Professional Ethics

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1 Introduction

It was mentioned in the previous chapter that before accepting an appointment, the auditor must ensure that the appointment will be ethical.

Ethics is seen as the unique selling proposition of professional accountants. If they do not adhere strictly to ethical principles, how could they continue to earn good fees? What is the point in paying someone for advice or assurance if they cannot be trusted or believed?

The ACCA Code of Ethics and Conduct ('the Code') is based on the IESBA’s Code of Ethics. It sets out certain fundamental principles about how its members should behave. It also recognises how its members could be subject to certain threats which would compromise their behaviour, and suggests ways in which members can safeguard themselves against the operation of those threats.

The conceptual framework approach to professional ethics recognises that there are:

• Fundamental principles to be followed
  

• These are subject to threats
  

• Threats must be addressed
  

The Code applies to all members of ACCA and also to all ACCA students. Note that applies not only to those in public practice ('auditors') but also those in industry and commerce ('in business').

2 Fundamental principles

The ACCA’s fundamental principles are as follows:

• Integrity
  

• Objectivity
  

• Professional competence and due care
  

• Confidentiality
  

• Professional behaviour
  

Note that in AAA you need to be able to explain when the duty of confidentiality must be set aside in order to disclose non-compliance with laws and regulations (see Chapter 6).

3 Threats to the fundamental principles

Threats to compliance with the fundamental principles arise from

• Self-interest
  

• Self-review
  

• Advocacy
  

• Familiarity
  

• Intimidation.
  

Note also there are management threats, where the auditor performs managerial functions for the client. These are not a separate category, but covered under several of the above, such as self-interest, familiarity and advocacy.

Where such threats exist, the auditor must:

• Eliminate the circumstance that creates the threat(s); or
  

• Apply safeguards, where available, to reduce the threats to an acceptable level (see s.4); or
  

• Decline or end the specific professional activity.
  

3.2 Self-interest threats

Self-interest threats may arise from the following:

• Financial interests – the provisions of the Code consider who holds the interest, whether the interest is direct or indirect and materiality. Firms, members of audit teams and immediate family members cannot hold direct or material indirect financial interests in audit clients. However, safeguards may be applied where a close family has such an interest.
  

• Close business relationships – cannot be entered into unless immaterial and insignificant to both the firm and the client or is management.
  

• Family and personal relationship – the existence and significance of any threat depends on the individual’s role in the audit team, the role of the individual within the client and the closeness of the relationship.
  

• Loans and guarantees – the existence and significance of any threat depends on whether making loans is the client’s business, the terms and conditions and to whom it is made.
  

• Fees – the Code does not prescribe the basis for calculating fees. However:
  

  • Contingent fees – are not permitted for audit engagements
    

  • Relative size – the only benchmark in the Code is 15% of total fees, for two consecutive years, for a PIE client
    

  • Low-balling – quoting a lower fee is not in itself unethical, but must not be so low that it threatens professional competence and due care
    

  • Overdue fees – may be seen as equivalent to a loan
    

• Recruiting services – generally, must not assume management responsibility (eg act as negotiator for management) and hiring decision must be the client’s. For a PIE, cannot seek or take up references for a director or senior management position.
  

3.3 Self-review threats

Self review threats arise when an auditor does work for a client and that work may then be subject to self-checking during the subsequent audit. For example, if the auditor prepares the financial statements, and then has to audit them, or the auditor performs internal audit services and then has to check that the system of internal control is operating properly. Auditors could obviously be reluctant to criticise the work which their own firms have earlier undertaken, and this could interfere with independence and objectivity.

Generally auditors must be very careful when undertaking such work. Certainly it is common for auditors to do additional work for their clients, but what is important that the work is done by an entirely different team from the audit firm.

Whether auditors should be allowed to provide non-assurance ('other') services to an audit client is a controversial topic, as there are both pros and cons. For example, auditors will know a great deal about the operations of their clients and this can make the performance of other work much more efficient. If entirely new companies have to be brought in to supply these services, much of the information they find out about the client will already be known by the auditor and there is a real duplication of effort.

The provision of many non-assurance services will create a self-review threat (eg bookkeeping, internal audit, tax calculations and valuations material to the financial statements).

Another danger, of course, is that the auditors come to rely too heavily on the fees earned from the other work and are therefore reluctant to risk losing a client if they express a modified audit opinion (ie self-interest threat). Large audit firms can at least use separate departments, though this may be difficult with small firms.

In the US listed companies are not allowed to obtain other services from their auditor. This is to ensure that the auditor is independent and performs only the audit. In most jurisdictions, there are no hard and fast rules but the overall guidance on ethics relating to objectivity and independence should be adhered to.

Remember that self-review threats can also arise if a member of the audit team:

• Recently served as a director/officer of the client
  

• Is seconded ('lent') to the client for a temporary assignment.

