audit

1. CHAPTER II
A framework of some concepts
related to the Professional
ethics for an external auditor
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2. Learning Objectifs
• In this chapter we will concentrate on some ethical concepts. Technical concepts as the audit
risk will be studied later.
• We will explain and discuss the importance of the concepts relating to the credibility of
auditors ’ work (i.e., Independence, Competence, Judgment and Skepticism)
• Explain the importance of auditors being independent of mind and independent in
appearance;
• Describe the circumstances in which auditors ’ independence may appear to be compromised;
• Discuss measures introduced by legislation and regulation which are designed to ensure that
auditors are independent;
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3. Professional ethics
• Ethics is “the set of moral principles that underlie a person's conduct". These codes of conduct
represent the cornerstone of an individual's behaviour. They will then affect the personal,
family or professional aspects of one's life.
• The purpose of professional ethics is to regulate the activities that take place within a
profession.
• Ethics, in general, is not coercive (it does not impose legal or normative sanctions). However,
professional ethics may be coercive, to some extent, in the ethical codes governing a
professional activity. Every profession has its code of practice (ethical code).
• A code of practice is “Principles, values, standards, or rules of behavior that guide the decisions,
procedures and systems of an organization in a way that (a) contributes to the welfare of its key
stakeholders, and (b) respects the rights of all constituents affected by its operations”
(International Federation of Accountants)
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4. Concept of Objectivity
• Objectivity is a state of mind that excludes bias, prejudice and compromise
and that gives fair and impartial consideration to all matters that are relevant
to the task in hand, disregarding those that are not. Objectivity is a
fundamental ethical principle and requires that the auditor ’s judgment is not
affected by conflicts of interest.
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5. Concept of competence
• Auditors act with professional skill, derived from their qualification, training and practical
experience. This demands an understanding of financial reporting and business issues,
together with expertise in accumulating and assessing the evidence necessary to form an
opinion.
• These competences are acquired through a combination of general and technical accounting
education, on-the-job training and work experience. In order to be “appropriately qualified”,
auditors must hold a “recognised professional qualification”.
• In France, to be an external auditor you need an MSc in Finance, a CCA Master, the DSCG,
engineering degree, etc.
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6. Integrity – Confidentiality – Professional Behavior
• (a) Integrity – to be straightforward and honest in all professional and
business relationships.
• (b) Confidentiality – to respect the confidentiality of information acquired as
a result of professional and business relationships and, therefore, not disclose
any such information to third parties, nor use the information for the personal
advantage of the professional accountant or third parties.
• (c) Professional Behavior – to comply with relevant laws and regulations and
avoid any action that discredits the profession.
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7. Concept of judgment
• The concept encapsulates the notion of applying knowledge and experience to
evaluate the circumstances, and/or available evidence, relevant to a known objective
and forming an opinion based on that evaluation. It contrasts with achieving an
objective by means of following an established set of rules or procedures.
• The auditor should not to give answers that apply routinely in a given situation. Each
audit is unique, and the circumstances of the particular audit must be considered
when auditors exercise their judgment.
• The judgment of the auditor varies according to the circumstances of the error or
omission, characteristics of the auditee and likely users of its financial statements.
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8. Concept of Skepticism
• “An attitude that includes a questioning mind, being alert to conditions which
may indicate possible misstatement due to error or fraud, and a critical
assessment of audit evidence”. ( ISA 200, para 13)
• “skepticism is a personal quality that relates to the attitude of individual
auditors: it is characterized by a questioning, probing – almost suspicious–
approach being applied throughout the audit” (Auditing Practices Board, APB)
• Skepticism means a need to critically evaluate (rather than merely accept)
information and explanations obtained from auditee personnel, and other
audit evidence gathered, with an objective attitude of mind.
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9. Independence
• Independence is a key concept – a characteristic that is essential for ensuring the credibility of auditors
’ work: without independence an audit is virtually worthless.
