Chapter 4: Ethics and acceptance of appointment

Chapter learning objectives

When you complete this chapter you will be able to:

• Define and apply the fundamental principles of professional ethics;
• Define and apply the conceptual framework including the threats to the fundamental principles;
• Discuss the safeguards to offset the threats;
• Describe the auditor's responsibility with regard to auditor independence, conflicts of interest and confidentiality;
• Discuss the preconditions and other requirements in relation to the acceptance of new audit engagements;
• Discuss the process by which an auditor obtains an audit engagement; and
• Explain the importance of engagement letters and state their contents.

1 Introduction – the need for professional ethics

The purpose of assurance engagements is to increase the confidence of end users of information by reducing their level of risk.

It therefore follows that the user needs to trust the professional who is providing the assurance. In order to be trusted the auditor needs to be independent of their client. Independence can be defined as having 'freedom from situations and relationships where objectivity would be perceived to be impaired by a reasonable and informed third party.’

Despite this need for trust the last thirty years has witnessed a number of high profile corporate scandals that have had far reaching implications for companies, economies and accountancy firms. Enron and Worldcom are perhaps two of the most high profile examples from recent times.

To improve the image of the profession and to restore trust between users of accountancy services and the practitioners, it is vital that accountants operate (and are perceived to operate) according to an accepted code of ethics.

2 The IFAC and ACCA codes and the conceptual framework

IFAC, through the International Ethics Standards Board for Accountants, has issued a code of ethics, as has the ACCA. The ACCA Code of Ethics is covered in this chapter however, both the IFAC and ACCA codes have the same roots and are, to all intents and purposes identical.

Both follow a conceptual framework which identifies:

• fundamental principles of ethical behaviour
• potential threats to ethical behaviour
• possible safeguards which can be implemented to counter the threats.

A conceptual framework relies on a principles rather than a rules based approach. This provides guidance so that the principles may be applied to wide ranging and - potentially - unique circumstances.

Giving the framework some teeth

Whilst it is expected that practitioners apply the spirit of the code to every day practice the framework and principles would be of little use if they could not be enforced.

Professional bodies like the ACCA therefore reserve the right to discipline members who infringe the rules through a process of:

• Disciplinary hearings which can result in:
  • fines
  • suspension of membership
  • withdrawal of membership.

3 The fundamental principles

The formal definitions of the fundamental principles are as follows:

• Objectivity: Members should not allow bias, conflicts of interest or undue influence of others to override professional or business judgements.
• Professional behaviour: Members should comply with relevant laws and regulations and should avoid any action that discredits the profession.
• Professional competence and due care: Members have a continuing duty to maintain professional knowledge and skill at a level required to ensure that a client or employer receives competent professional service based on current developments in practice, legislation and techniques.

• Integrity: Members should be straightforward and honest in all professional and business relationships.
• Confidentiality: Members should respect the confidentiality of information acquired as a result of professional and business relationships and should not disclose any such information to third parties without proper and specific authority or unless there is a legal or professional right or duty to disclose. Confidential information acquired as a result of professional and business relationships should not be used for the personal advantage of members or third parties.

Practitioners needs to 'behave and be seen to behave' in an ethical, professional manner. This means complying with the Code of Ethics in every professional situation.

4 Threats and safeguards

Definitions of threats

The following are all examples of behaviour that could threaten the practitioner's independence from their clients:

Self interest threat

This occurs when an auditor has a beneficial interest in a client's performance. Examples include:

• When the auditor or a member of their family owns shares in a client. They would directly benefit from increases in client profits and would be reluctant to raise any concerns that could adversely affect the performance of the client.
• When a firm is dependent upon one client for a significant proportion of their total fee income. The firm may not raise issues with the client for fear of losing them.
• The acceptance of gifts and hospitality. This could be perceived as bribery to keep quiet about issues in the financial statements

Self review threat

This occurs when an auditor has to review work that they previously performed. For example: if the external auditor prepared the financial statements and then audited them.

There is a risk that the auditor would not identify any shortcomings in their own work for fear of penalty (either financial or reputational).

