◄UNIT 1 :FUNDAMENTAL CONCEPTS IN AUDITINGUNIT 3: AUDITOR’S APPOINTMENT►

UNIT 2:LEGAL AND PROFESSIONAL REQUIREMENT

  • UNIT 2:LEGAL AND PROFESSIONAL REQUIREMENT

    Key unit competence: To be able to describe the legal and professional 

    standards required for an auditor

    Introductory activity
    MURENZI has recently completed his Certified Public Accountant (CPA) 
    course and got an offer in KM audit firm. On his first audit assignment, 
    the audit Partner instructed him to observe the auditing standards and 
    professional ethics. Further, he was requested to carry out his engagement 
    with due diligence and be able to mitigate any ethical threats/ challenges. 
    Given that it was his first engagement assignment, he was not sure about 
    the professional and legal requirements of the auditors. Furthermore, he did 
    not know the ethical threats partaning to the profession of auditing and their 

    mitigation strategies.

    In response to his problem, the auditor decided to consult the senior auditor 
    KEREKEZI with whom deployed to carry out the audit of BETA Co Ltd 
    financial statements for the period ended 31 December 2020, prepared 
    in conformity with common rules. MURENZI got ample explanations from 
    the colleague. Thereafter, he started the audit and the audit was done as 
    guided by the audit partners. The auditor conducted the audit in conformity 
    with international standards on auditing, local requirements, and observed 

    the professional requirements.

    Questions
    1. Why is it necessary for an auditor to comply with national and 
    international regulations on auditing? 

    2. In case the auditor does not comply with national and international 

    regulations on auditing, what happens?

    2.1. Audit standards

    Learning activity 2.1

    INEZA BAKERY produces different products from wheat flour like bread, 
    cakes etc. it has records of financial transactions. The management of this 
    bakery needs the help for checking if their records are accurate according 

    to General Accepted Accounting Principles. 

    1. As students in S6 Accounting, what do you think could be the 
    International Standards on Auditing that would applied while 

    checking the financial records of INEZA BAKERY? 

    2. What are the fundamental principles of ethics that you must fulfil in 

    order to become a member of professional body like ICPAR/IFAC?

    2.1.1. International standards on auditing

    a) Meaning of International Standards on Auditing (ISAs)

    International standards on auditing are professional standards for the 

    performance of financial audit of financial statements.

    b) Structure of International Standards

    The International standards are structured as follows:

    • Introduction: includes the purpose, scope and subject matter of the 

    ISA plus the responsibility of the auditor.

    • Objective: consists of a clear statement of the ISA’s objective in relation 

    to the audit area that the ISA addresses.

    • Definitions: of applicable terms used in the text.

    • Requirements: clearly stated as ‘the auditor shall…’

    • Application and other explanatory material: more precise explanations 

    of what requirements mean or are meant to cover.

    These standards are issued by International Federation of Accountants (IFAC) 
    through the International Auditing and Assurance or guarantee Standards Board 
    (IAASB). ISAs are mandatory in some jurisdictions for the audit of company’s 

    accounts.

    c) Process of setting Standards 
    • The IAASB identifies new developments.
    • The IAASB appoints a task force to draft a standard.
    • Consultation takes place.
    • An “exposure draft” is produced; essentially a draft standard issued 
    welcoming comments from the profession and any other interested 
    party.
    • The task force considers comments and may make amendments.
    • The Standard is finalised and formally approved by the IAASB.


    Examples of international standard on auditing
    • IAS200: Overall Objectives of the Independent Auditor and the Conduct 
    of an Audit in Accordance with International Standards on Auditing
    • IAS210: Agreeing the Terms of Audit Engagements
    • IAS230: Audit Documentation
    • IAS500: Audit evidence
    • IAS530: Audit sampling

    • IAS700: Forming an opinion and reporting on financial statements

    2.1.2. Ethical duties of auditors according to International 

    standards on auditing

    The IESBA Code of Ethics provides ethical guidance for members in its 
    five fundamental principles such as: integrity, objectivity, professional 

    competence and due care, confidentiality and professional behavior.

    a) Fundamental principles of ethics

    All members and students must comply with these five fundamental principles 

    set out in IESBA Code of Ethics.

    • Integrity: to be straightforward and honest in all professional and 
    business relationships.

    • Objectivity: Not to compromise professional or business judgments 
    because of bias, conflict of interest or undue influence of others.
    • Professional competence and due care: 

    – To attain and maintain professional knowledge or skills at the level 
    required to ensure that a client or employing organization receives 
    competent professional service, based on current technical and 
    professional standards and relevant legislation.

