1. Prepared by: Angela Davis CA, CFE, MSc Booth University College
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2. ETHICS, LEGAL LIABILITY AND CLIENT ACCEPTANCE
Describe the fundamental principles of professional ethics and list some of the specific rules professional accountants are required to follow
Define and explain auditor association and independence
Explain the relationship between an auditor and key groups they have a professional link with during the audit engagement
Explain the auditor’s legal liability to their client, contributory negligence, and the extent to which an auditor is liable to third parties
Identify the factors to consider in the client acceptance or continuance decision.
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3. Fundamental principles of professional ethics
All members of the three professional accounting bodies (CA, CGA, CMA) in Canada have professional codes of conduct.
Common fundamental ethical principles include:
Integrity
Objectivity
Professional competence and due care
Confidentiality
Professional behaviour
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4. Fundamental principles of professional ethics cont’d
Integrity
To be straightforward and honest
Objectivity
Not allow personal feelings or prejudices to influence professional judgement
Be unbiased
Not allow conflict of interest or influence of others to impair decision process
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5. Fundamental principles of professional ethics cont’d
Professional competence and due care
Maintain knowledge and skill at a level required by professional bodies,
Keep up-to-date with changes in regulations and standards,
Continue education and work experience,
Act diligently, taking care to complete each task thoroughly, document all work, finish on a timely basis
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6. Fundamental principles of professional ethics cont’d
Confidentiality
Refrain from disclosing information to people outside the workplace that is learned as a result of employment
Exception if legal requirement to disclose
Not allowed to use confidential information to their advantage or advantage of another person
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7. Fundamental principles of professional ethics cont’d
Professional behaviour
Comply with rules and regulations and do not harm reputation of the profession
Be honest in representations to current and prospective clients
Do not claim to provide services they cannot provide, or qualifications they do not possess, or experience they do not have
Do not undermine reputation of, or quality of work produced by, others
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8. Auditor independence
Independence is the ability to act with integrity, objectivity and with professional scepticism (questioning mind)
Lack of auditor independence impacts on credibility and reliability of the financial statements
The auditor must be, and be seen to be, independent
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9. Auditor independence cont’d
Independence of mind – ability to act independently; ability to make a decision free from bias, personal belief and client pressures
Also known as actual independence
Independence in appearance – belief that independence of mind has been achieved
Also known as perceived independence
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10. Auditor independence cont’d
Threats to independence
Self-interest
Self-review
Advocacy
Familiarity
Intimidation
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11. Auditor independence cont’d
Self-interest threat
Can occur if the audit firm or its staff have financial interest in audit client
Examples:
Bank account held with the client
Shares owned in the client
A loan to or from the client
Fee dependence, where the fees from a client form a significant proportion of all fees of the firm
Close business relationship with the client
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12. Auditor independence cont’d
Self-review threat
Can occur when the assurance team need to form an opinion on their own work or work done by others in their firm
Examples:
Assurance team member has recently been an employee or director of the client
Preparing information for the client that is then assured
Performing services for the client that are then assured
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13. Auditor independence cont’d
Advocacy threat
Can occur when an audit firm or assurance staff act, or is believed to act, on behalf of assurance client
Can lead to questioning of auditor’s objectivity
Examples:
Encouraging others to buy client’s shares or bonds
Representing client in negotiations with third party
Representing the client in a legal dispute
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14. Auditor independence cont’d
Familiarity threat
Can occur when close relationship exists or develops between assurance firm and client, or firm and client personnel
Assurance staff can become too sensitive to needs of client and lose objectivity
Examples:
Long association between assurance firm and client
Long association between assurance firm and client personnel
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15. Auditor independence cont’d
Familiarity threat cont’d
Close personal relationships between assurance firm staff and senior client personnel
Former partner of assurance firm holding senior position at the client
Acceptance of gifts by members of assurance team from their client (other than minor tokens)
Acceptance of hospitality by members of assurance team from client (other than minor gestures)
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16. Auditor independence cont’d
Intimidation threat
Can occur when member of assurance team feels threatened by the client’s staff or directors
Assurance team member unable to act objectively, fearing negative consequences
Examples:
Threat that client will use different assurance firm next year
Undue pressure to reduce audit hours to reduce fees paid
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17. Auditor independence cont’d
Additional requirements for public companies with market capitalization and a book value of total assets great than $10 million include:
Audit partner rotated off every 7 years, with 5 year break from audit engagement
Audit committee must pre-approve all services provided to the client
Audit partners not to be directly compensated for selling non assurance services to client
If engagement team member accepts employment in financial reporting role with client, firm refrains from being the auditor of client for one year from last filing
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18. Auditor independence cont’d
Safeguards to independence
Created by profession, legislation or regulation
Quality control standards
Code of ethics
Legislative requirement to be independent
Created by clients
Corporate governance
Policies and procedures
Created by accounting firms
Quality control procedures
Client acceptance and continuance
