◄UNIT 5: AUDITOR’S RESPONSIBILITYUNIT 7: AUDIT PLANNING►

UNIT 6: AUDITOR’S REGULATION AND ETHICS

  • UNIT 6: AUDITOR’S REGULATION AND ETHICS

    Key unit competence: To be able to comply with auditor’s regulation 

    and professional ethics.

    Introductory activity

    Financial and ethical reporting plays a significant role in sustainable 
    commercial development, as it provides the information required to assess 
    sustainable performance. In recent times, sustainability reporting has 
    constantly increased and is now a common business practice. 

    The countries that set the financial and ethical standards. However, the recent 
    role of emerging and developing nations requires that other regulations be 
    devised regarding not only financial stability but also inclusiveness and 
    economic development. 

    Because of the maturity of the institutional financial system and the efficient 
    market mechanism, the countries suggested reasons for international 
    differences concerning the context of financial reporting. This highlights the 
    importance of the auditing profession regaining and retaining the confidence 
    of the public, with duties performed in alignment with public interests. 

    Question

    What would be the international standards adopted to support all contexts 

    of auditing?

    6.1. International auditing standards

    Learning activity 6.1

    Look the picture above, and answer the following questions: 

    1. What do you see in this picture? 

    2. Which elements do you see that can be used as auditing standards?

    O ACCOUNTING

    Auditing | Student Book | Senior Six | Experimental version 75

    6.1. International auditing standards

    Look the picture above, and answer the following questions: 

    1. What do you see in this picture? 

    2. Which elements do you see that can be used as auditing standards?

    Learning activity 6.1

    6.1.1. The role of International Auditing and Assurance Standards Board

    International Standards on Auditing (ISAs) are set by the International Auditing 
    and Assurance Standards Board (IAASB), a technical committee of the 

    International Federation of Accountants (IFAC). 

    The IAASB is there to serve the public interest by setting high-quality 
    international standards for auditing, quality control, review, other assurance, 
    and related services, and by facilitating the convergence of international and 
    national standards. In doing so, the IAASB enhances the quality and uniformity 
    of practice throughout the world and strengthens public confidence in the global 

    auditing and assurance profession.

    Auditors are subject to ethical requirements imposed by their professional 
    bodies. One area where clients’ requirements may conflict with the requirements 
    for auditors to act ethically is whether the auditor should keep the affairs of 
    clients’ secret, or disclose them to others without obtaining the clients’consent. 
    The auditor should comply with the code of ethics for professional accountants 

    issued by the International Federation of Accountants. 

    6.1.2. International Standards on Auditing (ISA)

    International Standards on Auditing (ISAs) are set by the International Auditing 
    and Assurance Standards Board (IAASB), a technical committee of the 
    International Federation of Accountants (IFAC). ISAs are produced by IAASB, a 
    technical committee of IFAC. IAASB also produces other items of international 
    guidance, such as the International Standard on Quality Control (ISQC).

    The IAASB selects subjects for detailed study by way of a subcommittee 
    established for that purpose. As a result of that study, an exposure draft is 
    prepared for consideration by the IAASB. If approved, the exposure draft is widely 
    distributed for comment by auditor bodies of IFAC, and to such international 

    organisations that have an interest in auditing standards.

    The key standards issued by the IAASB include:

    Respective responsibilities, Audit planning, Internal control, Audit evidence, 

    Using work of other experts, Audit conclusions and audit report

    6.1.3. The regulation of auditors 

    The accounting and auditing profession varies in structure from country to 
    country. In some countries, accountants and auditors are subject to strict 

    legislative regulation, while in others the profession is allowed to regulate itself.

    Regulations governing auditors will, in most countries, be most important at the 
    national level. International regulation, however, can play a major part by: 
    • Setting minimum standards and requirements for auditors;
    • Providing guidance for those countries without a well-developed 
    national regulatory framework;
    • Aiding intra-country recognition of professional accountancy 

    qualifications.

    The audit regulations are: 
    • Statutory regulation 
    • Licensing of auditors 
    • Delegated regulation by professional bodies within a legal framework 

    (not self- regulation) 

    Regulatory mechanisms are: 
    • Statutory audit requirement 
    • Legal provisions on appointment and dismissal of auditors, 
    • Licensing of auditors 
    • Competence requirements 
    • Professional conduct rules 
    • Auditing standards 
    • Disciplinary procedures 

    • Governance rules for regulatory bodies 

    The regulation of audit is centrally concerned with the issue of ensuring that 
    auditors follow best practice standards in conducting the audit, and are 
    competent and independent; all of this being seen as essential in terms of 
    auditors’ capability to detect significant errors/omissions in financial statements 

    and to report faithfully on them.

    Application activity 6.1

    1. What is IFAC in full? 
    2. What are the key standards issued by the ISA?
    3. What are the purposes of International Standards on Auditing number 

    500 and 570

    6.2. The fundamental principles of auditing

    Learning activity 6.2

    Look at the picture above and answer the following questions: 
    1. What are the activities carried out by the above persons?