Advocacy threat

This can occur when the auditor is asked to promote or represent their client in some way. In this situation the auditor would have to be biased in favour of the client and therefore cannot be objective. This could happen if the client asked the auditor to promote their shares for a stock exchange listing or if the client asked the auditor to represent them in court.

Familiarity threat

This occurs when the auditor is too sympathetic or trusting of the client because of a close relationship with them. This may be because a close friend or relative of the auditor works in a key role for the client. The auditor may trust their friend or relative to not make mistakes and therefore not review their work as thoroughly as they should and as a result allow material errors to go undetected in the financial statements. This can also arise after a long association with a client.

Intimidation threat

Clients may try to harass or bully auditors into giving preferential audit reports. They may use the fee as leverage. The auditor should not give in to such pressure and, in the circumstances, may choose to resign from such a client.

Identifying the threats

In order to guard against these threats, real or perceived, firms should establish procedures to enable them to:

• Identify possible threats;
• Evaluate the risk arising from the threat;
• Evaluate whether the necessary safeguards are in place; and
• Take corrective action if necessary.

Usually this will be done through the use of checklists. Whilst ethics should always be of paramount consideration it must be considered at these vital junctures:

• On acceptance of a new client;
• At the planning stage of any audit;
• At the completion stage of any audit;
• Whenever additional, non audit services are provided to an audit client; and
• If any event, or change in circumstance, occurs to either the auditor or the client.

Possible safeguards

General safeguards, as recommended by ACCA

• Safeguards created by the profession. These include: education; training and experience requirements for entry into the profession; continuing professional development requirements; corporate governance regulations; professional standards; monitoring; external review of work and reports; and disciplinary action.
• Safeguards in the work environment. These include: oversight structures; ethics and conduct programmes; recruitment procedures; internal controls; disciplinary procedures; strong ethical leadership; policies and procedures to promote quality control; and culture.
• Safeguards created by individuals. These include: complying with professional development requirements; keeping records of contentious issues; using a mentor; and keeping in contact with professional bodies.

Specific safeguards

It is important to note that the safeguards listed below are generally well regarded principles that can be applied across a range of engagements and national boundaries. However, national regulatory authorities may have their own ethical standards (such as the UK's Auditing Practices Board's Ethical Standards) which are enforceable nationally. In certain circumstances the limits and thresholds may be different

Common safeguards that should be employed by auditors include:

• monitoring fees received from significant clients in comparison to total fees to reduce perception of dependence on clients;
• rotating senior audit staff on an engagement after a fixed period to reduce familiarity threat;
• using separate teams (and partners) where additional services are offered to audit clients to reduce self review threat;
• using independent partners to review work where any ethical threat is identified;
• not accepting gifts or hospitality, unless it is considered by a partner to be modest;
• not engaging in any business or financial relationship with a client;
• not allowing individuals with personal or family ties to a client to be involved in the audit of that company;
• not providing accountancy or internal audit services for listed audit clients;
• maintaining an up to date engagement letter; and
• in cases where no safeguard are considered sufficient the auditor should resign.

5 Confidentiality

External auditors are in a unique position of having a legal right of access to all information about their clients. The client must be able to trust the auditor not to disclose anything about their business to anyone as it could be detrimental to their operations.

As a basic rule, members of an audit team should not disclose any information to those outside of the audit team, whether or not they work for the same firm. There is little point using different teams for different work assignments if staff from different teams are disclosing information to each other!

Information should only be disclosed under certain circumstances. In some circumstances the auditor must disclose the information and in others the auditor may chose to disclose the information, as follows:

Public interest

• Whether or not it is in the public interest is difficult to prove and the auditor must proceed with caution if thinking of disclosing information for this reason. Such examples could include fraud, environmental pollution, or simply companies acting against the public good.

Legal advice should be sought beforehand to avoid the risk of being sued. Matters to consider before disclosing information in the public interest are whether that matter is likely to be repeated and how serious the effects of the client’s actions are.

