Staying on the right side of ethics

Ethics is a crucial and topical area for auditors and accountants and is constantly under scrutiny by both the industry and the press. The ethical codes of auditors are particularly debated each time there is a significant corporate failure and these guidelines change in response to a dynamic business environment. For students, ethics feature as a key part of the entire ACCA professional syllabus and are examined in many ways in many papers. A good understanding of ethical issues is therefore required in order to qualify as a chartered certified accountant. It is also important to be able to apply this ethical stance and the codes by which accountants are governed to the particular exam you are sitting.

In the Paper P7, Advanced Audit and Assurance, the ethical focus is on auditor behaviour and the rules and principles that auditors must abide by. Contrast this to the focus in Paper P2, Corporate Reporting, where the focus is on the directors choosing the ethically appropriate presentation of the accounts and wider information published, or Paper P1, Governance, Risk and Ethics and Paper P3, Business Analysis, where it is ethical business practices and strategies that come under scrutiny. This means that when answering the questions in the audit paper on ethics the focus must remain on considerations, the consequences and the actions to be taken by the auditor rather than the client or business that is being audited.

Within the exam, ethical issues are commonly examined alongside practice management issues as the implications of ethical guidelines will interlink with the processes and procedures that an audit or advisory firm must put in place to ensure compliance. This means that answers may need to cover both areas and will need to suggest actions required by the firm in order to remain compliant with the ethical rules.

From a technique point of view, the starting point is to learn the basic ethical principles that auditors must abide by. These are fundamental principles of Integrity; Objectivity; Professional competence and due care; Confidentiality; and Professional behaviour. This is the start point for assessing issues within a scenario and is also for when there is no specific guidance on an area. These principles sit within a conceptual ethical framework that requires ACCA members to consider and identify threats, evaluate those threats and respond to them. Where significant threats are identified, appropriate safeguards must be implemented to eliminate or reduce such threats to an acceptable level (ACCA code of Ethics and Conduct and the IESBA Code).

Beyond this general guidance, there are specific rules within auditing and industry ethical standards that should be applied in specific situations. For adapted paper variants these codes may be different but they all contain similar principles even where the exact requirements differ. More details can be found in any approved study text. This however will only be a starting place. These rules have been examined already in the initial audit paper and any question at the advanced level will require an ability to deal with these in more complex scenarios or judgemental areas.

Requirements from recent exams show how the issues may be interlinked. For example, in June 2013 there was a question where a new audit client requested advice on the acquisition of an existing audit client while also wanting financing advice on the potential purchase. This scenario requires consideration of the issues involved in offering advice on acquisitions (such as competence and several independence threats) and takes this further as the target financial statements have been audited by the firm itself. It also extends to dealing with a conflict of interest between clients, and confidentiality issues along with further advocacy threats to independence, and the appropriateness of providing financing advice.

Questions may also require competency judgements to be made regarding staff seniority and different aspects of individual assignments such as Question 2 of the June 2013 exam. This question required discussion of which tasks are appropriate for which team members in specific audit situations. Each situation presented may have subtle considerations which mean that the basic rules must be examined more closely. For example, in the December 2013 exam one scenario presented a request for valuation services by a listed client. Marks were available for saying that provision of material valuation services to listed clients are not permitted but additional marks were available for spotting that in this case the amount was immaterial therefore, subject to other considerations such as competence and availability of time and resources, that this was permitted.

In order to tackle these requirements there is a need to identify each relevant issue and show how it relates to the rules. For example in the case of the acquisition above there is a self-review threat. Identifying that self-review is an issue may score a half mark. In order to score well, the risk of self-review must be explained in relation to the scenario. So here an answer may go on to say that in examining the accounts of the target company the firm will be reviewing figures it has already audited and may be reluctant to highlight errors in those figures. Further when auditing the acquisition in the purchasing company, the goodwill and fair value figures will be based on work the audit firm did on the acquisition and hence a further self-review threat emerges where again the firm may be unwilling to highlight errors or unable to identify its own errors of judgement.  

This is a common area where students who have identified the right issue go on to score badly through a lack of specific explanation in relation to the scenario or through the use of circular explanations such as 'there is a self-review threat because the auditors will be reviewing their own work'. Such an answer does not explain what happens as a consequence of self-review, hence why it is a threat, nor does it apply the issue to the scenario. Each ethical threat must be expanded on in order to explain how it arises. The table below shows examples of how identification points for specific threats to independence can be converted into explanations.