    2. Tell me about a time you faced an ethical dilemma.

    6.2.1. The fundamental principles of auditing as per IESBA

    The IESBA Code of Ethics provides ethical guidance. The five fundamental 
    principles of ethics are as follows: integrity, objectivity, professional 

    competence and due care, confidentiality and professional behaviour.



    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 a 
    conclusion 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 onus is always on the auditor not only to be independent but also 
    to be seen to be independent. You will see that some situations will constitute 
    such a significant threat to independence that an audit practice should not act 

    as auditors if they arise. 

    The following examples of specific threats to independence are given 

    in the code

    • Self-interest threats

    There are many examples of a self-interest threat arising in the Code. They fall 

    into two general areas: 

    – Relationships

    Close relationships between audit staff and employees of audit clients can lead 
    to a lack of independence if the interests of the audit firm and client become too 
    closely aligned and audit staff lose objectivity. Close relationships also cause 

    familiarity threats. 

    Examples of such self-interest threats are when: 
    • The audit firm has a financial interest in an audit client; 
    • Business relations between the firm and client are too close;
    • Audit staff move to work at the audit client;
    • The audit partner sits on the client board; 
    • There are family/personal relationships between audit staff/client; 
    • Audit staff are offered gifts/hospitality by client staff; 
    • Audit fees from a single client are a high percentage of the audit firm’s 
    total fees; 
    • The audit firm, or an individual on the audit engagement, enters a loan 
    or guarantee arrangement with a client (that is not a bank or similar 

    institution carrying out its normal commercial business).

    If an auditor inherits shares in a client company, he/she should try and sell them 

    as soon as possible, and keep the firm informed about what is going on. 

    Audit firms should not enter into close business relationships with clients other 
    than that of the audit itself. They should not have joint ventures or joint marketing 

    policies.

    – Fee-related issues 

    An audit is carried out for a fee. However, self-interest threats arise if the fees 
    are so significant, or potentially so, that the audit firm loses its objectivity in 
    relation to the audit client. A key area is the proportion of total audit firm income 
    derived from a client. If it is too high, it indicates that the audit firm relies on that 

    audit client too much to be independent. 

    Contingent fee arrangements are prohibited for audit or assurance 
    engagements. Contingent fees are payable on condition of a favourable outcome 
    being achieved. For example, a firm may charge a client seeking a listing on the 

    stock exchange a contingent fee which is payable if the listing is successful.

    • Self-review threats

    If an auditor audits work he/she has carried out for a client, he/she is unlikely to 

    be able to be objective about it. 

    There are two general circumstances in which this situation might arise: 

    If the audit staff member has recently worked for the audit client, or if the audit 

    firm carries out more than audit for the audit client.

    – Recent service at audit client

    Individuals who have been a director or officer of the client, or an employee 
    in a position to exert significant influence over the preparation of the client’s 
    accounting records or the financial statements on which the firm will express an 

    opinion should not be assigned to the assurance team.

    If an individual had been closely involved with the client before the period 
    covered by the auditor’s report, the audit firm should consider the threat to 

    independence arising and apply appropriate safeguards.

    – Other services

    Audit firms often offer a host of services other than audit. Examples include 
    preparing accounts and financial statements, valuation services, taxation services, 
    internal audit services, corporate finance services, IT services, temporary staff 
    cover, recruitment services, litigation support and legal services. Some of these, 
    for example, the routine preparation of tax returns, are not perceived to threaten 
    independence; others, particularly where it seems that audit firm staff are acting 

    on behalf of management, do affect independence.

    Audit firms are not permitted to assume a management responsibility for the 
    client. Activities which would be considered management responsibility include: 
    – Setting policies and strategic direction; 
    – Hiring or dismissing employees;
    – Directing and taking responsibility for the actions of the entity’s 
    employees 
    – Authorising transactions;
    – Controlling or managing of bank accounts or investments; 
    – Deciding which recommendations of the firm or other third parties to 

    implement; 

    – Reporting to those charged with governance on behalf of 

    management; 

    – Taking responsibility for the preparation and fair presentation of the 

    financial statements;

    – Taking responsibility for designing, implementing and maintaining 

    internal control.

    Activities that are routine and administrative, or involve matters that are 
    insignificant, generally are deemed not to be a management responsibility 
    and are permitted by the IESBA Code. Firms should not prepare accounts or 
    financial statements for listed or public interest clients. For any client, assurance 

    firms are also not allowed to: 

    – Determine or change journal entries without client approval; 
    – Authorise or approve transactions;

    – Prepare source documents.

    In addition, in relation to the other services listed above, auditors should not 
    provide a valuation of an item that is going to be material to financial statements, 
    they should not carry out transactions on the client’s behalf when doing corporate 

    finance work, and should not underwrite the client’s shares.

    Even if the services do not pose a threat to independence in themselves, 
    independence might be threatened if the auditor carried out a lot of other services 
    for a client, or if circumstances made the audit firm appear not independent. 

    This will often be a matter of judgement for audit firms.