Conflicts of interest

Any advice given should be in the best interests of the client. However, where clients' interests conflict (for example, clients in the same line of business), the firm’s work should be arranged to avoid the interests of one being adversely affected by those of another.

The steps to be taken by the auditor are:

• once a conflict is noted, you should advise both clients of the situation
• reassure the client that adequate safeguards will be implemented, e.g. separate engagement leaders for each, separate teams, ‘Chinese walls’ to prevent the transfer of client information between teams and a second partner review
• suggest they seek additional independent advice
• if adequate safeguards can't be implemented, the auditor should resign.

6 Accepting new audit engagements

Preconditions

Auditors should only accept a new audit engagement, or continue an existing audit engagement if the 'preconditions for an audit' required by ISA 210 Agreeing the terms of audit engagements are present.

ISA 210 requires the auditor to:

• Determine whether the financial reporting framework to be applied in the preparation of the financial statements is appropriate; and
• Obtain the agreement of management that it acknowledges and understands its responsibilities.

If the preconditions for an audit are not present, the auditor should discuss the matter with management, and should not accept the engagement unless required to do so by law or regulation.

Procedures

If offered an audit role, the auditor should:

• ask the client for permission to contact the outgoing auditor (reject role if client refuses)
• contact the outgoing auditor, asking for any reasons why they should not accept appointment. If a reply is not received, the prospective auditor should try and contact the outgoing auditor by other means e.g. by telephone. If a reply is still not received the prospective auditor may still choose to accept but must proceed with care.
• ensure that the legal requirements in relation to the removal of the previous auditors and the appointment of the firm have been met (these were covered in chapter 2)
• carry out checks to ensure the firm can be independent, is competent to do this audit and has the necessary resources
• assess whether this work is suitably low risk
• assess the integrity of the company's directors
• as a commercial organisation, the firm should also ensure that this is a desirable client (e.g. right industry, suitable profit margin etc)
• not accept the appointment, where it is known that a limitation will be placed on the scope of the audit.

7 Engagement letters

Engagement letters – main considerations

The engagement letter will be sent before the audit. It specifies the nature of the contract between the audit firm and the client and minimises the risk of any misunderstanding of the auditor’s role.

It should be reviewed every year to ensure that it is up to date but does not need to be reissued every year unless there are changes to the terms of the engagement. The auditor must issue a new engagement letter if the scope or context of the assignment changes after initial appointment.

ISA 210 requires the auditor to consider whether there is a need to remind the entity of the existing terms of the audit engagement for recurring audits and many firms choose to send a new letter every year, to emphasise its importance to clients.

Reasons for changes

Reasons for changes include:

• Changes to statutory duties due to new legislation.
• Changes to professional duties, perhaps due to new ISAs.
• Changes to 'other services' as requested by clients.

The contents of the engagement letter

The contents of a letter of engagement for audit services are listed in ISA 210 Agreeing the Terms of Audit Engagements. They should include the following:

• The objective and scope of the audit;
• The responsibilities of the auditor;
• The responsibilities of management;
• The identification of an applicable financial reporting framework; and
• Reference to the expected form and content of any reports to be issued.

Illustration 1: Example of an audit engagement letter

25 November 20X0

To the Board of Directors of Blake Co.

This letter and the attached terms of business dated 25 November 20X0 set out the basis on which we are to provide services as auditors and your and our respective responsibilities.

The objective and scope of the audit: You have requested that we audit the financial statements of Blake Company, which comprise the statement of financial position as at December 31, and the income statement, statement of changes in equity and cash flow statement for the year then ended, and a summary of significant accounting policies and other explanatory information.

We are pleased to confirm our acceptance and our understanding of this audit engagement by means of this letter. Our audit will be conducted with the objective of our expressing an opinion on the financial statements.

The responsibilities of the auditor: We will conduct our audit in accordance with International Standards on Auditing (ISAs). Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

Because of the inherent limitations of an audit, together with the inherent limitations of internal control, there is an unavoidable risk that some material misstatements may not be detected, even though the audit is properly planned and performed in accordance with ISAs.

