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F8 Audit & Assurance

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F8 Audit & Assurance

Chapter 4 Ethics & Acceptance of Appointment


1. 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 have 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.

Codes of Ethics

Accountants have set of multiple ethical responsibilities. They are required to act ethically towards and in the best interests of the following three groups: Their clients or employers The accounting profession The public at a large

Therefore the accounting bodies such as the International Federation of Accountants (IFAC) and the Association of Certified Chartered Accountants (ACCA) publish and issue sets of ethical standards that they expect their members to live by. Both of these standards identify and outline five main principles that all members must comply with at all times.

Fundamental Principles of Ethics


1. Integrity: The principle requires members to be straightforward and honest in all professional and business relationships. For this, the accountant must ensure that the financial statements and assurances provided: a) Dont contain information which is false or deceptive b) Exclude information which is vague i.e. they must not misguide the users in short, integrity means acting with honesty and being fair and truthful at all times. 2. Objectivity: A professional accountant should be objective or unbiased. For all professional decisions which are to be taken, accountants must ensure that there is no conflict of interest. a) Must avoid any relationship which will affect their professional judgments b) Who provide assurance services, must not accept or offer gifts or hospitality which will affect their professional judgments. 3. Professional competence and due care: A professional accountant must ensure that they have the necessary skills and knowledge to handle the tasks that are assigned to them by their client. They must continuously update themselves with the latest developments with the respect to knowledge and practices in the profession. a) Keep their knowledge and skills up to date

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F8 Audit & Assurance b) Ensure that clients or employers are provided with professional services based on the latest developments in the profession, both legislative and technical. c) Be professionally competent and make sound judgment while applying their professional knowledge and skills. 4. Confidentiality: The principle requires that the accountants never disclose any confidential information of their clients or organizations to any other third party (apart from their staff who are also bound by the same confidentiality). It is important to note that an accountant is still bound by the same confidentiality principle even after they have left the employment of the organization. 5. Professional behavior: Members should comply with relevant laws and regulations and should avoid any action that discredits the profession. Organizations also require that their members act ethically when marketing and promoting their services. Members should not engage in false advertising.

3.
i. ii. iii. iv. v.

Threats to Independence

Self-interest threat Self-review threat Advocacy threat Familiarity threat Intimidation threat

I.
i. ii. iii. iv. v. vi. vii. viii.

Self-Interest Threat
Cross Selling Hospitality Overdue Fees Contingent Fees Shares Financial Interest Undue Dependence upon One Client Low Balling

II.
i. ii. iii. iv. v. vi. vii.

Self-Review Threat
Corporate Consultancy Internal Audit Service Accountancy Service Clients Staff joining Auditor Information System Services Taxation Service Valuation Service

III.
i. ii. iii.

Advocacy Threat
Consultancy Dealing in Clients Shares Legal Services

IV.
i. ii. iii.

Familiarity
Association for Long Time Personal Relationships Assurance/Audit Staff joining Client

V.
i. ii. iii.

Intimidation
Close Relations Litigations Assurance Partner joining Client

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F8 Audit & Assurance

Identification & Safeguards of Threats


Identification
In order to guard against above threats, 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 Take corrective action if necessary

Usually this will be done through 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 any audit client If any event or change in circumstances occurs to either the auditor or the client

Safeguards I.

General Safeguards
Created by Professional Body
These include education, training and experience requirements for entry into the profession, continuing professional development requirements, disciplinary actions etc.

Created by Work Environment/Firm


These include oversight structures, ethics and conduct programs, recruitment procedures, internal controls, disciplinary procedures and culture.

Created by Individuals
These include complying with professional development requirements, keeping record of contentious issues, using a mentor and keeping in contact with professional bodies.

II.

Specific Safeguards

It is important to note that the safeguards listed below are generally well regarded principles that can be applied across the world but national regulatory bodies may have their own ethical standards which are enforceable nationally. In certain circumstances limits and thresholds may be different. Common safeguards that should be employed by auditors include: Monitoring fees received from significant clients in comparison with 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 selfreview threat Using independent partners to review work where any ethical threat is identified Not accepting any gifts or hospitality, unless it is considered by a partner to be modest Not engaging in any business or financial relationship with 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 In cases where no safeguards are considered sufficient the auditor should resign

Rule of Confidentiality
External auditors are in a unique position of having a legal right of access to all information about their clients. It goes without saying that 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.

5|Page F8 Audit & Assurance As a basic rule, members of the audit team should not disclose any information to those outside the audit team or use the information for their own benefit. Exceptional circumstances where information can be disclosed to third parties are following: 1) 2) 3) 4) 5) 6) 7) Client is damaging public property Money laundering Drug trafficking Terrorism Act of treason By the order of court External Quality Control Review (QCR)

Conflicts of Interest
Any advice given should be in the best interests of the client. However, where clients interests conflict, the firms work should be arranged to avoid the interests of one being adversely affected by those of another. The steps to be taken by 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 cant be implemented, the auditor should resign.

