ETHICAL THREATS TO INDEPENDENCE (RELATED TO CHAPTER 10 OF BPP TEXT BOOK ON PROFESSIONAL ETHICS)

1. SELF-INTEREST THREAT Financial Interest close business relationships employment with assurance client partner on client board family and personal relationships gifts and hospitality loans and guarantees overdue fees Contingent fees High % of fees Lowballing Recruitment 4. FAMILIARITY THREAT Long association t assurance clients Family/personal relationships between clien/firm Employment with assurance client Recent service with assurance client 2. SELF-REVIEW THREAT Recent service with assurance client General other services Preparing accounting records and financial statements Valuation service Tax services Internal audit services Corporate finance Other services 3. ADVOCACY THREAT Legal services Contingent fees Corporate Finance

5. INTIMIDATION THREAT Close business relationships Family and personal relationships Assurance staff members move employment with client Litigation

to

6. CONFLICT OF INTEREST Members and client Between different clients Individual

www.accaforstudents.com

1. THREAT OF SELF-INTEREST
Independence and objectivity is under threat if the auditor has a SELF-INTEREST in the company being audited May arise as a result of FINANCIAL or other INTERESTS of AUDITORS/immediate FAMILY, e.g. Financial interest The audit firm has a FINANCIAL INTEREST in the clients affairs, e.g. OWNS SHARES in the client Who cannot have an interest in the client? The assurance FIRM itself The MEMBER of the assurance team The immediate FAMILY of a member of the assurance team Safeguards if have interest DISPOSE the interest REMOVE the INDIVIDUAL from the team if required Keeping the clients AUDIT COMMITTEE INFORMED of the situation using an INDEPENDENT PARTNER to REVIEW work carried out audit firms should have QUALITY CONTROL PROCEDURES requiring staff to DISCLOSE RELEVANT FINANCIAL INTERESTS for themselves and close family members Close business relationship The audit firm has a BUSINESS ASSOCIATION with the company e.g. material financial interest in a JOINT VENTURE, DISTRIBUTOR or MARKETING arrangements Unless the interest in clearly insignificant, an assurance provider SHOULD NOT PARTICIPATE in such a venture with an assurance client Safeguards END the ASSURANCE PROVISION TERMINATE the BUSINESS RELATIONSHIP Generally speaking, purchasing goods and services from an assurance client on an ARMS LENGTH BASIS does NOT constitute a threat to independence Employment with client There may be a situation where STAFF TRANSFER between an assurance firm and a client, or NEGOTIATIONS/INTERVIEWS to facilitate such movement might be IN PLACE A threat to independence because The audit STAFF member UNDER CONSIDERATION might be MOTIVATED to IMPRESS a possible future employer A FORMER PARTNER turned finance director has too MUCH KNOWLEDGE of the AUDIT FIRMS SYSTEMS and PROCEDURES Factors to consider ROLE of the individual, LENGTH of TIME elapsed, etc Safeguards:

Consider MODIFYING ASSURANCE PLAN Assign audit to someone of SUFFICIENT EXPERIENCE Involve ADDITIONAL PROFESSIONAL ACCOUNT not involved with the engagement Carry out QUALITY CONTROL REVIEW on engagement Partner on client board A PARTNER or EMPLOYEE of an assurance firm SHOULD NOT serve on the BOARD of an assurance client It may however be acceptable for a partner or an employee of an assurance firm to perform the role of company SECRETARY for an assurance client if the role is essentially ADMINISTRATIVE Family and personal relationships FAMILY or CLOSE PERSONAL RELATIONSHIPS between assurance firm and client staff could seriously threaten independence Factors to consider individuals ROLE in the engagement, CLOSENESS of relationship, ROLE of the other party If an immediate [FAMILY member of AUDITOR] is a [DIRECTOR, OFFICER, or EMPLOYEE] of the client with a position to [EXERT direct and significant INFLUENCE over matter information of the assurance engagement] REMOVE the INDIVIDUAL from the assurance team If INADVERTENTLY violated the rule take SAFEGUARDS such as QUALITY CONTROL REVIEW, discuss with AUDIT COMMITTEE, etc A firm should have QUALITY CONTROL POLICIES and PROCEDURES under which staff should DISCLOSE if a close family member employed by the client is promoted Gifts and hospitality An auditor should NOT accept GIFTS/HOSPITALITY unless the value of it is clearly INSIGNIFICANT NO SAFEGUARD to reduce such risk Loans and guarantees If the CLIENT is a financial institution that PROVIDES LOAN to the firm or auditor may have a threat on independence UNLESS ON NORMAL COMMERCIAL TERMS Loans to MEMBERS of the assurance team from a bank client are likely to be MATERIAL to the individual, but provided that they are on NORMAL COMMERCIAL term, these do no constitute a threat to independence However, if the CLIENT is NOT a BANK/FINANCIAL INSTITUTION, the audit firm/auditor on the assurance engagement should NOT ENTER into any loan or guarantee agreement with it