• Auditors are intermediaries between the management of an entity and external parties interested in
the entity. They have a duty to form and express an opinion on whether the entity’s financial
statements (prepared by management for use by shareholders and others outside the entity) provide a
true and fair view of the entity’s financial position and performance.
• If users of the financial statements are to believe and rely on the auditor’s opinion, it is essential that
the auditor is, and is perceived to be, independent of the entity, its management and all other
influences.
• If auditors are considered not to be independent of the client entity and its management, their opinion
will carry little credibility and users of the financial statements will gain little, if any, assurance from the
auditor ’ s report about the truth and fairness (or otherwise) of the financial statements. As a
consequence, the audit will have little purpose or value.
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10. Meaning of independence in the auditing context
• It is well accepted that independence, in the sense of being self-reliant and
not subordinating one’s professional judgment to the opinions of others, is a
fundamental hallmark of all professions (including auditing).
• However, in auditing the term means more than this. In addition to
maintaining an independent attitude of mind, it means avoiding situations
which could impair, or might be perceived as likely to impair, the auditor ’s
objectivity or to create personal bias.
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11. Meaning of independence in the auditing
context
• There are two forms of independence were usually referred to as ‘independence of mind’ and
‘independence in appearance’:
- Independence of mind – the state of mind that permits the expression of a conclusion
without being affected by influences that compromise professional judgment, thereby
allowing an individual to act with integrity, and exercise objectivity and professional
skepticism.
- Independence in appearance – the avoidance of facts and circumstances that are so
significant that a reasonable and informed third party would be likely to conclude, weighing all
the specific facts and circumstances, that a firm’s, or a member of the audit or assurance
team ’s, integrity, objectivity or professional skepticism has been compromised
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12. Meaning of independence in the auditing
context
• It is also possible to make the difference between objectivity and independence:
- Objectivity is a state of mind that excludes bias, prejudice and compromise and that gives fair and impartial
consideration to all matters that are relevant to the task in hand, disregarding those that are not. Like
integrity, objectivity is a fundamental ethical principle and requires that the auditor’s judgment is not
affected by conflicts of interest.
- Independence is freedom from situations and relationships which make it probable that a reasonable and
informed third party would conclude that objectivity either is impaired or could be impaired.
Independence is related to and underpins objectivity. However, whereas objectivity is a personal behavioural
characteristic concerning the auditor ’ s state of mind, independence relates to the circumstances surrounding
the audit, including the financial, employment, business and personal relationships between the auditor and
the audited entity.
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13. Threats to auditors independence
• Why it is difficult for an auditor to be independent ?
• Auditors are appointed by the company ’s shareholders. In practice, auditors
are hired, and paid by their clients’ managements; they work closely with
their clients ’ managements as they conduct their audits and, after a number
of years of acting as auditor for a client, they become very familiar with the
client and its management.
• Additionally, auditors frequently (and increasingly) provided non-audit
services to their clients.
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14. Threats to auditors independence
• There are the following several types of threats:
1. Self-interest threat– this arises when the auditor has a financial, business, personal or other interest in
the client (or with a director, senior executive or major shareholder of the client) which might cause the
auditor not to act in the best interests of users of the auditee ’ s financial statements, the audit firm or the
public. This threat may arise if the auditor:
- has some financial involvement with the client as a shareholder, debtholder or creditor;
- has a close family or personal relationship with a director or senior executive of the client;
- receives favorable treatment from the client in the form of goods, services or hospitality;
- depends on the client for a substantial portion of total fee income; this may be derived from the
provision of non-audit as well as audit services
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15. Threats to auditors independence
2. Self-review threat– this arises when the auditor (or other members of the audit Firm) provides
non-audit services to the audit client and those services impact the client ’ s accounting system,
accounting records and/or the amounts or disclosures in its financial statements. By providing such
services, the audit firm is associated with aspects of the preparation of the financial statements.
