2.6 Session 04

PROFESSIONAL CODES OF ETHICS AND BEHAVIOUR
OVERVIEW
Objective
To explain the ethical base of auditing.
PROFESSIONAL
CODES
Introduction ACCA RULES OF

Overseas members PROFESSIONAL IFAC CODE OF
CONDUCT ETHICS
Students
Fundamental principles Introduction
Objectives
Fundamental principles
The Code
Other services
INTEGRITY,
OBJECTIVITY & CONFIDENTIALITY CONFLICTS OF
INDEPENDENCE INTEREST
Principle Improper disclosure Member v client

Undue dependence Improper use Client v client
Overdue fees
Relationships
Beneficial interests
Audit appointments
Loans
Hospitality
Other services
Review procedures
Second opinions
 Accountancy Tuition Centre (Overseas Courses) Ltd 2001 0401

1 RULES OF PROFESSIONAL CONDUCT
1.1 Introduction
Members of the Association are required to observe proper standards of

professional conduct and refrain from misconduct
Failure to observe standards may result in disciplinary proceedings.
1.2 Overseas members
May adhere to local guidance where profession is controlled by a reputable

body or by law.
1.3 Students
Students, as affirmed by their signature to the application forms to be

enrolled as registered students, are bound by the ethical requirements of the
Association.
1.4 Fundamental Principles
Integrity In all professional, business and personal

financial relationships
Implies honesty, fair dealing and truthfulness.
Objectivity In all professional and business judgements
A state of mind which has regard to all

considerations relevant to the task but no other
Presupposes intellectual honesty.
Competence Should not accept work which cannot be

competently undertaken .
Due skill and care Professional work should be carried out with
due skill, care, diligence and expedition
With proper regard for technical and
professional standards expected.
Courtesy and consideration Towards all with whom they come into contact
while performing work.

2 INTEGRITY, OBJECTIVITY AND INDEPENDENCE
2.1 Principle
A member’s objectivity must be beyond question. Objectivity can only be assured if

the member is, and is seen to be, independent.
2.2 Area of risk – undue dependence on an audit client
2.2.1 Examples
The desire not to lose a prestigious client.
Fee income – for audit and other recurring work paid by one client (or a
group of connected clients) should not exceed the following extreme % of
gross practice income.
Initiate Extreme
review
Listed and other public interest companies 5% 10%
Other clients 10% 15%
Criterion does not apply to new practices.
The propriety of accepting or retaining clients should be reviewed

against lower % figures – and safeguards set up if engagement
accepted/retained.
A partner from another office in the practice may take final

reporting responsibility.
A company planning to seek a listing will be public interest before

it is listed (because publicity leading up to flotation will be “in the
public eye”).
Fee income – non-recurring assignments. If taken together with recurring

work, could give rise to dependency.
2.3 Area of risk – overdue fees
Can be a threat – akin to a loan (see below).

2.4 Area of risk – actual or threatened litigation
2.4.1 Examples
Issue of a writ for negligence
Allegations of fraud/deceit by officers of the company.
2.4.2 Discussion
Firm and client may be placed in adversarial positions, therefore
auditor unable to report impartially

client unwilling to disclose relevant information.
Auditor should have regard to circumstances where litigation might reasonably

be perceived by the public as in contemplation (eg where adverse publicity
affects a listed/public interest company and reference is made to reliance on
financial statements prepared by the firm).
2.5 Area of risk – family and other personal relationships
Legislation may prohibit an officer/employee of a company from accepting

appointment as auditor of that company (eg UK Companies Act 1989).
A member should not take part in the conduct of an audit of a company if he

has been an officer or employee of that company within the last 3 financial
years.
A practice should not report on a company if a company associated with the

practice fills the appointment of secretary to the client.
2.6 Area of risk – beneficial interests in shares and other investments
Shares acquired by a partner should be disposed of at the earliest practicable

date. Otherwise, disengage.
An auditor required to be a shareholder (eg by constitution should hold not

more than the minimum number of shares necessary to comply. The
shareholding should be disclosed in the accounts, in the directors’ report or
the auditor’s report.
A member should not have a Personal Equity Plan (PEP) which has among
its investments any audit client.