    – To act diligently in accordance with applicable technical and 
    professional standards.

    • Confidentiality: To respect the confidentiality of information acquired 

    as a result of professional and business relationships.

    • Professional behavior: to comply with relevant laws and regulations 
    and avoid any action that the professional accountant knows or might 

    discredit the profession.

    Compliance with the fundamental principles may potentially be threatened by a 

    broad range of

    Circumstances. The IESBA Code of Ethics categorises them as follows:

    • Self-interest (e.g. financial interests, concern over employment 

    security)

    • Self-review (e.g. decisions made and reviewed by same person)

    • Advocacy (not improper provided it does not result in misleading 

    information)

    • Familiarity (e.g. long association, acceptance of gifts)

    • Intimidation (e.g. threat of dismissal)

    Possible safeguards to above threats of independence are:
    • Setting the internal rules that for example no partners or staff have 
    shares in audits client ;
    • Setting client acceptance procedures ;
    • Carry out an annual review of independence both for the whole firm ;
    • Do a consultation procedure in case of doubt ;
    • Second partner review of certain client ;

    • Rotation of the engagement partner or rotation of senior auditor staff.

    b) Specific guidance and notes

    The IESBA Code of Ethics states that independence requires independence 
    of mind and independence in appearance. In other words, the auditor must be, 

    and must be seen to be independent.

    • Independence of mind is the state of mind that permits the provision 
    of conclusions without being affected by influences that compromise 
    professional judgement, allowing an individual to act with integrity, and 

    exercise objectivity and professional scepticism.

    • Independence in appearance is the avoidance of facts and 
    circumstances that are so significant a reasonable and informed third 
    party would be likely to conclude that a firm’s, or audit and Assurance 
    team members, integrity, objectivity or professional scepticism have 

    been compromised.

    It is very important that the auditor is impartial and independent of management, 
    so that he/she can give an objective view on the financial statements of an 
    entity. The responsibility is always on the auditor not only to be independent but 
    also to be seen to be independent.


    Application activity 2.1

    1. You are appointed as the auditor of XY Company. What are the main 

    principles of ethics you need to observe during the audit?

    2.2. Auditor of the company

    Learning activity 2.2

    Suppose you are the auditor of Star Ltd located at Nyagatare District and 
    you have a neighbour who has new business. He/she wants to know the 
    main responsibilities of an auditor. Help him/her to answer the following 

    question:

    1. What do you think could be the responsibilities of the auditor of Star 

    Ltd Company?

    2.2.1. Duties, obligations and rights of an auditor

    a) Duties of an auditor 

    An auditor has to:
    • Make a report to shareholders, ownersor government ( for external 
    auditors)
    • Make a report to the management (for internal auditors).
    • Assist in investigation.
    • Certify that whether loans are properly secured and not at terms 
    prejudicial to the interest of shareholders.
    • Certify whether transactions conducted by the company are not 

    prejudicial to the interest of shareholders.

    b) Obligations of an auditor

    An auditor must:

    • Pass an approved set of professional examinations, set by a Recognised 

    Qualifying Body (RQB) e.g. the ACCA, CPA, CA;

    • Become a member (and stay member) of a Recognised Supervisory 

    Body (RSB) e.g. ACCA, ICPAR;

    • Not to be a director or employee of the company, or of any associated 

    companies;

    • Not to be an employee or business partner of a director or employee of 

    the company or of any associated companies.

    c) Auditor’s rights

    The auditors have powerful rights to:

    • Access to all records needed (the books of the organisation at any 

    time);

    • Receive information and explanations of all transactions;

    • Call for information and explanations from employees, managing agents, 

    company secretaries, etc;

    • Attend and receive notice (within 21 days) about general meetings and 

    they have right to speak at general meetings on relevant matters;

    • Visit the company’s branches;

    • Take a legal and technical advice;

    • Remuneration;

    • Sign the audit report.

    2.2.2. Auditor’s liability

    a) Meaning of auditor’s liability agreements

    Auditor’s limited liability agreements are contracts designed to ensure that 
    auditors are not pursued for excessive losses, just reasonable proportion based 

    on their responsibility.

    b) Types of auditor’s liability

    Civil liability of Auditor for negligence: Civil liability is the legal responsibility 
    for a payment to an aggrieved third party, due to the violation of a civil law, tort, 
    or a breach of contract. Therefore, the auditor must exercise reasonable degree 
    of skill and care in the performance of his/her duties.An auditor can be held 

    liable for negligence of his/her duty if it is proved that:

    • Negligence in the performance of his/her duty;

    • A loss or damage as a result of his/her negligence;

    • The loss was suffered by his/her client.