When conducting a subsequent audit, the auditor may be (or may appear to be) unable to maintain
an objective and impartial attitude when reviewing these aspects of the financial statements.
3. Management threat– this arises when the auditor, a member of the audit team or others in the
audit firm make judgments or decisions which should be those of the client’s management. For
example: the audit firm might be engaged to design, select and/or implement a new information
technology system for the client.
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16. Threats to auditors independence
4. Familiarity (or trust) threat– this arises when the auditor is too ready to accept, or is insufficiently
skeptical about, information and/or documents and records provided by the audit client and its
personnel. This may occur, for example, if the auditor (or audit firm) has had a long association with
the audit client and, as a result, a close personal relationship has developed and/or, based on past
audits when nothing untoward has been encountered, the auditor becomes too trusting and makes
unjustified assumptions that ‘all is well’ instead of exercising an appropriate degree of skepticism
5. Intimidation threat – this arises when the auditor’s conduct is influenced by fear or threats from
the client (an aggressive and dominating director or senior executive) or some other influential party.
This may occur, for example, if the auditor challenges some significant aspect(s) of the client ’s
financial statements and an influential director or senior executive threatens to ensure the auditor is
replaced as the company ’ s auditor
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17. Solutions to strengthen the auditor
independence
1. The appointment of auditors by Public authority:
• Although the law places responsibility on shareholders to appoint their company’s
auditor and determine the associated remuneration, the shareholders generally
delegate this responsibility to the company ’ s management. This is regrettable as it
seems unlikely that auditors will be truly independent of their clients while their
appointment, dismissal and remuneration depends on their clients ’ managements–
those who prepare the financial statements the auditor is to examine.
• the idea is to consign the choice of the auditor to a structure that is independent of
the management in order to limit the risk of conflict of interest. This structure can be
a public authority.
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18. Solutions to strengthen the auditor
independence
• Disadvantages of this solution:
• However, this ‘solution’ to the auditor independence problem is not without significant
difficulties. This would introduce the possibility of auditors becoming susceptible to the
political agenda of the day and of the audit profession losing its political and professional
independence.
• Further, the body responsible for appointing auditors would face the difficulty of deciding
a basis for assigning particular auditors to particular companies. Each company would
need to be assigned an audit firm with the knowledge and skills, and complement of
suitably qualified and experienced staff, appropriate to its circumstances; equally, the
audits would need to be assigned equitably among the available audit firm.
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19. Solutions to strengthen the auditor
independence
2. The appointment of auditors by Shareholder or stakeholder panel:
• The shareholders could appoint a panel (which would exclude the company ’s
directors) to represent their interests in appointing, and determining the
remuneration of, the company ’s auditor and overseeing the external audit
function.
• Such a panel would represent a wider group of interests – those of the
company ’s stakeholders (including the shareholders) – rather than those of
the shareholders alone.
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20. Solutions to strengthen the auditor
independence
Disadvantages of this solution
• The panel is to be responsible for the appointment and oversight of the company ’ s auditor, its
members would gain detailed knowledge of the company, its financial performance and its
prospects that would not be available (at least at the same time) to all other shareholders and
investors. As a consequence, there is a danger that, if some members of the panel traded in the
company ’ s shares, they would be open to allegations of insider trading.
• the difficulty of appointing the shareholder or stakeholder panel. Should, for example, the
shareholder panel comprise only shareholders who intend, or guarantee, to hold their shares in the
company for – say – the next 12 months? Should the panel comprise only those who have been
shareholders in the company for a specified number of years? If so, what period should be
specified? and so on. The appointment criteria are even more problematic for a stakeholder panel.
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21. Solutions to strengthen the auditor
independence
• There is other safeguards that may include:
- Rotating audit members of the engagement team away from the audit client
after a pre-determined number of years
- Appointing an additional partner who is not, and has not recently been, a
member of the engagement team to review the work of the audit team
- The joint audit can be a solution (two auditing firms auditing the same client).