Audit Engagement Letter


It is a letter written by the auditor to audit committee or management before commencement of audit. It specifies the nature of the contract between the audit firm and the client and minimizes the risk of any misunderstanding of auditors role. It should be reviewed every year to ensure that it is up to date but does not need to be issued every year unless there are changes to the terms of engagement. The auditor must issue a new engagement letter if the scope or context of the assignment changes after initial appointment. Many firms of auditors choose to send a new letter every year, to emphasize its importance to clients.

Contents of Engagement Letter


It includes following items: 1. Objective of audit 2. Scope of audit 3. Managements Responsibilities 4. Auditors Responsibilities 5. Inherent Limitation Statement 6. Types of Other Services 7. Form of report by the auditor 8. Basis of audit fees (1. Time Basis) (2. Expense Basis) 9. Reference for future communications 10. Acknowledgement of statement

Exceptional Circumstances
It is not necessary to send a new engagement letter in recurring audit but can be done in following circumstances: Change in the nature of business Change in the volume of business Misunderstanding regarding audit Requirement of country Change in management In Case of Parent and Component Company Send new letter if board of directors and shareholders are different in Parent and Component Company If this is a statutory requirement

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F8 Audit & Assurance

Chapter 5 Internal Audit


Definition: It is an independent objective assurance assignment established by the management or board to add
value and to improve the efficiency of the operations through effective monitoring of internal control systems and risk management systems. Internal auditing is a function of examining and testing whether these systems have been properly designed and are functioning properly. It is important to note here that internal auditors play a very different and distinct role from management. Management is responsible for identifying potential risks in the strategy/ objective setting process. But internal auditors are required to review the risks that have been identified by the management as well as evaluate the controls they have put into place to mitigate those risks. At the end of their assessment, the internal auditors provide an opinion on whether the organizations controls are sufficient and working effectively.

Scope of Internal Audit


Examination of F/S Examination of Information Systems Examination of compliance with law and policies Review of Economy, efficiency and effectiveness Review of internal control systems and risk management systems Investigation of fraud and errors (on ad hoc basis)

If the internal audit department is to be effective in providing assurance it needs to be: Sufficiently resourced, both financially and in terms of qualified, experienced staff Well organized, so that it has well developed work practices Independent and objective

Implementation of Internal Audit Function


1. 2. 3. 4. 5. The scale, diversity and complexity of the organisations activities Whether there are any processes or departments that have a history of problems? Probability or possibility of fraud and corruption Cost of the department vs. the benefits that can be derived from it Role of corporate governance

For an effective internal audit system there are a number of best practice guidelines that can be uniformly applied to the structure and operations of any internal audit system, these include: Independent structure Qualified personnel Sufficient personnel Quality documentation Regular reporting Periodic review

Internal audit function can also assist the board in the following ways: Working in close co-ordination with the auditors Providing advice on the implementation of new standards and accounting practices Auditing the reports reviewed by the board

Comparison between Internal & External Audit


Areas
1. Objective 2. Level of independence 3. Appointed by

Internal Audit
To add value and to improve efficiency of operations. Limited Independence Board/Audit Committee

External Audit
To express opinion about the true and fair view of financial statements. High level of independence Shareholders

7|Page 4. Reportable to 5. Scope decided by 6. Approach 7. Requirement Board/Audit Committee Board/Audit Committee Risk based (whole business) Best practices

F8 Audit & Assurance Shareholders Standards Risk based (only financial statements) Statutory

Limitations of Internal Audit Function


1. Scope Not Defined by Any Statue
An internal audit is not a mandatory exercise like an external audit and therefore the objectives and the scope is not decided by any statute.

2. Qualifications of an Internal Auditor


Unlike external auditors, statutes do not prescribe any qualifications for internal auditors. Accordingly, it is often found that an internal auditor is not appropriately qualified to perform their duty diligently. This can affect the quality of the internal audit function.

3. Independence
The independence of the internal auditor is difficult to maintain. There is always the possibility that an internal auditor will be unduly influenced by comparatively senior level management.

4. Uniformity Not Maintained


The practice of internal audit varies from organization to organization and assignment to assignment. In contrast, external audit practices anywhere in the world are governed by the provisions of the ISA and therefore uniform.

Internal Audit Assignments


1. Value for Money (VFM) Audit
The principle of value for money implies that efforts must be made to ensure available funds are spent in the provision of services in a way that maximizes the benefit to the users of the services. The value for money principle focuses on three Es namely economy, efficiency and effectiveness in any activity of the organization. Economy Implies the principle of prudence i.e. the least possible cost should be incurred to fulfill any need. Efficiency This is the relationship between goods or services produced and the resource used to produce them. An efficient operation produces the maximum output for any given set of resource outputs. Effectiveness Focuses on the achievement of desired objectives through the spending of available funds. The three measures may be in conflict with each other.

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