2.7 Area of risk – voting on audit appointments
A partner or member of staff who holds shares in a company which is an

audit client of the practice should not vote at any general meeting in relation
to the auditor’s
− appointment
− removal
− remuneration.
2.8 Area of risk – loans
In respect of an audit client, a practice should not

− make a loan
− accept a loan
− guarantee borrowings.
Audit partners and employees may have overdraft facilities and have
mortgage loans with financial institution clients.
2.9 Area of risk – goods and services; hospitality
Should not be accepted unless value of any benefit is modest.
2.10 Area of risk – provision of other services to audit clients
2.10.1 Generally
There is no objection in principle to providing services additional to audit.

BUT, do not perform management functions/make management decisions.
2.10.2 Preparation of accounting records
It is common to provide a range of accountancy services including

preparation of accounting records.
For a public interest company audit clients, a practice should not participate
in preparing accounts and accounting records, except to assist in routine
clerical or emergency situations.
Safeguards (in all cases)
Client accepts responsibility for records as its own

Practice must not assume management role
Practice to make appropriate audit tests.

2.10.3 Others
Recruitment of key financial/administrative staff – audit practice may advertise,

interview, “short list” and recommend but final decision must be client’s.
Specialist valuation (eg of a pension fund) – a practice should not audit financial
statements which include such a valuation carried out by the practice.
2.11 Review procedures
2.11.1 Annual review
To confirm that each engagement may be properly accepted or continued.
To identify situations where independence may be at risk and safeguards

need to be applied.
2.11.2 Safeguards
Inclusion of a manager or other qualified employee in the audit team.

Rotation of the engagement partner.
Rotation of senior members of staff.
Procedure to report to partner other than engagement partner as last resort.
Final reporting responsibility rests with a partner from another office.
Example 1
Required:
Comment and conclude on the following four situations.
Solution
(1) Petr, a recently qualified member of ACCA, has decided to go into practice
alone. He already has a small private portfolio of $150,000 gross fee income
but has now been approached by his cousin to take over the audit of her
company, the last audit fee for which was $120,000.
Comment –
Conclusion –

(2) Paine & Co has been requested by a long standing client to do a special
investigation into a foreign group of companies. The target group is based in
Turkey where the firm has no representation. The client is very keen to use the
firm and are prepared to pay not only for the cost of the investigation but also
the additional costs of the firm having to use temporary staff to service other
existing clients. The firm’s gross practice income is normally $7,500,000, the
audit fee for this client is normally $800,000. The extra service is expected to
cost the client $1,600,000.
Comment –
Conclusions –
(3) Ambit plc is preparing to apply for admission to a recognised stock market, at
the same time offering a proportion of its shares to the public. The directors
have asked Schilling & Co, as its auditors, to set up and maintain the
company’s share register on a computer database.
Comment –
Conclusion –

(4) Sean & Co are the auditors of Starck a.s. During 2001, Starck has expanded
rapidly, taken over three other companies and is currently preparing to float a
proportion of its shares on a recognised stock exchange. As a result of several
special assignments connected with these events, total fees from Starck amount
to 19% of the total fee income of Sean & Co in 2001.
In addition, Sean & Co’s senior tax manager owns a small number of shares in
Starck, acquired several years ago when the company issued shares under a
business expansion scheme.
Comment –
Conclusion –
2.12 Second opinions
When an entity approaches an accounting firm who is not its auditor for an opinion on
the application of accounting standards or principles.
2.12.1 Risks
The firm may express an opinion which is not based on the facts as known to
the auditor.
The second opinion may create undue pressure on the judgement and
objectivity of the appointed auditor.
2.12.2 Safeguards
The person or firm asked for a second opinion:
must obtain all relevant information by contacting the auditor and

asking for any relevant facts
should be prepared to provide the auditor with their opinion, given

the client’s permission.
If communication with the auditor is refused, a second opinion must not be given.