    • Advocacy threat 

    If an audit firm is asked (or perceived) to promote their client or represent them, 
    for example in a legal claim, then the auditor would be biased in favour of their 

    client and would not be able to be objective. 

    This loss of objectivity gives rise to an advocacy threat. 

    Examples of circumstances that create advocacy threats include: 
    – The auditor provides legal support to an audit client in a legal dispute; 

    – The auditor acts as an advocate on behalf of an audit client in a 
    dispute with a third party such as a tax disputes;

    – The audit firm promotes shares in an audit client; 

    – The audit firm pitches a client reconstruction to a bank whilst 
    undertaking corporate finance services;

    – A partner or employee of the audit firm serves as a director or officer 

    of an audit client.

    The audit firm should ensure it does not accept work likely to cause an advocacy 
    threat, and it should withdraw from an engagement if the risk to independence 

    becomes too high.

    • Familiarity threat 

    We have already looked at the potential problems caused by relationships 
    between audit firm/staff and audit client/staff. These also cause a familiarity 
    threat, when audit staff become too familiar with a client, which causes them to 
    lose objectivity, and professional scepticism. Another familiarity threat is long 
    association, where an audit firm or its personnel have been involved in the audit 

    of a particular client over an extended period. This can also affect objectivity. 

    For the audit of private limited companies, this is an issue for audit firms to monitor 
    themselves and take steps to avoid. The IESBA rules are more prescriptive in 

    relation to public limited companies.

    • Intimidation threats 

    An intimidation threat arises when a member of the audit team is deterred from 
    acting objectively by threats (whether actual or perceived) from the directors, 
    officers or employees of an audit client. Such a threat may arise where the total 
    fees from an audit client represent a large proportion of the audit firm’s total 
    fees. Here the audit firm may be deemed to be dependent on the audit client 
    and this dependence may mean that they are more likely to give in to any threats 

    for fear of losing the audit client. 

    Similarly, an intimidation threat is created when an audit client threatens the firm 
    with litigation or takes legal action against them. In this situation the relationship 
    between client management and members of the audit team can no longer be 
    characterised by complete candour and full disclosure and therefore the audit 
    firm should stand down as auditors as the threat would be too significant to 

    avoid by other means.

    6.2.2. The professional duty of confidentiality

    “Auditors have a professional duty of confidentiality. However, they may be 
    compelled by law, or consider it desirable in the public interest, to disclose 

    details of clients’ affairs to third parties.”

    Confidentiality requires auditors to refrain from disclosing information acquired 

    in the course of professional work except where: 

    – Consent has been obtained from the client, employer or other 

    proper source or;

    – There is a public duty to disclose, or;

    – There is a legal or professional right or duty to disclose.

    The auditor agrees to serve a client in a professional capacity both the auditor 
    and the client should be aware that it is an implied term of that agreement that 
    the auditor will not disclose the client’s affairs to any other person with the 
    client’s consent or within the terms of certain recognised exceptions, which fall 

    under obligatory and voluntary disclosures.

    The auditors must first obtain an understanding of the non-compliance and 
    disclose it to management. The client should be advised to report the non-compliance. 
    If they do not do so then the auditors may report the matters 
    themselves, but they are not obliged to do so. The recognised exceptions to the 

    duty of confidentiality are as follows:

    Application activity 6.2

    1. Why an auditor should observe the professional ethics of integrity? 
    2. What will happen if an auditor knows or suspects his/her client to 

    have committed money-laundering or terrorist offences?

    Skills lab activity 6

    By carrying out research,students in their learning teams, identify the area 

    (audit process) where each of the standard would be applied and why

    End unit 6 assessment

    1. Explain the concept of objectivity with reference to external auditors, 

    and outline five general threats to objectivity.

    2. What is the principle of objectivity?

    3. Describe the review process that firms should adopt to ensure that 

    they have maintained independence.

    4. When is an auditor: 
    a) Obliged 
    b) Allowed

    c) To make disclosure of clients’ affairs to third parties?

    5. In which of the following situations is it not appropriate to disclose 
    confidential information? 
    a) Client has granted permission 
    b) To obtain evidence about an item in financial statements 
    c) To fulfil a public duty 

    d) To fulfil a legal duty to disclose

    6. Which of the following is not a fundamental principle of professional 
    ethics? 
    a) Independence 
    b) Integrity 
    c) Objectivity 

    d) Confidentiality

    7. It is important that an auditor’s independence is not questionable, 
    and that he/she should behave with integrity and objectivity in all 
    professional and business relationships. The following are a series 
    of questions, which were asked by auditors at a recent update 
    seminar on professional ethics. 

    a) A B & Co, the previous auditors, will not give my firm professional 
    clearance or the usual handover information because it is still 
    owed fees. Should I accept the client’s offer of appointment? 

    b) Can I prepare the financial statements of a company and remain 

    as auditor?

    Required: 

    Discuss the answers you would give to the above questions posed by the 

    auditors based on IESBA Code of Ethics.

    ◄UNIT 5: AUDITOR’S RESPONSIBILITYUNIT 7: AUDIT PLANNING►