20100115171401_02 as aa workbook chapter 1

7/31/2019 20100115171401_02 as AA Workbook Chapter 1

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Professional practice and ethics

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Introduction

This section of the A&A syllabus reintroduces the concepts of audit and

assurance, then considers the legal and ethical framework for theprofession. Although many of the topics covered here have beencovered in your earlier studies, the questions at Advanced Stage areless likely to be clear cut, so you will need to exercise more judgement.

ICAEW Chapter 1 Role and context of modern auditing

Much of the background knowledge here is revision from ProfessionalStage.

ICAEW Chapter 2 Ethics

Ethical issues are likely to be embedded in questions throughout the Advanced Stage papers, and the problems and solutions may be lessobvious than in your previous studies.

ICAEW Chapter 3 Governance

Corporate Governance is a topical issue, and has a real impact on theway businesses are run. It is therefore of significance to the auditor when they assess the control environment, and if you are faced with aquestion dealing with a listed company you should always consider theimpact of Governance.

This section also revises Sarbanes Oxley.


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1 Role and context of modern auditing

Overview of the audit process

Client acceptance / continuance

Establish engagement terms

Plan the audit

Develop the audit approach

Obtain audit evidence

Evaluate results

Issue audit report

Auditors responsibilities (CA 2006)

Form opinion on truth and fairness of the financial statements

Confirm financial statements adequately prepared in accordancewith Companies Act

Confirm that directors report is consistent with the financialstatements

Report by exception on

Returns from branches not visited received

Accounts agree with the underlying records

Proper accounting records kept

Information and explanations received

Directors transactions properly disclosed


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Directors responsibilities (CA 2006)

Responsibility Comments

Enlightened shareholder value Promote the success of the company

for the benefits of the members as awhole

Duty of skill and care

Conflicts of interest To be avoided. If the company suffersloss as result of a directors conflict of interest the director is personally liableto the company.

Fraudulent and wrongfultrading

See Insolvency section.

Theft If company deceives with consent of directors then both company anddirectors will be liable.

Keep adequate accountingrecords

Prepare and file annualaccounts

Safeguard assets Implement system of internal controls.

Directors loans and other transactions (CA 2006)

The aim of CA 2006 is to prevent directors abusing their position, byrequiring disclosure to, and approval by, the members of the companywhen significant loans or other transactions between the company andits directors take place (otherwise transactions voidable by company).

Audit risk high due to:

Materiality

Complexity of rules

Potential lack of formal documents


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All companies Relevant companies (plc or member of plc group)

Loans >10,000 todirectors must be

approved by membersof company (need to begiven details of loan andpurpose)

Advances for legitimatebusiness expensesallowed but must notexceed 50,000(approval of membersnot required)

Rules extended to connected persons(spouse, minor children, business

partner, company of which director owns >20% voting power)

The following transactions with adirector or connected person requiremember approval:

Loans >10,000

Credit transactions >15,000

Quasi-loans >10,000

Disclosure of directors transactions

For all transactions:

Statement that loan etc. made / existed in year

Name of director / connected person

Principal terms

Amount of loan and any amount repaid

Other transactions and contracts

Directors interests in contracts

Declare interests to board

Substantial property transactions between company anddirectors require approval by members

o Value at least 100,000 or

o Value at least 10% of companys net assets (de minimis5,000)

Directors interests must be disclosed in the financialstatements if material

Long service contracts must be approved by members (>2 years)


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2 Ethics

Sources of ethical guidance

IFAC Code of Ethics governs audits carried out under ISAs

ICAEW Code of Ethics to be followed by ACAs, but ispractically identical to the IFAC code

APB Ethical Standards

Fundamental principles

IFAC Code of Ethics (in ISA 200)

Integrity

Objectivity

Professional competence and due care

Confidentiality

Professional behaviour

General threats to objectivity

Self-interest

Self-review

Management

Advocacy

Familiarity or trust

Intimidation

Detailed guidance

APB Ethical Standards

ES1 Integrity, Objectivity and Independence

ES2 Financial, Business, Employment and PersonalRelationships

ES3 Long Association with the Audit Engagement

ES4 Fees, Remuneration and Evaluation Policies, Litigation,Gifts and Hospitality

ES5 Non-Audit Services Provided to Audit Clients

ES Provisions Available for Small Entities (ESPASE)


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ICAEW Code of Ethics

Confidentiality

Conflicts of interest

Changes in professional appointment

ES1 Integrity, Objectivity and Independence

Sets out requirement for firms to have policies and proceduresrelating to ethics.

