Audit Principles and Practices – DFA 3103

UNIT 3 PROFESSIONAL CODES OF ETHICS

Unit Structure

3.0 Overview
3.1 Learning Outcomes
3.2 Codes of Ethics in Auditing
3.3 The Fundamental Principles
3.4 Integrity, Objectivity and Independence
3.5 Confidentiality
3.6 Conflict of Interest
3.7 Changes in Professional Appointment
3.8 Fees
3.9 Letter of Engagement
3.10 Summary
3.11 Activity

3.0 OVERVIEW

Auditing is normally carried out by professional accountants. As any profession, auditors

have a duty to provide services of appropriate quality to clients. To do so, the auditors
should work within a professional framework including an ethical code and rules of
conduct. This unit is concerned with the fundamental ethical principles and concepts that
affect auditing.

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3.1 LEARNING OUTCOMES

By the end of this Unit, you should be able to do the following:

1. Describe the framework for professional ethics and codes of conduct applicable to
auditors.
2. Define the fundamental principles and concepts affecting auditing.
3. Discuss the requirements for professional ethics in relation to integrity, objectivity
and independence.
4. Analyse the requirements for professional ethics in relation to confidentiality and
conflict of interest.
5. Describe the requirements for professional ethics in relation to changes in auditors
appointment.
6. Examine the requirements for professional ethics in relation to audit fees.
7. Explain what a letter of engagement is and what are its main purposes.

3.2 CODES OF ETHICS IN AUDITING

Auditors are required to observe proper standards of professional conduct. Any

misconduct by the auditor is likely to bring discredit on himself, his professional body or
the profession in general. In this respect, the Association of Chartered Certified
Accountants (ACCA) has published an ethical guide for members known as the ‘Rules of
Professional Conduct’ or ‘The Rules’. IFAC also has its own ethical guide, that is, the
IFAC Code of Ethics for Professional Accountants. Both codes of ethics are quite similar
but the ACCA guidance is more strict than the IFAC guidance.

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‘The Rules’ deals with many areas of concern for professionals either in the public
practice or in business. The main areas covered are as follows:

 The fundamental principles

 Integrity, objectivity and independence
 Confidentiality and conflict of interest
 Changes in professional appointments
 Fees

3.3 THE FUNDAMENTAL PRINCIPLES

‘The Rules’ stipulate that:

 Integrity
Members should behave with integrity in all professional, business and personal
financial relationships. Integrity implies not merely honesty but fair dealing and
truthfulness.

 Objectivity
Members should strive for objectivity in all professional and business
judgements. Objectivity is the state of mind which has regards to all
considerations relevant to the task in hand but no other. It presupposes
intellectual honesty.

 Competence
Members should not accept or perform work which they are not competent to
undertake, unless they obtain such advice and assistance as will enable them
competently to carry out the work.

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 Due Skill and Care

Members should carry out their professional work with due skill, care,
diligence and expedition, and with proper regard to the technical and
professional standards expected of them as members.

 Courtesy
Members should conduct themselves with courtesy and consideration
towards all with whom they come into contact during the course of
performing their work.

3.4 INTEGRITY, OBJECTIVITY AND INDEPENDENCE

The auditor is responsible for the production of an audit opinion regarding the financial
statements. If this opinion is to be credible then it is essential that the auditor is, and is
seen to be, independent from the audit client. Independence is a characteristic of the
relationship between two parties, that is, where neither has any obligation to the other.
‘The Rules’ aims at ensuring that professional accountants (and auditors) are independent
and operate with a degree of integrity and objectivity. Objectivity is a state of mind,
characterised by giving a fair judgement on the matter under consideration.

Independence can be threatened in a number of ways:

 Excessive dependence on an audit client

A firm which derives most of its income from one client may find it difficult to
speak out on a specific issue as the loss of that client could lead to an adverse
impact on the firm’s financial position.

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 Holding shares in an audit client

The reporting partner or any staff should not hold shares in the client company. If
shares are held, the staff involved should dispose of them before starting the audit
or the staff should not work on a particular assignment.

 Business relationships or friendships with the client

Problems may emerge where the auditor has an involvement with a particular
client and is looked upon as a professional adviser rather than an independent
auditor.

 Making loan to, or receiving loans from the audit client

Loan transactions between the practice and the client would constitute a direct
financial link with the client. These transactions are specifically banned by ‘The
Rules’.

 Hospitality
Excessive hospitality or gifts received from the client would constitute a direct
financial interest with the client. Here it is important to determine what is
‘excessive’. For instance, a pen bearing the client’s name would be acceptable
whereas an all expenses paid weekend trip provided by the client for the auditor
and family would be unacceptable.

 Provision of other services to client

Where other services are provided by the auditor’s firm to the client in addition to
the statutory audit, like accounting and taxation services, these should ideally be
provided by staff not employed on the audit assignment. Where staff resources do
not permit this, adequate quality control reviews must be in place to ensure that
independence is maintained.

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3.5 CONFIDENTIALITY

The auditor has a statutory right to receive information and explanations from the client
in relation to any matter connected to the audit. These rights of access give the auditor a
position of considerable power and privilege, which must not be abused. In this context,
‘The Rules’ require the auditor not to disclose confidential data regarding the client to a
third party without the consent of the client. However, the auditor could reveal
confidential information without the client’s wishes if there is a public interest duty to do
so.

Members have an obligation to disclose confidential information:

 Where the courts order to do so.

 Where they suspect their client of any act of terrorism.
 Where they suspect their client of any illicit dealing, for example, drug traffic or
money laundering.
 Under specific legislations, they may report to appropriate regulators if they
consider their client is either acting recklessly or is not a fit and proper person to
manage such a business.

