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Part Three Audit Responsibilities

Part Three Audit Responsibilities. Structure of Seminar. 1.Auditing Standards 2.Professional auditing standards system 3.Fundamental principles of professional ethics 4.Audit Quality 5.Audit liability. 1.Auditing Standards.

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Part Three Audit Responsibilities

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  1. Part Three Audit Responsibilities

  2. Structure of Seminar • 1.Auditing Standards • 2.Professional auditing standards system • 3.Fundamental principles of professional ethics • 4.Audit Quality • 5.Audit liability

  3. 1.Auditing Standards • From 2004, Auditing & Assurance Standards Board (AUASB) constituted under the government’s Financial Reporting Council (FRC); issues Australian Auditing Standards (ASAs) • From 1 July 2006, Australia fully adopted international auditing standards (ISAs) • Standards a minimum level of care

  4. 2.Professional auditing standards system 1.Auditing standards -National auditing standards -Independent Auditing Standards -Internal auditing standards -International Standards on Auditing

  5. 3.Fundamental principles of professional ethics The CPA’s Code of ethics and conduct sets out five fundamental principles of professional ethics and provides a conceptual framework for applying those principles. Members must apply this conceptual framework to identify threats to compliance with the principles, evaluate their significance and apply appropriate safeguards to eliminate or reduce them so that compliance is not compromised.

  6. The fundamental principles • Members of the CPA must comply with the fundamental principles set out in the Code of ethics and conduct (integrity, objectivity, professional competence and due care, confidentiality and professional behaviour) • Confidentiality • Confidentiality requires members to refrain from disclosing information acquired in the course of professional work except where: - -Consent has been obtained from the client, employer or other proper source, or

  7. --There is a public duty to disclose, or --There is a legal or professional right or duty to disclose • A member acquiring information in the course of professional work should neither use nor appear to use that information for his personal advantage or for the advantage of a third party. • In general, where there is a right (as opposed to a duty) to disclose information, a member should only make disclosure in pursuit of a public duty or professional obligation.

  8. A member must make clear to a client that he may only act for him if the client agrees to disclose in full to the member all information relevant to the engagement. • Where a member agrees to serve a client in a professional capacity both the member and the client should be aware that it is an implied term of that agreement that the member will not disclose the client's affairs to any other person save with the client's consent or within the terms of certain recognised exceptions, which fall under obligatory and voluntary disclosures.

  9. If a member knows or suspects his client to have committed money-laundering, treason, drug-trafficking or terrorist offences, he is obliged to disclose all the information at his disposal to a competent authority. Auditing standards require auditors to consider whether non-compliance with laws and regulations affects the accounts. • Integrity, objectivity and independence The fundamental principles require that members behave with integrity in all professional and business relationships and they strive for objectivity in all their professional and business judgements. Objectivity is a

  10. state of mind but in certain roles the preservation of objectivity has to be shown by the maintenance of independence from those influences which could impair objectivity. It is very important that the auditor is impartial, and independent of management, so that he can give an objective view on the financial statements of an entity. The onus is always on the auditor not only to be ethical but also to be seen to be ethical. Independence and objectivity matter because of: (a) The expectations of those directly affected, particularly the members of the company. The audit

  11. should be able to provide objective assurance on the truth and fairness of the financial statements that the directors can never provide. (b) The public interest. Companies are public entities, governed by rules requiring the disclosure of information • What can the auditor do to preserve objectivity? The simple answer is to withdraw from any engagement where there is the slightest threat to objectivity. However there are disadvantages in this strict approach.

  12. --Clients may lose an auditor who knows their business. --It denies clients the freedom to be advised by the accountant of their choice. • A better approach would be to consider whether the auditors' own objectivity and the general safeguards operating in the professional environment are sufficient to offset the threat and to consider whether safeguards over and above the general safeguards are required, for example specified partners or staff not working on an assignment. • However the ultimate option must always be withdrawing from an engagement or refusing to act.

  13. Threats to independence and objectivity Compliance with the fundamental principles of professional ethics may potentially be threatened by a wide range of different circumstances. These generally fall into five categories: • 􀁸 Self-interest • 􀁸 Self-review • 􀁸 Advocacy • 􀁸 Familiarity • 􀁸 Intimidation

  14. 4.Audit Quality • DeAngelo [1981] – “the ability to detect misstatements plus to report the misstatements” • In other words: Quality = Competence + Independence • Both are essential!

