Have vested interest in the client doing well)
    • Close business relationship with the client.
  14. Threats to independence: self-review threat
    • Can occur when the assurance team need to form an opinion on their own work or work done by others in their firm.
    • Examples:
    • Assurance team member has recently been an employee or director of the client.
    • Preparing information for the client that is then assured.
    • Performing services for the client that are then assured.
  15. Threat to independence: Advocacy threat
    • Can occur when an audit firm or assurance staff act, or is believed to act, on behalf of assurance client.
    • Advertising the client.
    • Can lead to questioning of auditor’s objectivity.

    • Examples:
    • Encouraging others to buy client’s shares or bonds.
    • Representing client in negotiations with third party.
    • Representing the client in a legal dispute.
  16. Threats to independence: Familiarity threat
    • Can occur when close relationship exists or develops between assurance firm and client, or firm and client personnel.
    • Assurance staff can become too sensitive to needs of client and lose objectivity.


    Long association between assurance firm and client.

    –Long association between assurance firm and client personnel.

    –Close personal relationships between assurance firm staff and senior client personnel.

    Former partner of assurance firm holding senior position at the client.

    –Acceptance of gifts by members of assurance team from their client (other than minor tokens).

    –Acceptance of hospitality by members of assurance team from client (other than minor gestures).
  17. Threats to independence: intimidation threat
    • Can occur when members of assurance team feels threatened by the client's staff or directors.
    • Assurance team members unable to act objectively, fearing negative consequences.
    • Eg.: threat that client will use different assurance firm next year.
    • Undue pressure to reduce audit hours to reduce fees paid.
    • Can also be intimidated at individual level
  18. Safeguards to independence
    • Created by profession, legislation or regulation:
    • quality control standards
    • code of ethics
    • legislative requirement to be independent (corp act)

    • Created by clients:
    • corporate governance- audit committee
    • policies and procedures.

    • Created by accounting firms:
    • quality control procedures (eg. pre questions)
    • client acceptance and continuance.
  19. Relationship between auditors and shareholder
    • Audit report addressed to shareholders.
    • Auditor has to attend AGM
    • Shareholders appoint auditor (or audit committee if there are too many shareholders) (or majority shareholders decide)
  20. Relationship between auditors and board directors
    • Board of directors represent shareholders
    • Executive and non executive directors
    • Large companies have committees made up of several directors to deal with specific issues.
  21. Relationship auditors and the audit committee
    –A special committee of the board of directors.

    Acts on behalf of board in financial reporting and audit matters.

    –Top 500 listed companies must have audit committee, top 300 must follow ASX guidelines.

    • –Aid to auditor independence:
    • Non-executive directors, majority independent.
    • Financial accounting knowledge desirable.
    • Meets with external and internal auditors.
  22. Why have separate CEO and chairman of board
    • Compensation: they'd be deciding their own compensation
    • Corporate governance: enhance independence at company level
  23. Relationship between auditor and internal auditors
    Viewed by external auditor as part of client.

    • External auditor can reduce scope of testing if effective internal audit function (ASA 610: ISA 610).
    • Depends on internal auditor’s:
    • objectivity
    • technical competence
    • due professional care
    • communication with external auditors.
  24. Auditor's legal liability to their client: tort law
    • External auditor must exercise due care, be diligent in applying standards and documenting work.
    • Auditor can be found negligent and liable for damages under tort law if it is established that:

    1. A duty of care was owed by the auditor.

    • 2. There was a breach of the duty of care.
    • 3. A loss was suffered as a consequence of that breach
  25. Auditor's legal liability to their client: Contract
    Contract: failed duty of care implicit in acting as auditor and explicit in engagement letter.
  26. Contributory negligence
    • Contributory negligence applied in AWA (1992) case.
    • If directors are also negligent, each party is held accountable in proportion to their guilt.
  27. Legal liability to third parties
    No contract between auditor and third parties, they must rely on tort law and show duty of care.

    Duty of care less likely with third parties.
  28. Pacific Acceptance COrporation (1970)
    • Finance company making loans.
    • Audit company relied too much on management explanations
    • Auditor's staff were inexperienced and were not adequately supervised. 
    • Court decision: Lack of professional scepticism and not enough reliable evidence was collected to support the opinion given. 
    • Audit procedures should ensure that there is a reasonable chance of discovering any fraud or material error that might have occurred.
  29. Essanda (1997)
    Judge argued against Columbia finding.

    –Australian High Court ruled that for a third party to establish duty of care, they must show (PROXIMITY):

    »The report was prepared on the basis that it would be communicated to a third party.

    »The report was likely to be relied upon by that third party.

    »The third party ran the risk of suffering a loss if the report was negligently prepared.
  30. Avoidance of litigation
    • Hire competent staff, regular training.
    • Comply with ethical and auditor regulations.

    Meet with client’s audit committee to discuss significant issues arising in audit.

    Follow up any significant weaknesses in client’s internal control procedures from previous year audit.

    Implement policies and procedures:

    • Client acceptance.
    • Staff allocation.
    • Ethical and independence issue identification and rectification.
    • Adequate work documentation.
    • Gather adequate and appropriate evidence to support opinion.
  31. Client acceptance and continuance decisions- steps
    The first stage in any audit is client acceptance or continuance decision.

    –Step 1: assess client integrity.

    –Step 2: assess audit firm’s ability to meet ethical requirements, service client.

    –Step 3: prepare client engagement letter.
  32. Client integrity - auditor should consider:
    -Reputation of client, management, directors, key stakeholders.

    –Client’s reason for switching auditor.

    Client’s attitude to risk exposure and management. 

    –Client’s attitude to using internal controls to mitigate risk.

    • –Appropriateness of the client’s interpretation of accounting rules.

    –Client’s willingness to allow auditor full access to information required to form an opinion.

    • –Client’s attitude and willingness to pay fair amount for audit work.
  33. Acceptance and continuance: Auditor can obtain information from
    Communication with prior auditor (with client’s permission, APES 110), client personnel, third parties, key competitors.

    Review of press articles.
  34. Client acceptance and continuance decisions: ethical requirements
    –Consider if any threats to fundamental principles arise from appointment (APES 110 s.210).

    –Auditor must ensure it has sufficient staff available with required knowledge to complete audit (professional competence and due care).

    –Consider potential safeguards and remedies.

    -Decline appointment if threat insurmountable.
  35. Acceptance and continuance: engagement letter
    –Prepared by auditor, acknowledged by client.

    –Form of contract, can expand on obligations in Corporations Act.

    Explains scope of audit, timing of various aspects of audit, overview of client responsibilities.

    Confirms auditor’s right of access to information, independence considerations.

    Sets fees.
Card Set
Wk 2: Ethics, legal liability and client acceptance
Wk 2: Ethics, legal liability and client acceptance After studying this presentation you should be able to: 2.1 Explain the fundamental principles of professional ethics 2.2 Describe and assess auditor independence 2.3 Describe the relationship between an auditor and key groups they have a professional link with during the audit engagement 2.4 Illustrate the auditor’s legal liability to their client, contributory negligence and the extent to which an auditor is liable to third parties 2.5 Categorise the factors to consider in the client acceptance or continuance decision.