www.accaforstudents.com

2/4

Overdue Fees If there are overdue fees, the auditor runs the risk of MAKING a LOAN to a client in substance. Safeguard DISCUSS with those charged with governance, or even RESIGN if necessary Contingent Fees Are fees calculated on a PREDETERMINED BASIS relating to the OUTCOME or RESULT of a TRANSACTION or the RESULT of the WORK performed A firm should NOT enter into any fee arrangement for an assurance engagement under which the amount of the fee is CONTINGENT on the RESULT of the ASSURANCE work or on ITEMS that are the SUBJECT MATTER of the ASSURANCE engagement Safeguards DISCLOSE to AUDIT COMMITTEES, REVIEW of FEES by unrelated third party, QUALITY CONTROL POLICIES and PROCEDURES High percentage of fees Independence may be threaten if the total fees generated by an assurance client represent a LARGE PROPORTION of a firms total fees General rule >10% may be significant Safeguards Discuss the issues with AUDIT COMMITTEE Taking steps to REDUCE the DEPENDENCY on the client Obtaining external/internal QUALITY CONTROL REVIEW INCREASE REVENUE so that to REDUCE DEPENDENCY Lowballing Occurs when a firm quotes a SIGNIFICANTLY LOWER FEE level for an assurance service than would have been charged by the predecessor firm Safeguards if tender is successful: MAINTAIN RECORDS such that the firm is able to demonstrate that APPROPRIATE STAFF and TIME are spent on the engagement COMPLYING with all applicable ASSURANCE STANDARDS, GUIDELINES and QUALITY CONTROL PROCEDURES Recruitment RECRUITING SENIOR MANAGEMENT for the client creates self-interest because firm may INDIRECTLY make MANAGEMENT DECISIONS for the client Their INVOLVEMENT should be LIMITED to reviewing a SHORTLIST of CANDIDATES, providing that the client has drawn up the CRITERIA which they are to be selected

2. SELF-REVIEW THREAT
Occurs when a firm provides SERVICES OTHER THAN ASSURANCE SERVICES to an assurance client The PREVIOUS JUDGMENT (made by the firm) may need to be RE-EVALUATED Thus, if the judgment is RE-EVALUATED by the SAME PERSON responsible for the JUDGMENT, self-review threat occurs E.g. of services that may cause self-review threat Auditor with recent services with client INDIVIDUALS who have been a [DIRECTOR, OFFICER, or an EMPLOYEE] in a position to [EXERT DIRECT and SIGNIFICANT INFLUENCE over the SUBJECT matter of the assurance ENGAGEMENT] in the period under review or the previous TWO YEARS should NOT be assigned to the assurance team Safeguards QUALITY CONTROL REVIEW Discuss with AUDIT COMMITTEE General other services For assurance client, accountants are not allowed to: Authorize, execute or consummate a TRANSACTION Determine which RECOMMENDATION of the company should be IMPLEMENTED REPORT in a MANAGEMENT CAPACITY to those charged with corporate governance Safeguards Ensuring NON-ASSURANCE TEAM STAFF are used for these roles Involving an INDEPENDENT PROFESSIONAL ACCOUNTANT to advise QUALITY CONTROL POLICIES on what staff are and are not allowed to do for clients Making APPROPRIATE DISCLOSURES to those charged with governance RESIGNING from the assurance engagement
Preparing accounting records and financial statements

