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Professional accountants and auditors must comply with a Code of Ethics (such as the IESBA's Code of Ethics for Professional Accountants) (the Code).
Many professional bodies worldwide have adopted the IESBA's Code and made certain amendments to it to be country-specific.
But, for the most part, the IESBA Code applies to most professional bodies and their members.
The overarching principle of an auditor is to act independently and with objectivity.
There are two critical aspects to independence:
Independence of mind; and Independence in appearance.
Independence of Mind
This state of mind permits the provision of an opinion without being affected by influences that compromise professional judgement, allowing an individual to act with integrity and exercise objectivity and professional scepticism.
Independence in Appearance
This is the avoidance of facts and circumstances that are so significant that a reasonable and informed third party, knowing all relevant information, including safeguards applied, would reasonably conclude that the integrity, objectivity or professional scepticism of a firm, or a member of the assurance team, had been compromised.
Consequently, the audit of a set of financial statements ought to be able to provide objective assurance regarding whether or not the financial statements give a true and fair view (or present fairly in all material respects).
This is something that the directors of a reporting entity will never be able to provide.
It is commercially unreasonable to expect auditors to resign from every audit where there was even the slightest threat to their independence and objectivity. Yet, there are numerous instances in which there are at least some threats to an auditor's independence and objectivity.
Where threats to independence and objectivity exist, the key is to put adequate safeguards in place to eliminate or reduce the threats to acceptable levels.
Where threats to independence and objectivity are concerned, there are generally five such threats:
Self-interest threat
Self-review threat
Advocacy threat
Familiarity threat
Intimidation threat.
Self-Interest Threat
A self-interest threat occurs when a financial or other interest in the entity may unduly affect the judgement or behaviour of the professional accountant.
This could happen, for instance, if the professional accountant or auditor has interests in the company being audited (for example, where the professional accountant or auditor holds shares in the reporting entity) or if the auditing firm has an excessive dependency on the fees from the company being audited.
Other self-interest threats can include:
Loans and guarantees to the client;
Overdue fees from the client;
Family and personal relationships;
Close business relationships;
Gifts and hospitality from the client; and
Contingent fees.
Self-Review Threat
When a professional accountant relies on information that was prepared by either the professional accountant or another individual working in the professional accountant's firm, this poses a risk of self-review.
An example of a threat posed by self-review is when a professional accountant generates a set of financial statements for a reporting entity and then audits those very same financial statements.
In addition, when a member of the audit or assurance team has joined the audit firm from the audit client, this will also give rise to a self-review threat if that person is engaged on the audit of his/her previous employer.
Advocacy Threat
An advocacy threat occurs when the professional accountant promotes a client's or employer's position to the point that the professional accountant's objectivity is compromised.
Such an example would be where the professional accountant represents the client in legal proceedings.
Familiarity Threat
A familiarity threat emerges when a professional accountant becomes unduly close or familiar with the client to the point that they may be too sympathetic to the customer's interests.
Intimidation Threat
When a customer or company puts pressure on a professional accountant to the point that there is a possibility that the professional accountant would be dissuaded from behaving objectively, this is an example of an intimidation threat.
Safeguards to Reduce Threats to an Acceptable Level
The phrase "safeguards" refers to the steps that a professional accountant takes to either eliminate the threats to objectivity and independence in totality or reduce those threats to an acceptable level.
There are two distinct categories into which safeguards might be placed:
Safeguards created by the professional, legislation or regulation; and
Safeguards in the actual working environment.
Safeguards created by profession include compliance with professional standards, including those laid down by the professional body of which the accountant/auditor is a member.
There are also additional safeguards, including:
Training and development;
Corporate governance regulations;
Regulatory monitoring by professional bodies; and
External reviews.
Training and development include training and experience requirements for entry into the profession and maintenance of those skills by undertaking Continuing Professional Education (CPE).
CPE requirements apply to all professionals regardless of the sector or size of the business in which they operate.
Regulatory monitoring includes reviews of professional accountants' work by professional bodies to ensure that professional standards, independence and objectivity are always maintained.
External reviews can take various forms, but in terms of auditing, they are usually split into two types of review:
Hot file review; and
Cold file review.
Hot File Review
Before the auditor's report is released, a hot file review is performed by an external file reviewer.
These reviews look at the audit work carried out and determine whether the audit evidence acquired is enough and pertinent to back up the auditor's suggested opinion in the report.
Cold File Review
An external file reviewer undertakes a cold File Review after the auditor's report has been issued.
Suppose various professional organisations decide, as a result of their inspections, that the audit work was inadequate. In that case, they may require such evaluations to be carried out as a condition of continuing to practise.
Such activities may sometimes be required as part of a regulatory monitoring visit. Although this is the case, most firms nevertheless demand cold file reviews voluntarily to ensure that their quality assurance procedures are up to the very minimal requirements set out by the relevant authorities and professional bodies.
An audit firm should make it a priority to implement company-wide safeguards. These safeguards should make it possible for the firm to comply, in every possible way, with the fundamental principles and ensure that its employees will, at all times, act in the general public's best interests.
There are many different approaches that firms may take to ensure that they have enough safeguards in place to cope with potential threats, such as the following:
Published policies to identify various threats and the procedures to be adopted to evaluate those threats' significance. The firm should resign or decline the engagement if the threats cannot be eradicated or mitigated to an acceptable level.
Engaging different partners on audit and non-audit assignments.
Engaging different staff on audit engagements where non-audit services have been provided to an audit client.
Discussing difficult or contentious issues arising during the course of an audit with specially trained staff, for example, complicated taxation matters, should be referred to the firm's tax department or tax partner.
Ensuring staff are kept technically up-to-date through the use of CPE.
Formulating a disciplinary mechanism to promote the firm's policies and procedures.
Ensuring regular and independent file reviews are undertaken to ensure the firm is undertaking audit work in compliance with the ISAs.
Rotating senior personnel.
The aforementioned list is not complete; nonetheless, it offers examples of the concerns that audit firms need to consider to ensure that proper safeguards are put into place.
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