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University of New South Wales School of Accounting Auditing and Assurance Services 2010

University of New South Wales School of Accounting Auditing and Assurance Services 2010. Lecture 12 The Auditing Profession. Lecture Summary. This lecture discusses auditing in its ethical, social and legal context. The lecture will cover Ethical requirements for auditors

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University of New South Wales School of Accounting Auditing and Assurance Services 2010

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  1. University of New South WalesSchool of AccountingAuditing and Assurance Services 2010 Lecture 12 The Auditing Profession

  2. Lecture Summary • This lecture discusses auditing in its ethical, social and legalcontext. • The lecture will cover • Ethical requirements for auditors • Auditor independence • Quality control in audit firms • Corporate governance and audit committees • Legal liability of auditors

  3. The Public Interest • A distinguishing mark of the accounting profession is its acceptance of its responsibility to act in the public interest. Therefore, a member’s responsibility is not exclusively to satisfy the individual needs of a client or employer. • APES 100.1 • The public interest is defined as the collective wellbeing of the community of people and institutions that the member serves. • AUST 100.1.1

  4. Ethics • Ethics is a branch of moral philosophy that deals with concepts of “right” and “wrong”. • When an accountant faces a choice between their private interest and the public interest, ethics should guide their choice. • To assist the accountant, a code of ethics has been developed by the ICAA and CPAA.

  5. Australian Ethical Standards • In Australia, ethical standards are issued by the Accounting Professional and Ethical Standards Board (APES); an independent body established by the professional accounting bodies • Code of Ethics is set out in APES 110 • Code is Mandatory under ASA 200.14 • Mandatory under Corporations Act 2001 s307C

  6. Fundamental Principals • All accountants should have the following characteristics (APES 110 s100.4) • Integrity • Objectivity • Professional competence and due care • Confidentiality • Professional behaviour

  7. Auditor Independence • Independence is a key characteristic of an audit or assurance service provider. • For auditor to add credibility to financial report or other subject matter, there is a need to remain independent. • There are both ethical and legal (Corporations Act) rules. • Ethical – APES 110 s290 • Legal – Corporations Act 2001 s307C and s324C, ASA 200.7

  8. Independence – Ethical Requirements • Emphasises both: • Independence in Appearance — how others will view the auditor; and • Independence of mind — state of mind of the auditor. Can they actually eliminate bias and personal interest from their decisions, and not succumb to any pressures or influences. (s290.8) • Test for independence is reasonable person test • Would a reasonable person having access to all facts consider that the auditor was independent?

  9. Threats to Independence • APES 110 s290.41.3 – 6 lists five threats to auditor independence • Self interest threat • Self review threat • Advocacy threat • Familiarity threat • Intimidation threat • The auditors needs to asses the level of threat and either remove the threat or refuse/remove themselves from the audit engagement.

  10. Self Interest Threat • Self Interest threat occurs when a firm or person could benefit from a financial, or other self interest in the client • Equity or loans to the client • Fee dependence on the client • Business relationships with the client • Contingent audit fees • Possibility of future employment with the client

  11. Self Review Threat • A self review threat occurs when • The auditor audits work that they have previously done for the client • For example, the firm auditing the client’s accounts after the firm helped to prepare them. • The auditor was an employee of the client • This only applies to senior auditors (partners/managers) who were senior employees at the client and had the ability to influence the financial statements or accounting system.

  12. Advocacy Threat • Advocacy threat occurs when a firm or individual auditor undertakes activities to promotes a client’s position or interests. • Promoting a clients shares or debt securities • Acting as an advocate for the client in • Litigation • Disputes with third parties

  13. Familiarity Threat • Familiarity threat occurs when there is a close relationship between the auditor and the client, such that the auditor is or is perceived to be too sympathetic to the client’s interests • Immediate family members as employees or directors • Former partner being a director or senior employee of the client • Acceptance of excessive gifts from the client

  14. Intimidation Threat • Intimidation threat occurs when an auditor may be deterred from acting objectively by actual or perceived threats from the client • Threats to replace the auditor with another. • Threats to reduce the work done and the fees that auditor will be paid.

  15. Independence – Corporations Act • The Corporations Act 2001 contains several provisions about the independence of company auditors. • The key sections of the Act are: • s307C: Requires auditors to issue declaration that they are independent. • S324C: General and specific independence requirements

  16. Corporations Law Requirements • Auditor cannot have financial interest in client (debt or equity) • Disclosure in Directors’ report • officers who are former auditors • non-audit services • Two year ‘cooling off’ period prior to directorship. • Rotation of individuals playing a significant role each 5 years.