3.6 CONFLICT OF INTEREST

A conflict of interest could arise where an auditor or accountant accepts commission

payments from a third party as a result of providing advice to a client. The receipt of such
commissions should always be disclosed to the client and the auditor must ensure that the
advice given is in the client’s best interest.

A conflict of interest could also arise when an auditor acts for two clients who are in
competition. The auditor must be careful to ensure that neither client is disadvantaged as

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a result of acting for both. Obviously, different staff should be employed on the two
assignments with strict instructions not to discuss either client’s affairs.

3.7 CHANGES IN PROFESSIONAL APPOINTMENT

The Rules of Professional Conduct deal with the behaviour expected when a change of
auditor is to occur. These rules are known as the professional clearance procedures. The
new auditor is expected to find out from existing auditor whether there are any
professional reasons which would dictate that the audit should not be accepted.

The new and existing auditors must obtain the client’s permission before they are allowed
to communicate with each other. If the permission is not granted, then the new auditor
should turn down the appointment. Where an existing auditor receives a request for
information regarding the client, then permission to speak to the new auditor should be
sought from the client. If this permission is not given, the new auditor should be informed
and the audit should be declined. It is important to mention that ‘The Rules’ do not
preclude taking on problematical clients, but aim to ensure that a new audit client is not
taken on without adequate warning of any problems concerning the audit.

3.8 FEES

Appropriate fees for audit work may be charged, subject to the terms agreed with the
client and set out in the engagement letter. The normal basis for the computation of fees
is time spent. Where the fee is not agreed with the client beforehand, the auditors should
charge a fee based on the amount of time worked, seniority of staff involved and so on.
However, a flat fee is sometimes charged. It is clearly unacceptable to charge audit fees
on the basis of a percentage of profits or on a contingency basis such as an agreed fee
payable if profits exceed a certain level. Such arrangements would compromise the

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auditor’s independence as the auditor will have a direct financial link to the audit
assignment.

3.9 LETTER OF ENGAGEMENT

Before starting an audit assignment, the auditor should agree, in writing, the precise
scope and nature of the work to be undertaken. ISA 210 Terms of Audit Engagements
states that the auditor and client should agree on the terms of the engagement. In practice,
the terms of the engagement are formalised by a letter of engagement.

A letter of engagement is a letter prepared and sent by the auditors to the client at the
beginning of any new audit. It sets out the basis of the contract between the auditors and
the client to avoid any misunderstanding.

Purposes of a Letter of Engagement

The main purposes of a letter of engagement are:

 To set out the objective of the audit.

 To define clearly the extent of the auditor’s responsibilities.
 To define the scope of the audit including reference to legislation and standards.
 To describe the audit procedures including their inherent limitations.
 To confirm in writing verbal arrangements.
 To confirm acceptance by the auditor of his/her engagement.
 To describe the form of reports to be issued.

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Procedures for New Audit Engagement

The steps are as follows:

 Request client’s permission to speak to the existing auditor to know if there is

any professional reason why the appointment should not be accepted.
 Perform client screening to identify problematic areas.
 Discuss the precise terms with management or directors.
 Accept nomination and appointment by resolution of shareholders or directors.
 Send a letter of engagement to the client setting out the scope of the audit.
 Receive the client’s written acceptance of the terms of the engagement.
 Review the engagement letter every year and amend as appropriate.

3.10 SUMMARY

It is important to remember the following:

1. Auditors are required to observe proper standards of professional conduct.

2. Association of Chartered Certified Accountants (ACCA) has published an ethical
guide for members known as the ‘Rules of Professional Conduct’ or ‘The Rules’.
3. The Rules deals with many areas of concern for professionals either in the public
practice or in business.
4. Members should behave with integrity in all professional, business and personal
financial relationships.
5. Members should strive for objectivity in all professional and business judgements.
6. Members should not accept or perform work which they are not competent to
undertake, unless they obtain such advice and assistance that will enable them to
competently carry out the work.

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7. Members should carry out their professional work with due skill, care, diligence
and expedition, and with proper regard to the technical and professional standards
expected of them as members.
8. Members should conduct themselves with courtesy and consideration towards all
with whom they come into contact during the course of performing their work.
9. The auditor is responsible for the production of an audit opinion regarding the
financial statements. If this opinion is to be credible then it is essential that the
auditor is, and is seen to be, independent from the audit client
10. The Rules require the auditor not to disclose confidential data regarding the client
to a third party without the consent of the client. However, the auditor could
reveal confidential information without the client’s wishes if there a public
interest duty to do so.
11. A conflict of interest could arise where an auditor or accountant accepts
commission payments from a third party as a result of providing advice to a
client. The receipt of such commissions should always be disclosed to the client
and the auditor must ensure that the advice given is in the client’s best interests.
12. The new auditor is expected to find out from existing auditor whether there are
any professional reasons which would dictate that the audit should not be
accepted.
13. Appropriate fees for audit work may be charged, subject to the terms agreed with
the client and set out in the engagement letter. The normal basis for the
computation of fees is time spent.
14. A letter of engagement is a letter prepared and sent by the auditors to the client at
the beginning of any new audit. It sets out the basis of the contract between the
auditors and the client to avoid any misunderstanding.

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3.11 ACTIVITY

Question 1

Explain why it is necessary for external auditors to be and be seen to be independent of

their audit clients.

Question 2

‘The auditor is a watchdog not a bloodhound’. Explain this statement in the context of the
external auditor’s responsibility for the detection of fraud.

Question 3

Before acceptance of any new audit assignment, there are a number of reasons for non-
acceptance that have to be considered. List the circumstances in which acceptance of the
nomination would be inappropriate under the following headings:

(a) Legal
(b) Ethical
(c) Practical

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