The firm should appoint an ethics partner.

For listed clients, compliance with ethical standards should bereviewed by an independent partner.

Matters that bear on the auditors objectivity and independenceshould be communicated to client management.

Detailed guidance in ES 2-5

Ethicalstandard

Specificthreats

Safeguards

2 Beneficialinterest inshares

Audit partner and staff cannot hold sharesin audit client.

2 Mutualbusinessinterest

Should not go into business with auditclient.

2 Staff movingfrom auditfirm to client

Partner becomes client management within2 years of being involved in the audit firmshould resign as auditors.

Other staff firm must consider implicationsfor independence.

All partners and staff should discloseintention to move to client and be removedfrom the audit team.

2 Client staff joining auditfirm

Should not be allowed to work on the auditfor 2 years.

3 Acting for aprolongedperiod for

Rotate staff as follows:


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Ethicalstandard

Specificthreats

Safeguards

listed clients Engagement partner 5 years

Key audit partners and senior staff 7 years

3 Acting for aprolongedperiod for non-listedclients

Rotate staff as follows:

Engagement partner 10 years

Rules more relaxed might be ableto make a case that partner shouldremain for longer

4 Dependence

on client

Fees for services to clients should not

exceed following % of firms fee income: Listed: 10% (review at 5%)

Non-listed: 15% (review at 10%)

4 Loans, etc. Not allowed loans or guarantees.

Overdue fees akin to a loan.

4 Hospitality or other benefits

Firm should have a policy.

Basic idea is that they should be modest.4 Litigation Firm should resign as auditor if there is

actual or potential litigation between auditfirm and client.

5 Other services

Consider the impact of non-audit services.

Establish safeguards to counter anythreats.

Communicate with those charged with

governance.Document rationale for decisions taken.

Do not help PLCs prepare accounts exceptin an emergency.

Do not carry out IA / IT / Valuation workwhere the external audit opinion will placeheavy reliance upon this other work.


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ICAEW Guidance Confidentiality

Auditors should keep client information confidential unless there is aright or duty to disclose.

Right to disclose Duty to discloseClient permission obtained Money laundering

Public interest Ordered to by a court

To defend the audit firm Required by a regulator

ICAEW Guidance Conflicts of interest

Firm vs client E.g. where the auditor recommends another service to a client

and receives a commission for doing so

Disclose to client

Obtain client consent

Client vs client

E.g. the firm audits clients who are competitors

Main issue is confidentiality

Separate teams with separate reporting lines

Maintain confidentiality (Chinese walls)

Independent partner review

If sufficient safeguards cannot be implemented, consider resigning / refusing to act

ICAEW Guidance Changes in Professional Appointment

Outgoing auditor

Reply to requests for information from incoming auditor assuming client gives permission

Incoming auditor

Write to client asking for permission to contact the previousauditors

If client declines, do not accept engagement

If client allows, write to previous auditor asking them aboutmatters that may be relevant to acceptance


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Follow up if no reply

Consider reply e.g. unpaid fees, disagreements about accountingtreatment

If no reply, can accept the engagement but be scepticalDuty to report misconduct

ICAEW members have duty to report possible misconduct of other members:

To ICAEW Professional Conduct Directorate

In writing

May wish to seek legal advice first

No need to investigate before reporting, but need facts rather than just suspicion

Examples of when to report

Committed offence involving dishonesty, fraud, or cheating

Breach of regulations e.g. IA86, Money laundering

Gross incompetence

Failure to report is grounds for disciplinary action

Current issues in ethics

The following issues are being considered as part of a consultationpaper on revisions to the Ethical Standards:-

Rotation period for the audit engagement partner should it be 5or 7 years?

Potential conflict of interest when auditor also providesrestructuring advice

Existing financial interests of potential new partners which aredifficult to dispose of, that may currently restrict the ability of firms to appoint new partners externally

Clarification of the definition in ES4 of the 'audit team' whenconsidering remuneration and evaluation policies


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3 Governance

Underlying concepts of Corporate Governance

Concept Explanation

Fairness Decisions / systems of co should be fair to allstakeholders.

Transparency Financial statement and other, voluntary, disclosurehelps shareholders understand the company.

Independence Independent non-execs promote the interests of shareholders and other stakeholders bychallenging the executive.

Honesty Dont mislead stakeholders.

Responsibility System in place that penalises mismanagementand takes corrective action.

Accountability Board accountable to shareholders who shouldalso exercise their voting rights and take someresponsibility.

