1. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-1 Chapter 3 Ethics, independence and corporate governance

2. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-2 Learning objective 1: The nature and importance of professional ethics Ethics is concerned with the requirements for the general well-being, prosperity, health and happiness of people. It requires knowledge of moral principles, and skills in applying them to problems and decisions.

3. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-3 Ethical rules The establishment of ethical codes and disciplinary rules does not necessarily create an ethical culture or ensure the moral integrity of employees. APES 110 'Code of Ethics for Profession Accountants', issued by the Accounting Professional and Ethical Standards Board (APESB), indicates that members are expected to comply with the spirit as well as the letter of the rules. Ethics is principally an attitude of mind rather than compliance with written rules of conduct.

4. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-4 Learning objective 2: Ethical theory Teleological ethics: deals with consequences or outcomes of actions —Generally, if the benefits of a proposed action outweigh the costs, the decision is morally correct. Deontological ethics: based on duties and rights —Duties and rights set down in rules that must be followed. Virtue ethics: focus on personal qualities, such as the integrity of the decision maker.

5. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-5 Learning objective 3: Accounting bodies’ codes of ethics APES 110 sets out main ethical pronouncements that relate to the undertaking of an audit. ASA 200 (ISA 200) requires that auditors comply with relevant ethical requirements. APES 110 consists of three sections: 1.Part A: General Application of the Code 2.Part B: Members in Public Practice 3.Part C: Members in Business There are also a number of APES standards and miscellaneous Professional Statements promoting ‘competence’.

6. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-6 Purpose of the code of ethics Code of ethics: formal, systematic statement of rules and principles developed by the community to promote its well-being and punish undermining behaviour. The code therefore: —Makes explicit the values implicitly required —Indicates how members should act toward one another —Provides an objective basis for sanctions.

7. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-7 Virtues of an auditor Distinguishing mark of accountancy profession is acceptance to act in the public interest, defined as 'the collective well-being of the community of people that the members serve'. (APES 110, s 100.1)

8. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-8 Fundamental principles Five fundamental principles contained in the codes of ethics: 1.Integrity 2.Objectivity 3.Professional competence and due care 4.Confidentiality 5.Professional behaviour (APES 110, s 100.4). Specific guidance on independence requirements provided in APES 110, s 290.

9. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-9 Learning objective 4: Applying ethics Sound ethical decision making is dependent on: —Knowledge of the basic principles on which moral values and rules are based —Competence in decision making —The ability to choose appropriate policies and decision procedures in different situations.

10. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-10 Ethical decision models There are three main models: 1.American Accounting Association Model 2.Mary Guy Model 3.Laura Nash Model.

11. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-11 Learning objective 5: Corporate governance Corporate governance: system by which companies are directed and managed. Concerned primarily with management and stewardship issues including: —Corporate strategy —Succession planning —Integrity of internal control structure —Remuneration policy.

12. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-12 Parties in corporate governance Board of directors Management Auditors

13. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-13 Groups advocating improved corporate governance The business community, including the Australian Institute of Company Directors (AICD) Investors Australian Stock Exchange (ASX) Australian Securities and Investments Commission (ASIC) CPA Australia and the Institute of Chartered Accountants Australia (ICAA)

14. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-14 ASX Corporate Governance Council’s Principles of Good Corporate Governance Principle 1:Lay solid foundation for management and oversight Principle 2: Structure the board to add value Principle 3: Promote ethical and responsible decision making Principle 4: Safeguard integrity in financial reporting Principle 5:Make timely and balanced disclosure

15. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-15 ASX Corporate Governance Council’s Principles of Good Corporate Governance (cont.) Principle 6: Respect the rights of shareholders Principle 7: Recognise and manage risks Principle 8: Encourage enhanced performance Principle 9: Remunerate fairly and responsibly Principle 10: Recognise the legitimate interests of stakeholders

16. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-16 Audit committees Sub-committee of board of directors, which should consist mainly of non-executive directors Auditor’s major dealings with the board of directors are normally through this sub-committee Important component of corporate governance, with most listed companies in Australia having an audit committee Top 500 companies on ASX now required to have an audit committee

17. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-17 Functions of audit committees Assist the board of directors Add to credibility and objectivity of financial reports Enhance auditor independence and effectiveness Consider appropriateness of accounting policies Consider policies for unethical or illegal activities Consider internal and management controls Communication link between management, board and auditors

18. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-18 Learning objective 6: Whistleblowing in Australia The Corporations Act 2001, s 311, imposes a responsibility on auditors to inform ASIC of any significant contraventions of the Act discovered in the normal course of their duties, and any other contraventions that cannot be remedied by comment in the audit report or by bringing the matter to the attention of directors. Arguably, this places an obligation on the auditor to whistleblow.

19. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-19 Whistleblowing defined A person ‘who discloses information he (or she) reasonably believes evidences a violation of any law, rule, or regulation, or mismanagement, a gross waste of public funds, an abuse of authority, or a substantial or specific danger to public health or safety’ is a whistleblower. United States Civil Service Reform Act 1978

20. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-20 Auditor’s responsibilities regarding whistleblowing An auditor does not have to actively look for contraventions of the Corporations Act 2001. The decision to blow the whistle is not easy for an auditor. Whistleblowing requires resolution of the conflict between the principles of independence, objectivity, integrity and public interest on the one hand, and client confidentiality on the other.

21. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-21 Auditor’s responsibilities regarding whistleblowing (cont.) ASA 240 (ISA 240) outlines that where an entity’s governing body fails to take appropriate action in regard to fraud, the auditor may take legal advice in considering whether to report the fraud to a third party.

22. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-22 Learning objective 7: The importance of audit independence Independence is a key characteristic of an audit or assurance service provider. In order for auditors to add credibility to financial reports or other subject matter, they need to remain independent. One of the fundamental ethical virtues or principles of APES 110.

23. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-23 Independence: Corporations Act 2001 s 307C: Independence declaration —Auditors must give directors a written declaration of their independence, and this is to be included in the directors’ report. s 324CA: Conflict of interest —Auditor must take reasonable steps to ensure conflict of interest situation ceases to exist. Conflict of interest is where members of audit team are not capable of exercising objective and impartial judgment, as judged by a reasonable person.

24. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-24 Independence: Corporations Act 2001 (cont.) s 300 (1)(ca): former auditors. Directors’ report is to include names of each officer of client who was a former partner or director of current auditor. s 324CI: member of audit firm cannot become director, company secretary or senior management of a client until two years after ceasing to be with audit firm. s 324DA: rotation of audit partners. Lead or review partner for five successive years cannot play a significant role in the audit of that entity for at least another two successive years.

25. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-25 Independence: Corporations Act 2001 (cont.) s 300(11)(B): non-audit services. Boards of all listed companies are required to provide a statement in their annual report that identifies all non-audit services provided by an audit firm, fees, and explanation why provision of service did not impair independence.

26. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-26 Auditor’s appointment s 327B: shareholders are responsible for the appointment of auditor: —Auditor is in breach of independence requirements if, while auditing at a time that a s 324CH(1) relationship exists, the auditor is aware of relationship and does not take all reasonable steps to discontinue the audit. s 324CH(1) relationships include: —Auditor or immediate family member being an officer or audit-critical member (influencing financial report) of client —Auditor cannot provide remuneration to officer or audit-critical employee for acting as consultant —Auditor cannot have an investment in client —Auditor cannot owe more than $5000 to a client (unless a housing loan on normal terms).

27. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-27 Auditors’ removal and resignation Removal: difficult to remove auditor. s 329: requires a resolution of company at a general meeting of which special notice is given. Auditor entitled to make written representation and speak at general meeting. A copy of notice must be sent to ASIC. Resignation: auditor can resign. Must have written consent from ASIC. Application outlines reason, and ASIC must approve the reason. Designed to ensure independence and integrity of audit function is maintained.

28. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-28 Right of access to records and reasonable fees s 310: auditor has right of access at all reasonable times to the accounting and other records and registers, and an entitlement to require from any officer of the company such information and explanations as required for the purposes of audit. s 331: auditor is entitled to receive reasonable fees and expenses for the work carried out. Collectively, these provisions assist an auditor to maintain actual and perceived independence, and attempt to create a suitable environment for an audit process that is free from undue influence and obstruction.

29. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-29 Independence: ethical requirements Test for independence is a reasonable person test: would a reasonable person having access to all facts consider that the auditor was independent? Ethical rules emphasise both: —Perceived independence (independence in appearance) — how others will view the auditor —Actual independence (independence of mind) — state of mind of the auditor. Whether the auditor can actually eliminate bias and personal interest from his or her decisions and not succumb to any pressures or influences. Related to integrity, objectivity and strength of character.

30. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-30 Learning objective 8: Recent developments in auditor independence Ramsay Report (Aust): issued October 2001 IFAC independence rules: adopted conceptual approach using a framework for identifying, evaluating and responding to threats to independence APES 110: based on IFAC independence rules Sarbanes-Oxley Act (USA): 2002

31. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-31 Learning objective 8: Recent developments in auditor independence (cont.) Joint Committee of Public Accounts and Auditors (Australia): 2002 HIH Royal Commission: 2003 Corporate Law Economic Reform Program (CLERP 9) (Australia): 2002–4

32. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-32 APES 110, s 290: Threats to independence Self-interest threats: auditor could benefit from a financial interest in the client. Self-review threats: auditor could have to re-evaluate his or her own work. Advocacy threats: auditor could promote the audit client’s point of view and compromise objectivity. Familiarity threats: auditor may become too sympathetic to the client’s interests. Intimidation threats: auditor may be deterred from acting objectively by actual or perceived threats from client.

33. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-33 APES 110, s 290: Safeguards Safeguards fall into three broad categories. For an auditor these are: 1.Safeguards created by the profession, legislation or regulation — education, professional standards, monitoring and disciplinary processes, and inspections and reviews. 2.Safeguards within the audit client — competent employees, corporate governance structures. 3.Safeguards within the audit firm — quality control, policies and procedures. The safeguards are aimed at reducing or resolving circumstances that pose threats.

34. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-34 Learning objective 9: Major threats to auditor independence Auditor employment relationships Financial and business relationships, including: —Investments in audit clients —Loans to and from clients —Business relationships —Goods and services from clients

35. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-35 Learning objective 9: Major threats to auditor independence (cont.) Provision of non-audit services, including: —Preparing financial reports —Taxation —Internal audit —Design of systems —Legal services —Corporate finance

36. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-36 Learning objective 10: Suggestions for improving auditor independence In Australia, the FRC now acts as a public oversight board for the AUASB (AUASB still has a number of practising auditors as members) Strengthening the role of audit committees Rotation of audit partners and audit firms Audit firm independence boards Client policies, such as restricting other services provided by audit firm

37. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-37 Learning objective 11: Fee determination Audit fees should be commensurate with the service provided. Thus, they should reflect the time taken to audit, and the knowledge, skills and expertise required. An auditor should not enter into fee arrangements that may compromise his or her independence. Fees for a period should not be dependent on fees from the provision of future audits or other services.

38. Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 3-38 Obtaining clients Advertising, publicity and solicitation are permitted provided they are not false, misleading, deceptive or otherwise reflect adversely on the profession. Competing for prospective clients through tenders is now quite common. Auditors should be careful of audit clients that are opinion shopping.