In making our risk assessments, we consider internal control relevant to the entity's preparation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. However, we will communicate to you in writing concerning any significant deficiencies in internal control relevant to the audit of the financial statements that we have identified during the audit.

The responsibilities of management: Our audit will be conducted on the basis that management acknowledge and understand that they have responsibility:

(a)For the preparation and fair presentation of the financial statements in accordance with International Financial Reporting Standards;

(b)For such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error; and

(c)To provide us with:

As part of our audit process, we will request from management written confirmation concerning representations made to us in connection with the audit.

We look forward to full cooperation from your staff during our audit.

Report: We will report to the members of Blake Company as a body, whether in our opinion the financial statements present fairly in all material respects, the financial position of Blake Company as at December 31, and its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards. The form and content of our report may need to be amended in the light of our audit findings.

Fees: Our fees, which will be billed as work progresses, are based on the time required by the individuals assigned to the engagement plus out-of-pocket expenses. Individual hourly rates vary according to the degree of responsibility involved and the experience and skill required.

Period of engagement: This engagement will start on 01 January 20X1 with the company's accounting period ending on 31 December. We will not be responsible for earlier years. The company’s previous advisers, Jones & Mackay Inc. will deal with outstanding returns, assessments and other matters relating to earlier periods.

This letter supersedes any previous engagement letter for the period covered. Once agreed, this letter will remain effective for future years from the date of signature unless it is terminated, amended or superseded. You or we may agree to vary or terminate our authority to act on your behalf at any time without penalty. Notice of variation or termination must be given in writing.

Limitation of liability: To the fullest extent permitted by law, we will not be responsible for any losses, where you or others supply incorrect or incomplete information, or fail to supply any appropriate information or where you fail to act on our advice or respond promptly to communications from us.

Our work is not, unless there is a legal or regulatory requirement, to be made available to third parties without our written permission and we will accept no responsibility to third parties for any aspect of our professional services or work that is made available to them.

Confirmation of your agreement: Please confirm your agreement to the terms of this letter and the attached terms of business by signing and returning the enclosed copies.

Please sign and return the attached copy of this letter to indicate your acknowledgement of, and agreement with, the arrangements for our audit of the financial statements including our respective responsibilities.

If this letter and the attached terms of business are not in accordance with your understanding of our terms of appointment, please let us know.

Whites & Harper Inc.

Acknowledged and agreed on behalf of Blake Company by
(signed)

..........................
Name and Title
Date

Contents of the engagement letter

In addition to the above the engagement letter may also make reference to:

• The unavoidable risk that some material misstatements may go undetected due to the inherent limitations in an audit;
• Arrangements regarding the planning and performance of the audit;
• The expectation that management will provide written representations;
• The agreement of management to make available to the auditor draft financial statements and other information in time to complete the audit in accordance with the proposed timetable;
• The agreement of management to inform the auditor of facts that may affect the financial statements;
• The basis on which fees are computed and billing arrangements;
• A request for management to acknowledge receipt of the engagement letter and to agree the terms outlined;
• Agreements concerning the involvement of auditors experts and internal auditors; and
• Restrictions to the auditor's liability.

UK Syllabus Focus

The APB has issued a set of UK specific ethical standards designed to ensure practitioners comply with the IFAC Code of Ethics. These can be summarised as follows:

Ethical Standard 1 - integrity, objectivity and independence

• The audit firm shall establish policies and procedures to ensure that the firm, and all those involved in the audit, act with integrity, objectivity and independence;
• The leadership of the audit firm shall take responsibility for establishing a control environment that places adherence to ethical principles above commercial considerations;
• the audit firm shall designate an ethics partner;
• The audit firm shall establish policies and procedures to prevent employees from taking decisions that are the responsibility of management of the audited entity;
• The audit firm shall establish policies and procedures to assess the significance of threats to the auditor's objectivity:

• The audit engagement partner shall not accept or shall not continue an audit engagement if he or she concludes that any threats to the auditor's objectivity and independence cannot be reduced to an acceptable level.
• In the case of listed companies the engagement quality control reviewer shall:

Ethical Standard 2 - financial, business, employment and personal relationships

• The audit firm, or employees, shall not hold any financial interest in an audited entity;
• Audit firms and employees shall not make loans to, or guarantee the borrowings of, an audited entity (and vice versa);
• Audit firms and employees shall not enter into business relationships with an audited entity;
• An audit firm shall not second partners or employees to an audit client unless:

  (i)the agreement is for a short period of time; and

  (ii) the audited entity agrees that the individual concerned will not hold a management position.