3.4 Advocacy threats

Advocacy is where the assurance or audit firm promotes a point of view or opinion to the extent the subsequent objectivity is compromised. An example would be where the audit firm promotes the shares in a listed company or supports the company in some sort of dispute (eg with the tax authorities). Advocacy can interfere with professional scepticism.

As always, the audit firm should weigh up the risks to its objectivity, integrity and independence and should withdraw from performing further work if those risks are too high.

3.5 Familiarity threats

Familiarity threats arise because of the close relationship between members of the audit team and the client. The close relationship can arise by friendship, family or through business connections. There is no general definition of what’s meant by close relationships, but if you were an auditor and your brother was the Finance Director of a client firm then there probably is a close relationship! If however the finance director was a remote cousin of yours, there might not be a close relationship. Note that there does not have to be any family or legal relationship: friendship can threaten independence and integrity.

Long association of senior personal creates a familiarity (and self-interest) threat. The Code requires that an engagement partner cannot serve a PIE client for more than seven years (the 'time-on' period). This is to prevent too close a relationship and friendship growing between the two parties. The problem is that when a close relationship does grow, objectivity and skepticism are more likely to be lost. After the time-on period, the 'cooling-off' period for an engagement partner is five consecutive years. The cooling-off period for an individual responsible for the engagement quality (EQ) review (see Chapter 9) is three years.

3.6 Intimidation

The final groups of threats are intimidation threats. These can deter the assurance team from acting properly.

Examples could be threatened litigation, blackmail, or there might even be physical intimidation, though it is to be hoped that that is rare. Blackmail could be more subtly applied . For example, if a gift or hospitality from a client were to be accepted, the possibility of that being made public would create an intimidation threat to objectivity.

4 Safeguards

Applying safeguards may be a suitable response to address an identified threat. Other responses are to eliminate the source of the threat or decline/end the activity.

The ACCA Code of Ethics (2019) defines safeguards as "actions, individually or in combination, taken by the professional accountant that effectively eliminate threats to compliance with the fundamental principles or reduce them to an acceptable level".

The ‘test’ of what is acceptable is whether a “reasonable and well informed party… would be likely to conclude that … compliance with the fundamental principles is not compromised”.

Although the Code is ‘principles-based’, that does not mean that ‘anything goes’ (ie nothing is actually prohibited). Some threats are considered ‘too significant’ that no safeguards could reduce the threats to an acceptable level.

Note that the concepts of broader safeguards (“created by the profession”, “in the work environment”, “implemented by the entity”) are not now regarded as safeguards.

These “no longer safeguards” may, however, affect the evaluation of a threat. For example, “seeking advice” does not meet the definition of a safeguard but may assist in assessing a complex matter.

A professional accountant’s action is not a safeguard unless it is effective.

5 Conflict of interest

This is not a fundamental principle but a situation that creates a threat to objectivity (and possibly other fundamental principles). An example is where the auditor has two clients and one of the clients wants to buy the other. The auditor has been asked to advise the purchaser. The conflict of interest arises because the auditor will have detailed knowledge about the target company: costs, mark-ups, budgets etc which would be very useful to the purchaser. Even if no confidential information was supplied, there can be the suspicion that it might be and you can understand why clients might feel uncomfortable.

In such a situation, the audit firm should inform both parties. They might say that they are not bothered, but even then the audit firm must judge whether it would be seen to be independent and if there is a risk to reputation the work should be turned down.

6 Proposed Revisions to the Code

IESBA Proposed Revisions to the Code to Promote the Role and Mindset Expected of Professional Accountants is an examinable document. The objective of the "role and mindset" (formerly "professional skepticism") project is to ensure that the Code promotes the role, mindset and behavioural characteristics expected of all professional accountants.

7 Example solutions

Solution 1 – No safeguards (only five were asked for)

• An audit firm having a direct financial interest or material indirect financial interest in an audit client. (So if a firm had shares in Alfa Co it would have to dispose of them to accept the audit appointment.)
  

• Close business (commercial) relationships (eg the firm and client package their services or the client marketing the firm’s services).
  

• Accepting loans and guarantees that are not the client’s business or not on normal terms.
  

• Contingent fees for an audit engagement.
  

• Assuming any management responsibility for an audit client.
  

• Providing valuation services to a PIE that are material to the financial statements. (Also for a non-PIE client if the valuation involves a significant degree of subjectivity.)
  

• Giving tax or corporate finance advice which depends on a particular accounting treatment and has consequences that are material to the financial statements.
  

• A partner or employee of the firm serving as a director or officer of an audit client.
  

• Acting as an advocate for an audit client before a court (unless amount involved are immaterial).
  

• Promoting, dealing in or underwriting client’s shares.
  

• Gifts and hospitality unless trivial and inconsequential.

Solution 2 – Safeguards to reduce threat to an acceptable level (only five were asked for)

Note that the examples of the threats to which these safeguards may be applied cannot include any of the threats in Solution 1.