3 CONFIDENTIALITY
Two aspects
3.1 Improper disclosure 3.2 Improper use
3.1 Improper disclosure
3.1.1 Principle
Information acquired in the course of professional work should not be disclosed to

third parties without first obtaining the client’s permission.
Exceptions
there is a statutory right or duty to disclose

under obligation of a court order.
3.1.2 General position
Confidentiality is an implied term of a contract between an auditor and client.
It is in the public interest that this professional duty of confidence exists.
Auditors are normally under NO legal obligation to disclose defaults or

unlawful acts (or suspicions thereof) to anyone other than the client’s
management.
Where there is a right (as opposed to a duty), disclosure should only be made
in pursuit of a public duty or professional obligation.
Members are strongly recommended to take legal advice.
3.1.3 Obligatory disclosure
UK examples include actual or suspected offences of

terrorism
treason
money laundering
drug trafficking.
3.1.4 Voluntary disclosure
In the “public interest” to a person having proper interest to receive

information eg the police
To protect the auditor’s interests eg in defending against ACCA disciplinary
proceedings
Authorised by statute
To non-governmental bodies.

3.2 Improper use of information
3.2.1 Principle
A member acquiring information in the course of his or her professional work should
neither use nor appear to use that information for his personal advantage or for the
advantage of a third party.
3.2.2 Examples
When a member changes firm or employment he should distinguish between
− experience gained in the previous firm or employment; and

− confidential information acquired there.
A member should not deal in the shares of a company with which he has a
professional association as might make it appear that he was turning
information obtained in his professional capacity to his own advantage.
4 CONFLICTS OF INTEREST
4.1 Two types
4.2 Member v client 4.3 Client v client
The implications arising from possession and use of confidential information

are separate issues.
4.2 Member v client
4.2.1 Principle
Members should place clients’ interests before their own.
A firm should not accept or continue an engagement in which there is or is

likely to be a significant conflict of interests between the firm and the client.
Any financial gain which accrues or is likely to accrue to the firm as a result
of the engagement (other than properly earned fees etc) will ALWAYS
amount to a significant conflict of interest.

4.2.2 Commission
Where any commission, fee or reward may be earned for the introduction of a
client, or as a result of advice given to a client, the client should be informed
in writing
− that such commission, etc will be received; and

− as soon as practicable, of its amount and terms.
4.3 Client v client
4.3.1 General
There is nothing improper in a firm having two or more clients whose

interests may be in conflict.
However, the firm’s work should be so managed to avoid the interests of one
client adversely affecting those of another.
Where the acceptance or continuance of an engagement would, even with

safeguards, materially prejudice the interests of any client the appointment
should not be accepted or continued.
4.3.2 Managing conflict between clients’ interests
All reasonable steps should be taken to ascertain whether any conflict of

interests exists or is likely to arise in the future.
Relationships with existing clients need to be considered before accepting a

new appointment and regularly thereafter.
A relationship which ended over 2 years before is unlikely to give rise to

conflict.
4.3.3 Disclosure
A material conflict of interests between existing or potential clients should be

sufficiently disclosed so that they may make an informed decision whether to
engage or continue their relationship with the firm.
4.3.4 Safeguards
Use different partners and teams of staff for different engagements.
Standing instructions etc to prevent leakage of confidential information

between different teams and sections within the firm.
Regular review of the situation by a senior partner or compliance officer not

personally involved with either client.
Advising at least one or all clients to seek additional independent advice.

4.3.5 Disengagement
When necessary should be done as speedily as is compatible with the

interests of the clients concerned.
Example 2
Required:
Comment and conclude on the following situations:
Solution
(1) The audit senior of Neutron, a limited liability company, is having an affair
with the credit controller and is staying with her during the week and leaving
the audit files in the boot of his car overnight. There are no other audit staff
available that the client considers to be capable of replacing him on the
assignment.
Comment –
Conclusion –
(2) A part-time partner in Spoils & Co is also a councillor in the local authority.
She has been acting for Radnor Ltd whose business venture now requires
planning permission from the local authority. The partner sits on the planning
committee and recently vigorously opposed a similar application.
Comment –
Conclusion –
(3) In an effort to reduce audit fees your client, Finders Ltd, has employed an
accountant on a temporary basis to assist you with your audit work. The client
feels that it will be cheaper for the temporary accountant to perform some of the
audit testing, replacing one member of your staff.
Comment –
Conclusion –