• Where a partner or employee returns to a firm on completion of a secondment to an audit client, that individual shall not be given any role on the audit involving any function or activity that they performed or supervised during that assignment.
• Where a partner joins an audited entity, the audit firm shall take action to ensure that no connections remain between the firm and the individual;
• Where a partner leaves a firm and is appointed as a director or to a key management position with an audited entity, having acted as audit engagement partner at any time in the two years prior to this appointment, the firm shall resign as auditor.
• A partner, or employee of the audit firm who undertakes audit work, shall not accept appointment:

  (i)to the board of directors of the audited entity; or

  (ii) to any subcommittee of that board;

ES 3 - Long association with the audit engagement

• The audit firm shall establish policies and procedures to monitor the length of time that senior staff serve as members of the engagement team for each audit;
• Where senior staff have a long association with the audit, the audit firm shall assess the threats to the auditor’s objectivity and independence and shall apply safeguards to reduce the threats to an acceptable level. Where appropriate safeguards cannot be applied, the audit firm shall either resign as auditor or not stand for reappointment, as appropriate;
• Once an audit engagement partner has held this role for ten years, careful consideration must be given as to whether their objectivity would be perceived to be impaired;
• In the case of listed companies the audit firm shall establish policies and procedures to ensure that no one shall act as audit engagement partner for more than five years; and
• In the case of listed companies, the audit engagement partner shall review the safeguards put in place to address the threats arising where senior staff have been involved in the audit a period longer than seven years.

ES 4 - Fees, remuneration and evaluation policies, litigation, gifts and hospitality

• The audit engagement partner shall ensure that audit fees are not influenced or determined by the provision of non-audit services;
• An audit shall not be undertaken on a contingent fee basis;
• Audit fee for the previous audit and the arrangements for its payment shall be agreed with the audited entity before the audit firm formally accepts appointment as auditor in respect of the following period;
• Where it is expected that the total fees receivable from a listed audited entity will regularly exceed 10% of the annual fee income (15% if non-listed) of the audit firm, the firm shall not act as the auditor of that entity;
• The audit firm shall establish policies and procedures to ensure that the objectives and appraisal of members of the audit team do not include selling non-audit services.
• Where litigation with a client is already in progress, or where it is probable, the audit firm shall either not continue with or not accept the audit engagement;
• The audit firm, including employees, shall not accept gifts from the audited entity, unless the value is clearly insignificant; and
• Audit firm employees shall not accept hospitality from the audited entity, unless it is reasonable in terms of its frequency, nature and cost.

ES 5 - non-audit services provided to audited entities

• Before the audit firm accepts a proposed engagement to provide non-audit services to an audit client, the audit engagement partner shall:

  (i)consider whether a reasonable third party would regard the objectives of the proposed engagement as being inconsistent with the objectives of the audit;

  (ii) identify and assess any threats to the auditor's objectivity, including any perceived loss of independence; and

  (iii)identify and assess the effectiveness of the available safeguards to eliminate the threats or reduce them to an acceptable level.

• Where the audit partner considers it probable that a reasonable third party would regard the objectives of the proposed non-audit service engagement as being inconsistent with the objectives of the audit, the audit firm shall either:

  (i)not undertake the non-audit service engagement; or

  (ii) not accept or withdraw from the audit engagement.

• Specifically, the audit firm shall not undertake an engagement to provide internal audit services to an audited entity where it is reasonably foreseeable that:

  (i)for the purposes of the audit of the financial statements, the auditor would place significant reliance on the internal audit work performed by the audit firm; or

  (ii) for the purposes of the internal audit services, the audit firm would undertake part of the role of management.

