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Auditors are required to monitor their procedure to comply with regulations and to achieve the accounting standard base on integrity, objectivity and independence. The auditors' duty is to analyze the financial statements of the company and working toward safeguarding financial stability and the interest of investor interests such as shareholders. It is important to have a financial audit showing the state of a company's finances to shareholders for its stewardship. The case of Enron in the United States showed that auditors received their fee from non audit services more than audit work. Therefore rules were imposed by the professional bodies, such as the Code of Ethics which states the fundamental principles for auditors to follow and safeguard them from threats to their independence. The interests of shareholders need to be protected by auditors to ensure that the auditor's interest and shareholders' interests do not conflict with each other so the measure is in place to ensure that conflict of interest do not affect auditor independence.
Moreover, IFAC state that auditors or audit partners should be rotated every 7-10 years as a precaution and a firm listed on the stock market requires the independence audit committee to appoint an auditor with shareholders approval. These rules were created by considering the previous risks and audit failures, therefore the safeguard is in place.
Definition of Independence
Independence of Mind
The professional judgment on the state of mind that allow auditor to express their opinion and conclusion without affected by any influences, therefore the involvement of exercise objectivity, professional care and act with integrity are necessary.(IFAC)
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, of a member of the audit team's, integrity, objectivity or professional skepticism has been compromised.(IFAC)
The professional account's is not necessary to provide service in particular needs of the employer or individual client. The affect from collapse of Enron have imposed a new roles to prevent future scandal. Therefore, the purpose of these codes of ethics is for professional accountant to follow while they are acting for the public interest. The professional bodies have set up the standard and fundamental principles outlining the guide of conduct for auditors to follow.
This required professional account to be honest and faithful to the business relationship.
The professional account should not have any conflict with the interest and must not bias with the judgments of the business.
Professional competent and due care
The professional accountant if required to maintain their knowledge and skills at the level required base on legislation, technique and current practice. This to ensure that the client will receive the professional service thus to provide the professional service the account should be accordance with professional standard.
The professional accountant should not disclose any information to the third party unless there are authorise by the client or they have the right by legal.
The professional accountant should comply with Company Act 2006 and regulation and should prevent the action that could cause discredit the profession.
Ethical standard 1
The ethical standard 1 is concerning about integrity, objectivity and Independent of audit, including the statement of fundamental principles which influencing work of professional accountants. Therefore, integrity, objectivity and independence are the conduct for auditors to comply with when they audit the financial statement. (IFAC)
It is important for auditors to act or to be seen with integrity, Integrity is essential for anyone that act for the public interest. The integrity is range of intellectual honesty and confidentiality this would include fairness, candor and courage.
The clients expect to rely on the auditors in order to treat their financial information during an audit confidentially. Except the authorized is disclose or already known by the third parties or auditor have right to disclose. However if auditor fail to disclose their financial information this mean auditor self regulation is weaken. (IFAC)
This is a state of mind where an auditor gives fair judgment to all matters and not bias by the conflict of interest. The auditors are required to give their opinion base on the situation of financial statements and audit evidence whether it give true and fair view regardless directors' judgments, auditor can disagree if it necessary. For example, there are choices to be made by the board of directors in deciding on the accounting policies to be adopted by the entity: the directors have to select the ones that they consider most appropriate and this decision can have a material impact on the financial statements. Many items in the financial statement cannot be measure with absolute precision, if the directors whether deliberately or inadvertently, make a biased judgment or an otherwise inappropriate decision, the financial statements may be misstated or misleading.
The independence is related to involvement of personal relationships between client and auditors. The need for independence is increase because sometime the third parties and financial statement user do not receive all information to identify whether the auditor is objective. In this situation auditors themselves could assure that their work in not impaired but on the other hand the third parties may have a different point of view. For example if auditors have a relationship to the business or personal relationship with the client, the third parties are aware of this situation and they may think that auditors' judgment would be unbiased. The result this auditors could suffer from disbelief of their information that provide to third parties is unimpaired. (the auditing practice board) However The audit firm is required to take responsibility to comply with integrity; objectivity and independence to control in self regulation where the weaknesses are appear. The audit firm start their procedures and policies to encourage and supervise these requirements from the person that have authority over the outcome of the audit and the conduct.
Threats to objectivity and independence
The self-interest occur when the auditor agreed to take action that interest leading to contrary for example, when they have a investment in the client, are seeking to provide additional services to the client or need to recover long outstanding fees from the client.
This self-review occur when the auditors provide non-audit service that mirror to the amount disclose in the financial statements. For example, where the audit firm has been involved in the maintaining the accounting records, or undertaking valuations that are incorporated in the financial statements.
The management threat occur when audit firm are involve with making decision and making judgment which are not relevant to their work, in fact that is a responsibility of management. For example. where it has been involved in the design, selection and implementation of financial information technology system. The affect of the may cause auditors' objectivity and independence to be impaired or likely to be impaired.
The advocacy threat occur when auditors act for company. For example by acting as a legal advocate for the client in litigation. it may show the auditors is bias to the company and this will create threats to auditors' objectivity and independence.
The familiarity threats occur when the auditors trusted the client and not aware of any..........For example, where they develop close personal relationship with client personal thought long association with the client.
The intimidation threats occur when threats in fear are influence with the auditors' work. For example, where they encounter an aggressive and dominating individual.
If the audit engagement partner identifies threats to the auditors' objectivity, including any perceived loss of independence, he or she should identify and assess the effectiveness of the available safeguards and apply such safeguards as are sufficient to eliminate the threats or reduce them to an acceptable level.
The engagement partner should not accept or should not continue an audit engagement if he or she concludes that any threats to the auditor's objectivity and independence cannot be reduce to an acceptable level.