  17. Quality Control in Audit Firms • The AUASB has issued a standard to force firms to establish internal quality control systems. • ASQC 1 Quality Control for Firms that Perform Audits and Reviews of Financial Reports and Other Financial Information, and Other Assurance Engagements • This is not a standard on how to audit but a standard on how to control an audit firm.

  18. Objective of Audit Firm • The objective of the firm is to establish and maintain a system of quality control to provide it with reasonable assurance that: • (a) The firm and its personnel comply with AUASB Standards, relevant ethical requirements, and applicable legal and regulatory requirements; and • (b) Reports issued by the firm or engagement partners are appropriate in the circumstances. • ASQC1.11

  19. Elements of Quality Control • The firm shall establish and maintain a system of quality control that includes policies and procedures that address each of the following elements: • (a) Leadership responsibilities for quality within the firm. • (b) Relevant ethical requirements. • (c) Acceptance and continuance of client relationships and specific engagements. • (d) Human resources. • (e) Engagement performance. • (f) Monitoring. • ASQC1.16

  20. Requirements • For each of the six elements of control, the firm shall • Establish policies and procedures to ensure that that element of control exists. • Communicate these policies to all staff. • Monitor and report on the effectiveness of and compliance with the policies. • Document the policies and their communcaiton and enforcement.

  21. Corporate Governance • Corporate governance is the system that describes the relationship between shareholders, directors and managers of companies. • Corporate governance is relevant to auditors, as the assurance they provide is one mechanism of corporate governance.

  22. The Audit Committee • The audit committee is a subcommittee of the board of directors. • It should be made up entirely of non executive directors. • It should contain members with experience in finance and accounting. • Its role is to provide a link between the external auditors, the boardand management.

  23. Audit Committee Functions • The functions of the audit committee are • Appointment of the external auditor and negotiation of fees • Removal of the external auditor • Communication with external auditors • Including resolving conflicts between management and external auditors. • Discussion of accounting policies • Including issues and errors raised by external auditors. • Oversight and review of internal controls. • Including those internal control issues raised by external auditors and internal auditors.

  24. Legal Liability of Auditors • Auditors can be sued for breach of contract by the company. • Auditors can also be sued for negligence by • The company • Third parties • These issues will be covered briefly, as this is not a course in corporate law, contract law or torts.

  25. Negligence • Any conduct which is careless or unintentional in nature and entails a breach of any contractual duty or duty of care in tort owed to another person or persons. • Elements the plaintiff must prove: • A duty was owed to plaintiff by defendant; • A breach of the duty of care (negligent conduct occurred); • Loss or damage was suffered by plaintiff; and • That a causal relationship existed between breach of duty by. defendant and harm suffered by plaintiff

  26. Common Law Duty of Care • In the Pacific Acceptance case, Moffit J declared that an auditor has the following duties and responsibilities: • to use reasonable care and skill, • to check and see for themselves, • to appropriately supervise and review, • to properly document procedures, • reliance can be placed on internal controls, • duty to warn and inform appropriate level of management, • duty to take further action where suspicion is aroused, • expectation of discovering material error or fraud; and • professional auditing standards provide a guide.

  27. Contributory Negligence • Contributory negligence exists where the plaintiff fails to exercise the required standard of care, thus contributing to its own loss. • The main case is AWA • AWA lost money due to internal control weaknesses over foreign exchange trading. • The auditor found these weaknesses but did not report them to the board of directors. • AWA sued the auditor for the failure to report - AWA won • The auditor appealed, claiming that it was the responsibility of the board to establish internal controls – they can’t just rely on the auditor. • The court ruled that AWA had contributed to its losses through its own negligence – the auditor has to pay reduced damages.

  28. Liability to Third Parties • For a claim of negligence, there must be a duty of care. • Does the auditor owe a duty of care to third parties? • The legal test is the proximity test • Is there a close enough relationship between the auditor and the third party for there to be a duty? • The law on this has varied widely over the years.

  29. Esanda • The current law was established in the Esanda case, decided by the High Court in 1997. • Esanda lent money to companies that collapsed. • They sued the auditor, claiming that they had relied on the auditor’s unqualified audit reports. • The high court held that the auditor did not have a duty of care because their audit reports were not designed to induce a third party to do anything. • It is now very difficult for third parties to sue auditors for negligence.

  30. Privity Letters • A privity letter is a letter from an auditor to a third party stating that they can rely on the audit report for a specific purpose. • A privity letter establishes a duty of care. • The auditor is paid to issue the letter. • AGS 1014 Privity Letters, provides specific guidance

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