• The audit firm shall not undertake an engagement to design, provide or implement information technology systems for an audited entity where:

  (i)the systems concerned would be important to any significant part of the accounting system and the auditor would place significant reliance upon them as part of the audit of the financial statements; or

  (ii) for the purposes of the information technology services, the audit firm would undertake part of the role of management.

ES - Provisions Available for Small Entities (PASE)

• When auditing the financial statements of a small entity the audit firm is not required to:
• Comply with the requirement that an external independent quality control review is performed;
• Apply safeguards to address self-review threat provided:

  (i)the audited entity has 'informed management'; and

  (ii) the audit firm extends the cyclical inspection of completed engagements that is performed for quality control purposes.

• Adhere to the prohibitions in APB Ethical Standard 5, relating to providing non-audit services that involve the audit firm undertaking part of the role of management, provided that it discusses objectivity and independence issues related to the provision of non-audit services with those charged with governance, confirming that management accept responsibility for any decisions taken;
• Comply with APB Ethical Standard 5, paragraph 82 (acting as an advocate by providing tax services to an audit client during an appeal/tribunal); and
• Comply with APB Ethical Standard 2, paragraph 48 (partner leaving firm and being appointed as director of audit client) provided that it takes appropriate steps to determine that there has been no significant threat to the audit team's integrity, objectivity and independence.

Test your understanding 1: FIXED TEST 1 - JT & Co.

You are a manager in the audit firm of JT & Co; and this is your first time you have worked on one of the firm's established clients, Pink Co. The main activity of Pink Co is providing investment advice to individuals regarding saving for retirement, purchase of shares and securities and investing in tax efficient savings schemes. Pink is regulated by the relevant financial services authority.

You have been asked to start the audit planning for Pink Co, by Mrs Goodall, a partner in JT & Co. Mrs Goodall has been the engagement partner for Pink Co, for the previous six years and so has a sound knowledge of the client. Mrs Goodall has informed you that she would like her son Simon to be part of the audit team this year; Simon is currently studying for his first set of fundamentals papers for her ACCA qualification. Mrs Goodall also informs you that Mr Supper, the audit senior, received investment advice from Pink Co during the year and intends to do the same next year.

In an initial meeting with the finance director of Pink Co, you learn that the audit team will not be entertained on Pink Co's yacht this year as this could appear to be an attempt to influence the opinion of the audit. Instead, he has arranged a day at the horse races costing less than two fifth's of the expense of using the yacht and hopes this will be acceptable.

JT & Co have done some consultive work previously and the invoice is still outstanding.

Required:

(a)   (i)    Explain the ethical threats which may affect the auditor of Pink Co.

Answer plan

You are a manager in the audit firm of JT & Co; and this is your first time you have worked on one of the firm's established clients, Pink Co. The main activity of Pink Co is providing investment advice to individuals regarding saving for retirement, purchase of shares and securities and investing in tax efficient savings schemes. Pink is regulated by the relevant financial services authority.

You have been asked to start the audit planning for Pink Co, by Mrs Goodall, a partner in JT & Co. Mrs Goodall has been the engagement partner for Pink Co, for the previous six years and so has a sound knowledge of the client. Mrs Goodall has informed you that she would like her son Simon to be part of the audit team this year; Simon is currently studying for his first set of fundamentals papers for her ACCA qualification. Mrs Goodall also informs you that Mr Supper, the audit senior, received investment advice from Pink Co during the year and intends to do the same next year.

In an initial meeting with the finance director of Pink Co, you learn that the audit team will not be entertained on Pink Co's yacht this year as this could appear to be an attempt to influence the opinion of the audit. Instead, he has arranged a day at the horse races costing less than two fifth's of the expense of using the yacht and hopes this will be acceptable.

JT & Co have done some consultive work previously and the invoice is still outstanding.

Required:

(a)   (i)    Explain the ethical threats which may affect the auditor of Pink Co.

Test your understanding 2

Explain each of the FIVE fundamental principles of ACCA’s Code of Ethics and Conduct.

Real exam question: December 2007

Test your understanding 3

(a)There are legal and professional arrangements for the appointment and removal of auditors.