Ethical Statement 2
This standard is the guidance on financial relationship, business relationship to the audit client that may create threats to auditors' objectivity and independence.
It gives examples of safeguards that can, in some circumstances where this is not possible, either do not accept or withdraw from the audit engagement, as appropriate.
This is the financial interests that involve share or loan with the client company. The audit firm that influence or person that has interest on the conduct of outcome of the audit would not hold direct or indirect on financial interest of the client company.
This will affect the auditors' objectivity and independence where the financial interest is held by audit firm or person specific in above paragraph may have no safeguard to reduce them to an acceptable level.
A business relationship between the audit firm and close family involve in the sililar interest from the conduct and outcome of the audit. For example, renting the office from client company and include product or services of the client company with the audit firm to market with reference to both parties. The business relationship may create self-interest, advocacy and intimidation threats to the auditors' objectivity and independence.
If the person was employed by the client company the audit firm should not accept the partnership of that person to take audit work.
If the audit firm decides to provide loan staff to client company, threats of objectivity and independence will apply. A management threat will occur when making judgment and taking decision which should be responsibility of management.
Engagement members joining an client company
The financial statement should not influence by previous member of the audit firm that were client recently and still have the connection with the audit firm. The threats to this are self-interest, familiarity and intimidation threats.
Family members employed by client company
In the case of close family of audit firm were employed by client company, the audit firm should aware if their position is influence with the accounting record or financial statement. However if they are their position should be terminate in that area or report the matters to engagement partner.
Employment with audit firm
If former employee of client company is employed ny the audit firm and become the engagement team this will create self-interest, familarlity and self-review. For example financial statements which they prepare or element of the financial statement which they prepare or element of the financial statement for which they responsibility while the audit client.
Family and other personal relationship
The general relationship will not have impact on the auditors' judgment but if their family and close relationship in involve with the business' financial this may create self-interest, familiarity or intimidation threats to auditors' objectivity and independence.
Ethical Statement 3
This is where the audit engagement partner, key partner and senior staff are with the client company too long, it result of objectivity and independence compromise. The threats to this would be self-interest and familiarity threats. The safeguard is to rotating the audit partner in number of year and reappointment new audit partner which not recently involve with the engagement team.
Rotation required for private company;
5 years for engagement partner
7 years for key partner
7 years for senior staff but his must have the good reason
Ethical Statement 4
This standard is to prevent threats from audit fees such as gift or hospitality that would affect auditors' objectivity and independence.
This give sample of safeguard to avoid or reduce the threats in acceptable level, some circumstances this is impossible to avoid thus auditor need to make the decision either not accept or resign from audit engagement.
The audit fees should not be charge on contingent fee basis, this fee arrangements create self-interest threat to auditors objectivity and independence.
The total fee from audit and non-audit services should not exceed 10% in the case of companies lised and 15% for private company for small businesses. The auditors' income is annual fee basis calculate from the profit share.
The selling a non-audit services to client is not the objective for audit team, there are no remuneration concerning base on the success of selling non-audit services.
Gift and hospitality
The audit firm or auditor themselves should not accept gift from the client company as it will have impact on the conduct and outcome of the audit.
In the case of fees is unpaid for a long period because of the the issue unqualified audit report or outstanding fees unpaid of finance difficulties. There may be no safeguard to reduce them to an acceptable level, auditors should considering whether they should continue or resign.
Ethical Standard 5
This standard is providing alert for the threats that me occur with non-audit services, the threats that may occur are self-interest, self-review, management and advocacy threat. For example the self-interest appear auditors' action is adverse the interest of audit firm. However, no such safeguards are applied, the audit either not to undertake the engagement to provide the non-service in question or not to accept the audit engagement.
The audit firm not allow to provide Information technology service to design system as this may create self-review threat and management threat. For example, management threat that involves with making judgment that responsibility of management.
The audit not allow to provide some Tax service as a self-review threat may occur where the audit firm do the tax planning for client company this have no safeguard to reduce it to acceptable level so the audit firm should consider whether to not take engagement work or resign from the client company.
However, the auditors may be able to adopt appropriate safeguard if Tax service provide to an client include ensuring that the tax service provide to partner and staff who have no involvement in the audit of financial statement.
Evaluation of non-audit services
The agreement for non-audit services
The audit firm may have fails to control the audit quality, the auditor have allowed the accounting treatment because their independence has been compromised. Therefore they maybe become to familiar with the client company or maybe because their income is rely on the one client. It believe that this is the only solution to prevent auditors provide any other services rather than audit to client company. (ICAEW)
The disagreement for non-audit services
Separations of non-audit services seem to increase the cost and reduce the quality of service. If the economic dependence that cause by auditor and client relationship could implement the safeguard and profession's guidelines to follow than the companies will decide whether they would use service from auditors for non-audit service. (ICAEW)
Evaluation on rotation of auditors
The agreement on rotation
Having the auditors for a long period make them acting more freely and may oversee their mistake. By rotating audit firm will increase the concern that new auditor might detect the oversight. (The CPA Journal)
Disagreement on rotation
The auditor might not solve the problem, regardless distance it will not keep them apart in such relationship. In addition, the client may feel more comfortable with auditors sharing the information and discuss the problem rather than auditors acting too independence. The communication between client and auditors is important as getting to know the client and their characterize it give feeling that when client is not revealing all information, this come from knowing the client and management. The new auditors may have difficulties to get to know each other or not have respect from the client. This relationship will take time to build whereas the close relationship is critical to the audit process. ( The CPA Journal)
The independence still arises since the roles where introduce to performing non-audit service, more safeguard should be in place. The restriction should be place on circumstances which required skilled person. The authority issues rules dealing with the appointment of auditors and skilled persons these will help to reduce conflict of interest when the skilled persons are in position to act objectively when facing the problems.