Clearly a threat of self-review Safeguards Using staff members OTHER THAN assurance team members to carry out work Obtaining APPROVAL for work undertaken CHINESE WALL REJECT engagement Valuation services Valuation comprise the MAKING of ASSUMPTIONS with regard to FUTURE DEVELOPMENTS, the application of certain METHODOLOGIES and TECHNIQUES, and the combination of both in order to COMPUTE a CERTAIN VALUE for an ASSET, LIABILITY or for a biz as a whole Valuations give rise to self-review threat Audit firms should not carry out valuations on MATTERS which will be MATERIAL to the FS 3/4

www.accaforstudents.com

 If IMMATERIAL, need to apply safeguards SECOND PARTNER review Confirming that the CLIENT UNDERSTANDS the valuation and the assumptions used Ensuring the client ACKNOWLEDGES RESPONSIBILITY for the valuation Using SEPARATE PERSONNEL for the valuation and audit Taxation services The provision of taxation services is generally NOT seen to threaten independence because it is a matter of fact and is supported by documentations Internal audit services May provide such services But CLIENT should ACKNOWLEDGES its RESPONSIBILITY for ESTABLISHING, MAINTAINING, and MONITORING the system of IC Safeguards Ensure that EMPLOYEE of the CLIENT is designated responsible for internal audit activities and that the client approves all the work that internal audit does Corporate Finance Corporate finance matters that are NOT allowed Promote, deal in or underwrite an assurance clients SHARES COMMIT to the terms of a TRANSACTION or CONSUMMATE a TRANSACTION on the clients behalf Corporate finance matters that are ALLOWED Assisting in defining CORPORATE STRATEGIES Identifying possible SOURCES of CAPITAL Providing STRUCTURING ADVICE

4. FAMILIARITY THREAT
Occurs when members become TOO SYMPATHETIC to the interest of others because of CLOSE RELATIONSHIPS There is substantial risk of loss of PROFESSIONAL SKEPTICISM Very often arise IN CONJUNCTION with SELFINTEREST THREAT, e.g. family relationship Also if senior member of staff at an audit firm have a LONG ASSOCIATION with the client Safeguards ROTATE staff, SECOND PARTNER review, independent INTERNAL QUALITY CONTROL review

5. INTIMIDATION THREAT
Arises when member of the assurance team may be DETERRED from ACTING OBJECTIVELY by THREATS, ACTUAL or PERCEIVED Arise from FAMILY and personal RELATIONSHIPS, LITIGATION, close BIZ RELATIONSHIPS e.g. client threaten to sue the assurance firm for work that has been done previously safeguards disclose to AUDIT COMMITTEE the nature and extent of the litigation REMOVING specific affected INDIVIDUALS from the engagement team involving an ADDITIONAL PROFESSIONAL ACCOUNTANT on the team to review work WITHDRAW from engagement

6. CONFLICT OF INTEREST
Besides the self-interest conflict mentioned above, conflict of interest may also arise when a firm has TWO or more AUDIT CLIENTS both of which have reason to be unhappy that their auditors are also auditors to the other company e.g. companies are in DIRECT COMPETITION and the auditors have access to particularly sensitive information safeguards full and frank EXPLANATION NOT ACCEPTING appointment CHINESE WALL different groups, physical separation, strict procedures

3. ADVOCACY THREAT
Arise in those situations where the assurance FIRM PROMOTES a POSITION or OPINION to the point that subsequent OBJECTIVITY is COMPROMISED E.g. commenting publicly on future events in particular circumstances, having made assertions without detailing the transactions, acting as an advocate on behalf of the client, promote shares Safeguards Using DIFFERENT DEPARTMENTS to carry out the work Making disclosures to AUDIT COMMITTEE WITHDRAW from engagement

www.accaforstudents.com

4/4