You are a manager in the audit department of Whilling and Abel. A potential new client, Truckers Ltd, a haulage company, has approached your firm to do the statutory audit in addition to some other non-audit services for the financial year ended 30 September 2011. Your audit firm was recommended to Truckers by an existing client, O&P, a shipping company who is also a major customer of Truckers Ltd.

You have been chosen to lead the assignment as you have experience of auditing haulage companies and you also manage the audit of O&P. Whilst arranging the initial meeting with the directors of Truckers you discover that you studied accountancy with the finance director at university.

During the meeting, you establish that Truckers has not made a profit for the last 2 years. The directors explain that this is largely due to escalating costs in the industry including fuel price rises. They are confident they have now controlled their costs for the current year to 30 September 2010. They have also been approached to tender for a large profitable contract which would improve their financial performance going forward. They would like you to assist them with the preparation of this tender and present with them on the day.

The current year's financial statements and audit are being finalised with another audit firm. The finance director tells you that the current auditors have identified material misstatements but the board of directors are refusing to make these adjustments. If adjusted, it would turn the break even position into a loss. The finance director told you this information informally whilst catching up on old times at the local pub.

The current auditors have replied to your professional clearance letter and have informed you that they are still owed fees relating to the year ended 30 September 2010. This is under dispute with the client.

Once back from the meeting you calculate that the potential fees from Truckers would amount to about 14% of your firms total fee income.

Required:

(b)Identify and explain the threats to auditor independence if Whilling and Abel accept Truckers as a new client. For each threat, recommend how the threat can be managed.

Test your understanding 4

Client confidentiality underpins the relationship between Chartered Certified Accountants in practice and their clients.

It is a core element of ACCA's Rules of Professional Conduct.

Required:

(a)Explain the circumstances in which ACCA's Rules of Professional Conduct permit or require external auditors to disclose information relating to their clients to third parties without the knowledge or consent of the client.

(b)A waste disposal company has breached tax regulations, environmental regulations and health and safety regulations. The auditor has been approached by the tax authorities, the government body supervising the award of licences to such companies and a trade union representative. All of them have asked the auditor to provide them with information about the company. The auditor has also been approached by the police. They are investigating a suspected fraud perpetrated by the managing director of the company and they wish to ask the auditor certain questions about him.

Describe how the auditor should respond to these types of request.

8 Chapter summary

Test your understanding answers

Test your understanding 1: FIXED TEST 1 - JT & Co.

THIS IS A FIXED TEST – Please answer the question in full (long form written). Then log on to EN-gage at the following address: www.en-gage.co.uk. Follow the link to 'Fixed Test 1' and answer the questions based on your homework answer.

Once you have answered the questions on EN-gage, a model answer will be available for your reference.

Test your understanding 2

Fundamental principles

Integrity. A professional accountant should be honest and straightforward in performing professional services.

Objectivity. A professional accountant should be fair and not allow personal bias, conflict of interest or influence of others to override objectivity.

Professional competence and due care. When performing professional services, a professional accountant should show competence and duty of care by keeping up-to-date with developments in practice, legislation and techniques.

Confidentiality. A professional accountant should respect the confidentiality of information acquired during the course of providing professional services and should not use or disclose such information without obtaining client permission.

Professional behaviour. A professional accountant should act in a manner consistent with the good reputation of the profession and refrain from any conduct which might bring discredit to the profession.

Test your understanding 3

(a)

• They are not a member of an RSB (recognised supervisory body) or not allowed to practice under the rules of an RSB;
• If they are an officer or employee of the company; or
• If they are a business partner or employee of the company.

• A decision must be made by the shareholders at a general meeting usually with a majority vote being required.
• Advance notice should be made to the company and the auditors prior to any general meeting – in the UK for example 21 days notice would be required.
• Auditors have the right to attend and speak at the GM or have representation read out on their behalf. The company should ensure that this is adhered to.

(b)Threats to independence

Test your understanding 4

(a)Disclosure of information relating to clients to third parties

(b) Response to requests

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