(4) Trainees of Porterhouse, a firm of Certified Accountants, have been offered

overdraft facilities up to $3,000, on student terms, by a client bank.
Comment –
Conclusion –
5 IFAC CODE OF ETHICS FOR PROFESSIONAL ACCOUNTANTS
5.1 Introduction
IFAC believes that member bodies (eg ACCA) are primarily responsible for
preparing detailed ethical requirement
implementing and enforcing such requirements.
The international code sets standards of conduct and states fundamental

principles to be the basis on which ethical requirements should be founded.
5.2 Objectives of the accountancy profession
To work to the highest standards of professionalism

To attain the highest levels of performance
To meet the public interest requirement.
5.3 Fundamental Principles
These are the same as the ACCA’s but described under the headings of
Integrity
Objectivity
Professional competence and due care
Confidentiality
Professional behaviour
Technical standards.
5.4 The Code
Provides guidance on the practical application of the objectives and

fundamental principles regarding typical situations concerning
Integrity and objectivity
Independence
Resolution of ethical conflicts
Professional competence
Confidentiality.
Guidance is not reproduced as all relevant considerations have been dealt with by the
ACCA’s “Rules of Professional Conduct”

5.5 Provision of other services
5.5.1 Arguments against prohibiting
It is economic for auditors to offer financial and management consultancy

services.
Many companies would be adversely affected if “other services” were

prohibited.
Providing advice on tax and the system of internal control is unavoidable in

the conduct of an audit.
6 INTERNAL AUDITORS
6.1 Professional bodies
There are many national and international associations, institutes and other professional
bodies of internal auditors. For example:
The Institute of Internal Auditors (IIA); and

The IIA-UK and Ireland.
6.2 Codes of Ethics
Like many recognised professions, internal auditing has developed codes of

professional ethics. These codes are comparable to those of independent auditors. A
code of ethics is necessary and appropriate for the profession of internal auditing,
founded as it is on the trust placed in its objective assurance about risk, control, and
governance.
The purpose of the Code of Ethics of The Institute of Internal Auditors (IIA) is to
promote an ethical culture in the global profession of internal auditing. It applies to
both individuals and entities that provide internal audit services.
The IIA’s Code (adopted June 2000) has two essential components:
Principles ; and
Rules of Conduct (which provide guidance on practical application of the Principles).
6.2.1 Integrity
Principle – establishes trust which provides the basis for reliance on their
judgment.
Rules of Conduct:
to perform work with honesty, diligence and responsibility;
to observe the law and the profession;
to not knowingly be a party to any illegal activity, or engage in acts

discreditable to the profession or the organization;
to respect and contribute to the legitimate and ethical objectives of

the organization.

6.2.2 Objectivity
Objectivity An unbiased mental attitude that requires internal auditors to perform

—
engagements in such a manner that they have an honest belief in their work product and
that no significant quality compromises are made. Objectivity requires internal auditors
not to subordinate their judgement on audit matters to that of others.
Principle – judgements are not unduly influenced by the interests of the

internal auditor or others.
Rules of Conduct:
not to participate in any activity or relationship (including conflicts

of interest) that may (presume to) impair an unbiased assessment;
not to accept anything that may (presume to) impair professional

judgment;
to disclose all material facts known that, if not disclosed, may

distort the reporting of activities under review.
Impairments to individual objectivity and organizational independence may

include:
personal conflicts of interest;

scope limitations
restrictions on access to records, personnel and properties; and
resource limitations (funding).
6.2.3 Confidentiality
Principle – respecting the value and ownership of information received.
Rules of Conduct:
to be prudent in the use and protection of information acquired in

the course of duties;
not to use information for personal gain or in a manner contrary to the

law or detrimental to the organisation’s legitimate and ethical objectives.
6.2.4 Competency
Principle – applying the knowledge, skills, and experience needed.
Rules of Conduct:
to engage only in those services for which they have the necessary
knowledge, skills, and experience;
to perform internal auditing services in accordance with the

Standards for the Professional Practice of Internal Auditing;
to continually improve their proficiency and the effectiveness and

quality of services.