Reputation Co reputation is often very valuable so should bepromoted.

Judgement Board should make decisions that enhance thecompanys prosperity.

Integrity Straightforward dealing, which requires personalhonesty and professionalism.

The Combined Code

UK incorporated companies listed on the main LSE mustdisclose in their annual reports how they have complied with theCode

Overseas companies listed on the main LSE must disclose anysignificant differences between their corporate governancepractice and those of the Code

Reduced compliance allowed for companies below the FTSE350

Does not apply to non-listed companies (including AIM) althoughprovides measure of best practice for all companies


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The main provisions of the Combined Code

Directors Effective Board should lead and control thecompany

Chair and CEO roles should be separate public justification required for combiningroles

Balance of executive and non-executive

Majority of non-executives independent

Formal and transparent procedure for Board appointment

Regular re-election

Directorsremuneration

Enough to attract high calibre candidates

Not excessive

Proportion linked to performance

Formal and transparent procedure for fixingremuneration

Annual report states remuneration policyand details of remuneration of eachdirector

Service contracts of more than 12 monthsrequire careful consideration

Relations withshareholders

Companies should be prepared to enter into a dialogue with institutional investors

Board should use the AGM tocommunicate with private investors

Accountability andaudit Annual report should show a balanced andunderstandable assessment of the

companys position and prospects

Maintain a good system of controls tosafeguard shareholders investments

Establish an Audit Committee

Institutionalshareholders

Have a responsibility to use their votes

Should be prepared to enter into a dialoguewith companies


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Combined Code Disclosure Requirements

Requirement Location in annual report

Statement of compliance with CC CG statement or directors report

Assessment of position / prospects Chairmans statement, OFR, or directors report

Combining Chairman / CEO CG statement or directors report

Identify Chairman, CEO, other directors and committee members

CG statement or directors report

Directors responsibilities Immediately before the auditreport

Auditors responsibilities Audit reportDirectors statement on goingconcern

OFR

Auditors review of statement oncompliance with CC

Audit report

Turnbull report

Key points Disclosures

Guidance on how to applyCC with regards to internalcontrols

Encourages a risk basedapproach

Directors should consider

Control environment Risk assessment

Information systems

Control procedures

Monitoring

Statement in annual reportdisclosing that there is aprocess for identifying,evaluating and managingrisks

Additional information onthe ICS may be given


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Audit Committees

Smith Report Guidance as follows:

At least 3 members all independent non-executive directors

At least 1 member with relevant financial experience

All to be trained

Review ICS

Monitor and review IA effectiveness

Monitor and review EA independence, objectivity andeffectiveness

Report in the directors report APB advice on the relationship between auditors and the auditcommittee:

Should be open communication

Should be discussion at the end of the audit about

Non-compliance with laws and regulations

Control environment

Significant adjustments to the financial statements

How differences between management and EA wereresolved


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Sarbanes-Oxley Act 2002

Principles Key provisions from audit pointof view

Audit committeeresponsible for FR andaccuracy

Increases FS disclosures

Required companies tohave internal code of ethics

Imposes restrictions onshare trading by companyofficers

New regulator to setstandards, with disciplinarypower (Public Company

Accounting OversightBoard)

Auditing standardstightened

Provision of other servicesseverely restricted (ban on

IA, bookkeeping, valuation;all others subject to auditcommittee review)

Auditor to discussaccounting policies,management letter andunadjusted differences withaudit committee

Increased whistleblower protection in case of fraud

Auditors responsibilities with regards to CorporateGovernance

The auditor is required to review parts of the directors statement on thecombined code.

APB Bulletin 2006/5 identifies procedures to perform:

General On the Board review and reporton effectiveness of ICS

Review board minutes

Review supportingdocuments prepared for the Board

Make enquiries of directors

Attend meetings of theaudit committee at whichthe annual report isconsidered

Concentrate on the reviewcarried out

Review the statement bydirectors, make enquiries,review supportingdocumentation

Communicate anyweaknesses found duringaudit promptly


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Reporting responsibilities

Bulletin 2006/5 recommends the following wording in the auditreport: We are not required to consider whether the boardsstatement on internal controls covers all risks and controls, or

form an opinion on the effectiveness of the companys corporategovernance procedures or its risk and control procedures.

Report by exception if problems arise e.g. Board have notconducted annual review of ICS

Report will be an additional paragraph headed Other matterafter the opinion paragraph an emphasis of matter as the auditopinion is not affected

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