    Criminal liability: responsibility for any illegal behaviour that causes harm or 

    damage to someone or something which means open to punishment for a crime.

    c) Sources of legal liability for an auditor
    • The Legal Liability of Auditors to Third parties;
    • Unjustified/unfair Lawsuits;
    • Successful Lawsuits against Auditors.

    Third parties: can be a person or group besides the two primarily involved 
    in a situation, especially a dispute. Third parties may include any individual 
    shareholders, potential investors and the banks.     In these cases, there is no 
    contract with the audit firm. Therefore, there is no implied duty of care. In order 
    to hold the auditor criminally liable, the following must be proved:
    • that the statement made was false in material facts;
    • that the auditor willfully made such a false statement, and;
    • That the statement complained of has been made in any return report, 
    balance sheet, certificate or any other document required to be made 

    under any provision of the Companies Act.

    It may be stated here that the court has the powers to relieve an auditor either 
    partly or wholly; if a case is proceeding against him/her for negligence, default 
    or breach of duty or trust provided it is satisfied that the auditor acted honestly 

    and reasonably by taking into consideration all the circumstances of the case.

    An auditor may be also held liable for damages to third parties, if they have 
    suffered any loss relying on any balance sheet or any financial statement signed 
    by him/her. Such liability arises where there is no direct contractual liability. It 

    may arise in the following cases.


    • Where the auditor has been proved negligence and any third party has 
    suffered a financial loss due to negligence of the auditor;

    • Where the auditor did not attach a disclaim to this report to the effect 
    that the report was not intended to be relied upon by third parties;

    • Where the auditor was made fully aware that third parties were going 
    to rely on his/her report;

    • Where the third parties can prove that no other external factors 
    influenced their decision making except the auditor’s report;

    • Where the auditor owed a duty of care to the third parties;

    • Where the auditor gives reference regarding his/her client’s credit 
    worthiness;

    Although it is difficult to determine to which third parties the auditor will be liable. 
    However, the auditor may be liable generally to the following third parties:
    • Any person to whom he/she owes duty of care e.g. debtors or creditors 

    of his/her client;

    • Persons who may rely on his/her work provided the auditor knew 
    that those persons will rely on his/her work e.g. bank managers, tax 

    authorities etc;

    • Any person who is affected due to his/her audit report e.g. the employees 

    of his/her client.

    The auditor can take the following steps to minimise the danger of any claim 

    against him/her for negligence work:

    • Gather conclusive evidence and supporting documents before passing 

    any entries and drawing an opinion;

    • Review the risky audit areas before releasing the final audit report to 

    the shareholders;

    • Withdraw his/her consent and give a public notice to this effect after 

    registration of prospectus but before allotment of shares;

    • Use well trained and experienced staff during the audit work who will 

    carry out their duties completely;

    • He/she should obtain supporting evidence e.g. letters of representation 

    to prove his/her competences;

    • Withdraw his/her consent in writing before such a prospectus has 

    been registered and before it is for public use.

    Application activity 2.2

    Question 

    1. AMAHORO Ltd is an audit firm located in Bugesera District. It is 
    appointed to audit the industry that manufactures agricultural 
    products. The owner of AMAHORO Ltd asks for assistance on ways 
    of minimising the risks/dangers of any claim against for negligence.

     How AMAHORO Ltd will minimize the risks of negligance?

    Skills lab activity 2

    Through internet search, students in their learning teams search different 

    cases that can lead the auditor to criminal liabilities and civil liabilities. 

    End unit 2 assessment

    1. What are the components of International Standards on Auditing?
    2. Which of the following are not engagement standards issued by the 
    IAASB?
    a) International Standards on Auditing
    b) International Standards on Quality Control
    c) International Auditing Practice Statements
    d) International Standards on Related Services
    e) International Standards on Assurance Engagements

    f) International Standards on Review Engagements

    3. Under what circumstances an auditor may be held liable to a third 

    party for negligence.

    4. Which cases may lead an auditor to be held liable to criminal

    offence?

    ◄UNIT 1 :FUNDAMENTAL CONCEPTS IN AUDITINGUNIT 3: AUDITOR’S APPOINTMENT►