FOCUS
You should now be able to
define the fundamental concepts of professional ethics
define the detailed requirements of, and illustrate and analyse the application of,
professional ethics in the context of independence, objectivity and integrity
define the detailed requirements of, and illustrate and analyse the application of,
professional ethics in the context of confidentiality and conflicts of interest
distinguish between the elements of professional ethics applicable to internal

auditors and those applicable to external auditors.
Session5 deals with ethical guidance relating to a change in professional appointment.

EXAMPLE SOLUTIONS
Solution 1 – Undue dependence
(1) The 15% rule need not be applied when a practice is being established, but safeguards are
necessary.
Family relationship may cause a problem if a disagreement arises. Even if he is not very
close to his cousin, objectivity may appear to be threatened.
Possible safeguard – arrangement for consultation with another practitioner. In due course
Petr may have a qualified employee (for inclusion in the audit team) or enter into a
partnership (allowing rotation of engagement partner).
Conclusion – Decline, unless safeguards adequate, on “relationship” grounds.
(2) The 15% rule applies to recurring work. Nevertheless, objectivity should be reviewed with
respect to audit assignment as audit fee >10%. Total income from client in current year is
likely to create undue dependence: [(800k + 1,600k) ÷ (7,500k + 1,600k) ≈ 26%].
It is extremely unusual for the client to bear the additional costs to the practice caused by its
lack of resources. The partners must be absolutely convinced that they would be able to
resist any pressure that the client might exert before accepting.
Competence of temporary staff would need to be established.
Possible safeguard – different staff members/partner assigned to audit and special

investigation.
Conclusions – As existing clients, in particular, are likely to perceive undue dependence

special investigation should be declined. Engagement partner on audit should be rotated.
(3) Resources required to set up (and subsequently maintain) the database may affect service
offered to other existing clients. In particular, database expertise will be required.
Nature of additional service is unlikely to appear to threaten objectivity (eg no managerial

involvement).
As a plc, recurring fees (audit + maintenance) must not exceed 10% gross practice income.
Safeguards required if >5%.
Conclusion – Additional service is likely to be acceptable within ethical constraints.
(4) 19% of total fee income may not affect independence if recurring element is less than 10%.
(Company may have only recently become “public interest” thereby reducing a 15% fees limit
to 10%.) However, 19% may be undesirably high in appearing to detract from objectivity.
Beneficial interest in shares does not affect independence because holder is tax (not audit)
and manager (not partner). However, as the tax manager has an interest in understating the
tax charge, objectivity may appear to be impaired.
Staff involved in the special assignment should not be responsible for the audit as a special
relationship may be established.
Conclusion – If recurring element constitutes 5-10% gross practice income, can retain with
safeguards.

Solution 2 – Ethical issues
(1) Objectivity appears to be threatened by personal relationship. Even if credit controller is not
regarded as a senior employee the senior’s objectivity may be impaired, eg when reporting
weaknesses in credit control.
Senior is not keeping audit working papers in safe custody – could result in breach of duty of
confidentiality.
It is not up to the client to determine who is capable of undertaking the assignment –

otherwise this would constitute undue influence. No audit senior is irreplaceable.
Conclusion – Senior should be replaced immediately. Audit timetable may have to be put
back. The Senior's work should be reviewed as soon as possible and, if necessary, re-
performed.
(2) A conflict of interest has arisen between partner and client. She must declare her position to
the client. To abstain from debating or voting on this issue in council may be a breach of her
duty as councillor. Another partner within the firm may be able to assume responsibility to
act for Radnor Ltd in this matter.
Conclusion – Client may not accept that any safeguards will resolve the conflict ∴ partner
should disengage – if not removed.
(3) Qualifications held/previous experience of temporary accountant – is he competent? The