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19. Auditor’s relationships with others
Shareholders
Audit report addressed to them
Attendance at AGM
Formal responsibility for auditor appointment
Board of directors
Represents shareholders
Executive and non-executive directors
Large companies have committees made up of several directors to deal with specific issues
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20. Auditor’s relationships with others cont’d
Audit committee
A special committee of the board of directors
Acts on behalf of board in financial reporting and audit matters
Canadian Securities Administrators require all listed companies must have an audit committee
Aid to auditor independence
Non-executive directors, majority independent
At least three independent directors must be financially literate
Meets with external and internal auditors
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21. Auditor’s relationships with others cont’d
Internal auditors
Viewed by external auditor as part of client
External auditor can modify the nature and timing of their procedures and reduce the extent of their testing if there is an effective internal audit function (CAS 610). Depends on internal auditor’s:
Objectivity
Technical competence
Due professional care
Communication with external auditors
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22. Internal vs External Auditor
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23. Legal liability
External auditor must exercise due care, be diligent in applying standards and documenting work
Auditor can be found negligent and liable for damages under tort law if it is established that:
A duty of care was owed by the auditor
There was a breach of the duty of care
A loss was suffered as a consequence of that breach
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24. Legal liability cont’d
Legal liability to clients:
Liability under either contract or tort law
Negligence: failed in performance of audit by being careless and breaching duty of care
Contract: failed duty of care implicit in acting as auditor and explicit in engagement letter
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25. Legal liability cont’d
Contributory Negligence
Where a plaintiff (party suing) and the defendant (the auditor) can be proven to have been negligent, each party must be held responsible in proportion to their guilt.
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26. Legal liability cont’d
Legal liability to third parties
Third party = anyone other than the client and its shareholders who use the financial information to make a decision
No contract between auditor and third parties
Need to establish that a duty of care was owed to the third party and that the auditor’s negligence was responsible for the third party’s loss
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27. Legal liability cont’d
Legal liability to third parties
Utramares Corp vs. Touche (1931 US): auditors not liable for ordinary negligence to parties that they do not have a contractual relationship with
Hedley Byrne & Co Ltd. vs. Heller and Partners Ltd (1963): expanded concept of liability beyond the contractual one to those third parties provided the auditors knew before hand this party would be relying on their opinion
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28. Legal liability cont’d
Haig vs. Bamford et al (1976): although the auditor did not know the actual name of the investor, they new the financial statements were being passed on to unidentified members of a limited class for use in a transaction
Hercules Management vs. Ernst & Young (1997): ruled the audited financial statements were prepared to evaluate management stewardship, not for individuals making investment decisions
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29. Legal liability cont’d
Overall:
To determine care owed to third parties
The third party must establish auditor was aware of the third party was going to use the financial statements and that they relied upon the financial statements for the purpose they were prepared.
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30. Legal liability cont’d
Auditor can take steps to avoid litigation
Hire competent staff, regular training
Comply with ethical and auditor regulations
Implement policies and procedures:
Client acceptance
Staff allocation
Ethical and independence issue identification and rectification
Adequate work documentation
Gather adequate and appropriate evidence to support opinion
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31. Legal liability cont’d
Auditor can take steps to avoid litigation cont’d
Meet with client’s audit committee to discuss significant issues arising in audit
Follow up any significant weaknesses in client’s internal control procedures from previous year audit
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32. Client acceptance and continuance
The first stage in any audit is client acceptance or continuance decision
Guidance provided in CSQC1
Step 1: Assess client integrity
Step 2: Assess audit firm’s ability to meet ethical requirements, service client
Step 3: Prepare client engagement letter
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33. Client acceptance and continuance cont’d
Client integrity - Auditor should consider:
Reputation of client, management, directors, key stakeholders
Client’s reason for switching auditor
Client’s attitude to risk exposure and management
Client’s attitude to using internal controls to mitigate risk
Appropriateness of the client’s interpretation of accounting rules
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34. Client acceptance and continuance cont’d
Client integrity cont’d
Client’s willingness to allow auditor full access to information required to form an opinion
Client’s attitude and willingness to pay fair amount for audit work
Auditor can obtain information from:
Communication with prior auditor, client personnel, third parties, key competitors
Review of press articles
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35. Client acceptance and continuance cont’d
Ethical requirements
Consider if any threats to fundamental principles arise from appointment
Auditor must ensure it has sufficient staff available with required knowledge to complete audit (professional competence and due care)
Consider potential safeguards and remedies
Decline appointment if threat insurmountable
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36. Client acceptance and continuance cont’d
Engagement letter (CAS 210)
Prepared by auditor, acknowledged by client (need to update each year)
Explains scope of audit, timing of various aspects of audit, overview of client responsibilities
Identifies the applicable financial reporting framework and form/content of audit report
Confirms auditor’s right of access to information, independence considerations
Sets fees
See figure 2.1 for example
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37. Sample Independence Letter
Figure 2.1

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