  15. 5.Audit liability • 1) The Legal Environment • Auditors, as professionals, have a fiduciary duty to act in the best interests of shareholders • Auditors are accountable in law for their professional conduct • Alleged audit failures can result in litigation against audit firms • Requirement to hold a practising certificate imposes obligation to have professional indemnity (PI) insurance for possible liability

  16. Audit liability • A “hard” insurance market • This source of “compensation” (insurance) creates a perception of auditors having “deep pockets”, thus claims against auditors • This is consistent with the insurance hypothesis of the demand for auditing!

  17. The “Litigation Crisis”

  18. The Litigation Crisis

  19. Settled Cases

  20. Out of Court Settlements • Protection of auditors’ reputation BUT • Confidence problems not addressed • Auditing standards may not be adjusted • Audit expectations gap may not be addressed • Lack of impetus for regulatory change • Issues related to audit quality & independence are not publicly analysed

  21. Audit liability • 2) Bases of Liability • Contract law • Engagement letter is contract between auditor & directors • Common law (tort of negligence) (next slide) • Trade Practices law • S.52 prohibits deceptive & misleading conduct • Issuing a ‘clean’ opinion when a qualified opinion is warranted?

  22. Audit liability 3.)Professional Negligence • Action for damages may also be brought against an auditor under tort of negligence • Conduct that is careless or unintentional & breaches duty of care • Extension of Donoghue & Stevenson (1932) to financial injury • Negligent misstatement • What are the essential elements? • What constitutes due care? • To whom does the auditor owe a duty of care?

  23. What is Due Care? • Kingston Cotton Mill Co. (1896) • London & General Bank (1895) • The auditor is not necessarily answerable for an error of judgment, provided he/she exercises the skill and care of a reasonably competent and well-informed member of the profession • A “watchdog” not a “bloodhound” • Pacific Acceptance Case (1970) • “Reasonable skill and care” calls for changed standards to meet changed conditions or changed

  24. What is Due Care? understanding of dangers, and in this sense standards are more exacting today than in 1896 • Standards are thus a minimum standard of care • HIH Royal Commission emphasised the fiduciary duty of auditors, as users rely on their integrity

  25. Duty to Third Parties

  26. Duty to Third Parties • Esanda – good news for auditors, but is it socially desirable? • Liability of experts for consequences of negligent advice • Common law remains complex and uncertain due to differences in judicial opinions & interpretation • Courts must balance rights & responsibilities of auditors, investors & wider society

  27. Audit liability • 4)Reform of Legal Liability • Professional Standards Legislation (PSL) 2004 • Co-ordinates state & territory level legislation to be nationally consistent • Limits civil liability for misleading & deceptive conduct • Occupational schemes registered under PSL • Must have minimum PI cover of $500,000 • A statutory cap on liability relative to fees charged • Proportionate liability replaces joint & several liability • Contributory negligence (AWA Case) now irrelevant

  28. Reform of Legal Liability • CLERP 9 Act (2004) • Companies can be registered as an auditor • Authorised Audit Company • Each director must be a registered auditor • AAC must have adequate PI cover • Suggested cover to be 10 times the maximum engagement fee • Reforms designed to address possible dysfunctional consequences of litigation and insurance crises.

  29. Audit liability • 5)Avoidance of Litigation • Engagement letters • Audit & non-audit services • Clearly define scope & responsibility • Investigate prospective clients thoroughly • The first line of defence! • Comply fully with professional standards • Recognise their limitations – a minimum standard only

  30. Engagement letters • Audit & non-audit services • Clearly define scope & responsibility • Investigate prospective clients thoroughly • The first line of defence! • Comply fully with professional standards • Recognise their limitations – a minimum standard only

  31. Audit liability • 6) Conclusions • Business failure ≠ audit failure! • Litigation is a significant & costly issue for the profession • Auditors must take great care to protect themselves from litigation by complying with professional pronouncements, using sound judgment and maintaining quality & independence

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