degree of supervision and review of his work required may stretch resource of more senior
audit staff.
Independence of temp may be impaired, eg if an employee of the client rather than a temping
agency.
His objectivity may be impaired, eg if he will be recording transactions to be audited.
Conclusion – If suitable (eg low risk) work could be allocated, the conduct of the audit may
not be impaired.
(4) Loans (including overdrafts) on normal commercial terms may be accepted by members of
staff (including trainees). (Only loans to audit practice are prohibited.)
“Student terms” may be “normal commercial” if the bank offers them to all accountancy
trainees – not just those of Porterhouse. If not “normal commercial”, is benefit more than
“modest”?
Conclusion – Engagement and compliance partners may decide that acceptance of the offer
will not appear to threaten objectivity even if the terms are special. However, as a safeguard
it should be confirmed that terms are no more favourable (or no less unfavourable!!) than
those offered to other trainees.

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PROFESSIONAL CODES OF ETHICS AND BEHAVIOUR

To explain the ethical base of auditing.

Introduction ACCA RULES OF

Principle Improper disclosure Member v client

 Accountancy Tuition Centre (Overseas Courses) Ltd 2001 0401

1 RULES OF PROFESSIONAL CONDUCT

Members of the Association are required to observe proper standards of

Failure to observe standards may result in disciplinary proceedings.

1.2 Overseas members

May adhere to local guidance where profession is controlled by a reputable

Students, as affirmed by their signature to the application forms to be

1.4 Fundamental Principles

Integrity In all professional, business and personal

Objectivity In all professional and business judgements

A state of mind which has regard to all

Competence Should not accept work which cannot be

 Accountancy Tuition Centre (Overseas Courses) Ltd 2001 0402

2 INTEGRITY, OBJECTIVITY AND INDEPENDENCE

A member’s objectivity must be beyond question. Objectivity can only be assured if

2.2 Area of risk – undue dependence on an audit client

The desire not to lose a prestigious client.

Listed and other public interest companies 5% 10%

Other clients 10% 15%

Criterion does not apply to new practices.

The propriety of accepting or retaining clients should be reviewed

A partner from another office in the practice may take final

A company planning to seek a listing will be public interest before

Fee income – non-recurring assignments. If taken together with recurring

2.3 Area of risk – overdue fees

Can be a threat – akin to a loan (see below).

 Accountancy Tuition Centre (Overseas Courses) Ltd 2001 0403

2.4 Area of risk – actual or threatened litigation

Issue of a writ for negligence

Allegations of fraud/deceit by officers of the company.

Firm and client may be placed in adversarial positions, therefore

auditor unable to report impartially

Auditor should have regard to circumstances where litigation might reasonably

2.5 Area of risk – family and other personal relationships

Legislation may prohibit an officer/employee of a company from accepting

A member should not take part in the conduct of an audit of a company if he

A practice should not report on a company if a company associated with the

2.6 Area of risk – beneficial interests in shares and other investments

Shares acquired by a partner should be disposed of at the earliest practicable

An auditor required to be a shareholder (eg by constitution should hold not

 Accountancy Tuition Centre (Overseas Courses) Ltd 2001 0404

2.7 Area of risk – voting on audit appointments

A partner or member of staff who holds shares in a company which is an

2.8 Area of risk – loans

In respect of an audit client, a practice should not

2.9 Area of risk – goods and services; hospitality

Should not be accepted unless value of any benefit is modest.

2.10 Area of risk – provision of other services to audit clients

There is no objection in principle to providing services additional to audit.

2.10.2 Preparation of accounting records

It is common to provide a range of accountancy services including

Safeguards (in all cases)

Client accepts responsibility for records as its own

 Accountancy Tuition Centre (Overseas Courses) Ltd 2001 0405

Recruitment of key financial/administrative staff – audit practice may advertise,

2.11 Review procedures

2.11.1 Annual review

To confirm that each engagement may be properly accepted or continued.

To identify situations where independence may be at risk and safeguards

Inclusion of a manager or other qualified employee in the audit team.