Independence
threat

Example scenario

Possible answer
Self-review
(June 2013)
New audit client wishing to purchase existing clientThe due diligence review may lead to a self-review threat as the firm will be reviewing financial statements on which it has already given an opinion and may be reluctant to highlight errors
Advocacy
(June 2013)
Above client seeking financing advice for the acquisition 

Advocacy threats may arise if the firm appears to be promoting the client in negotiations with the bank

Self-interest
(December 2013)

Overdue fees

Overdue fees could in effect amount to a loan to the client. In such as case the auditor may be tempted to provide a favourable opinion in order to increase the chance of fee recoverability

Management
(December 2013)

Owner managed business requesting audit and business advice

Providing business advice may result in the firm taking decisions which are the responsibility of the client

Familiarity
(December 2012)

Prior year audit manager (Bob) is being considered for the finance director role at client

Bob will have a previous working relationship with the audit team causing them to trust him more and therefore lose professional scepticism


Bob will also know the firms audit procedures and be able to circumvent them

Intimidation
(December 2012)

As above

Junior members may feel intimidated Bob as he was previously their manager and fail to challenge him properly

Following this the answer must go on to recommend how to solve these issues, what if any, specific rules might be in place, what actions the firm can take? These recommendations should be specific to the scenario given and carry an amount of commercial sense. This is one area where weaker students struggle most. The examiner is looking for an application of the rules to the scenario and rote learnt repetition of the standard rules will score only a minimum of credit. The examiner expects students to spot that the firm is large or small and therefore whether rules regarding acceptable recurring fee levels from a single client might be applicable. If you are looking at a large firm and a small client then self-interest due to high fee levels is not a high risk.  Similarly if the piece of work is a one off rather than recurring then a recurring fee level test is not relevant. It is also worth noting that the IESBA code contains additional specific requirements for public interest entities such as listed companies. The details of these can be found in study texts.

Another common mistake for students to make is to not take in to account where in the audit/client cycle the question is set when making recommendations. If the audit has already happened when an independence issue comes to light then replacing the auditor for the final audit is not an option. It’s in the past and therefore additional partner reviews, possible identification of areas requiring more work and putting in place stronger procedures for next year are more appropriate. Similarly if the firm is considering a new client, they can’t resign during the tender stage as they haven’t been appointed to the position yet. The option would be to withdraw from the tender process. Conversely if we have a new client we have already been appointed to then it’s too late to start carrying out the acceptance procedures. Acceptance procedures such as professional clearance, assessing client integrity and considering the firms competence to undertake the assignment should already have been completed in deciding to accept the client.  One way to keep track during the exam is to think of the basic audit cycle and to mark on it where in the process the question is set in order to ensure the right focus of recommendations.


Figure 1, Basic audit cycle

audit-cycle


When recommending actions in the exam the basic rule is to reduce the threat to an acceptable level and if that is not possible, avoid the threat through not accepting the assignment or withdrawing. When expressing actions in the exam, be specific. If a piece of work should be reviewed, say who should be reviewing. Is it a manager reviewing a juniors work during the evidence phase, or is it the partner on the assignment reviewing the whole assignment in order to come to the audit opinion. With partner reviews, is it a second partner review (hot) you are recommending, such as a concurring partner review prior to the issue of higher risk reports or is it a quality control review, being done after the report is issued (cold) to check for compliance. If the correct course of action is to decline an assignment, a strong answer would go on to say that the reasons should be explained politely to the potential client.

A final word of caution for the ethics section in the Advance Audit and Assurance paper is to check that your answer has the right focus. Always keep in mind the answers will be actions for the auditor not the client’s management. The appropriateness of management’s decision to expand the business into a new market or product will not form part of your answer. It is a common examiner review point that students often spend time in the exam writing on such issues at a tangent to the requirement set. This means that the answer given in the exam appears to be a long and in depth analysis but score no marks as it is rarely required. With regard to the ethics of the managers of the client, the considerations for the auditor are whether they wish to be associated with the client, a decision at the acceptance/continuation stage, or whether they need to increase their level of scepticism in the evidence gathering stage. Keeping the focus on the auditor in the exam will enable students to answer the question set.       

Helen Milner, freelance financial reporting and audit tutor