In France, the joint audit is mandatory for some listed firms.
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22. Role and responsibility of audit committees
• An audit committee is a committee of the board of directors which has
delegated responsibility from the board for overseeing the external financial
reporting process and the external audit.
• The value of audit committees as a means of enhancing external financial
reporting, and ensuring the independence of external auditors, has been
increasingly recognised and these committees have become a normal feature
of corporate life, especially of public companies, in many parts of the world.
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23. Role and responsibility of audit committees
• The role of an audit committee is:
- ensuring the maintenance of an effective accounting system (with effective internal financial
controls);
- reviewing the company’s accounting policies and external reporting requirements;
- selecting, and recommending for appointment, the company ’ s external auditor and
recommending the auditor ’ s remuneration;
- appointing the company ’s chief internal auditor;
- reviewing implementation of the auditors ’ recommendations;
- reviewing the company’s annual report (including its financial statements) prior to its
submission to the full board of directors
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24. QUIZZ
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25. • The concept of objectivity is:
A/ Acting with professional skill, derived from qualification, training and
practical experience
B/ Not to have financial relations with the auditee
C/ A state of mind that excludes bias, prejudice and compromise
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26. • The concept of judgment implies that all audit processes are similar:
A/ True
B/ False
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27. • The study and practice of auditing is unlike other areas in accounting because
it
A) Requires the memorization of formulas and patterns.
B) Requires the knowledge of the applicable financial reporting framework.
C) Requires common sense and some creativity.
D) Is required by law for all companies
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28. Which of the following best describes the reason why an independent auditor is
often retained to report on financial statements?
A) Different interests may exist between the entity preparing the
statements and the persons using the statements, and thus outside assurance is
needed to enhance the credibility of the statements.
B) A misstatement of account balances may exist, and all misstatements are
generally corrected as a result of the independent auditor’s work.
C) An entity may have a poorly designed internal control system.
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29. Which of the following best describes the primary reason an independent
auditor reports on financial statements?
A) To identify a poorly designed internal control structure that may produce
unreliable financial statements.
B) To provide expertise to management, which may not be totally
knowledgeable of the applicable financial reporting framework.
C) To add credibility, where appropriate, since management may not be
perceived as objective with respect to its own financial statements.
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30. Several months after an unqualified audit report was issued, the auditor discovers the financial statements were materially
misstated. The client’s CEO agrees that there are misstatements, but refuses to correct them. He claims that
“confidentiality” prevents the auditor from informing anyone.
• A) The CEO is correct and the auditor must maintain confidentiality.
• B) The CEO is incorrect, but because the audit report has been issued it is too late.
• C) The CEO is correct, but to be ethically correct the auditor should violate the confidentiality rule and disclose the error.
• D) The CEO is incorrect, and the auditor has an obligation to issue a revised audit report, even if the CEO will not correct
the financial statements.
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31. • In determining independence with respect to any audit engagement, the ultimate decision as
to whether or not the auditor is independent must be made by the:
• A. Auditor.
• B. Client.
• C. Audit committee.
• D. Public.
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32. In which circumstance is a audit firm's independence most likely to be impaired?
• A)An individual on the audit firm has a close relative who is a
receptionist for the client.
• B)The father of the audit senior holds a material financial interest in the
client of which the senior is unaware.
• C)The spouse of a staff member on the audit firm has an immaterial
common stock investment in the audit client.
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33. • Mr. Jones was an employee of Firm A and he participated to the preparation of the
balance sheet for 2018. He left the firm in 2020 and was recruited by an audit firm. The
same year, he was appointed as an auditor of firm A. This is a case of a self review threat
A/ True
B/ False
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34. • An auditor received a gift from the manager after the end of his contract in a
company. Is this situation considered as a threat for the auditor independence
?
A/ True
B/ False
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35. • A company has the right to give a bonus to the auditor if he signs a report with an
unmodified opinion
A/ True
B/ False
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