What are your expectations for this

course?

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 What you’ll need to do well in this
course
• Analytical skills
• Problem solving skills
• Communications skills
• Type of traveler
– Hitchhiker: gets by on the efforts of others. Relies on study groups and
friends. Individual effort /discipline never put to the test – all hitched
to the success of others
– Short cut taker: Google cut & paste/comes to tutorials to take notes
– One track mind – opposite of hitchhiker: no time for group work/study
group. You know you are here to get 1st class honours and you know
how to get it
– One who enjoys the journey and not just about the destination

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 ACCT3043 – AUDITING I

Auditing Framework,
Professional Ethics & Auditor Liability

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 Learning Objectives
At the end of this lecture you should be able to:
▪ Define auditing and state its objectives
▪ Distinguish between auditing and accounting
▪ Outline, in broad terms, the structure of the profession
▪ Explain the importance of standards to the audit process
▪ Explain the steps to resolve ethical conflict
▪ Explain some of the key principles of the ICAJ Code
▪ Explain the auditor’s duty of care in reporting to
shareholders
▪ Explain the auditor’s liability to third parties

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 Definition / Nature of Auditing
Auditing is the accumulation and evaluation of
evidence about information to determine and report on
the degree of correspondence between the information
and established criteria.

Auditing should be done by a competent, independent

person.

The final stage in the auditing process is preparing the

Audit Report, which is the communication of the
auditor’s findings to users.
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 Objective of financial statement audit

ISA 200 states the objective of an audit of financial

statements is to enable the auditor to express an opinion
whether the financial statements are prepared, in all
material respects, in accordance with an identified financial
reporting framework.

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Stakeholders of a company?

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Relationships Among Auditors, Client,
and External Users

Client or audit Auditor Auditor issues

committee hires report relied
auditor upon by users

Unequal perceptions of
External
Client responsibilities =
Users
“Expectation gap”

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 Distinguish Between
Auditing and Accounting
Accounting is the recording, classifying, and
summarizing of economic events for the purpose
of providing financial information used in
decision making.

Auditing is determining whether recorded

information properly reflects the economic events
that occurred during the accounting period.

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 Economic Demand
for Auditing

Reduce Information risk:

the possibility that the information upon
which the business decision was made was
inaccurate.

Promotes credibility in the capital market

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 TYPES OF AUDIT
Audit of financial statements (aka Statutory Audit)
Examine financial statements, determine if they give
a true and fair view or fairly present the financial
statements.
Operational Audit
A study of a specific unit of an organization for the
purpose of measuring its performance.
Compliance Audit
A review of an organization’s procedures and
financial records performed to determine whether
the organization is following specific procedures,
rules, or regulations set out by some higher
authority.

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 Types of Auditors
• Internal auditors are employed by individual
companies to investigate and appraise the
effectiveness of company operations for
management.

• Independent auditors are typically certified

either by a professional organization or
government agency.

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 Statutory Audit and Regulation

• The Regulatory Framework – auditors rights and duties are

government by national legislation eg in Jamaica it’s the
Companies Act 2017
• Appointment, Removal and Resignation of Auditors –
appointment and removal require shareholders’ resolutions.
Auditors may resign at anytime by giving notice in writing.
• International Federation of Accountants (IFAC) – is an
international organization of accountancy bodies. Its mission is to
establish and promote adherence to high quality professional
standards.
• International Auditing and Assurance Standards Board (IAASB)
this is an operating board of IFAC, produces international
standards on auditing, assurance and related services
• Regulation by the profession professional bodies, such as ICAJ,
establish regulation relating to education and training and ethics

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 International Auditing and Assurance Standards
Board (IAASB) Issues:

• International Standards on Auditing (ISAs) as the standards to be

applied by auditors in reporting on historical financial
information.
• International Standards on Assurance Engagements (ISAEs) as
the standards to be applied by practitioners in assurance
engagements dealing with information other than historical
financial information
• International Standards on Quality Control (ISQCs) as the
standards to be applied for all services falling under the Standards
of the IAASB
• International Standards on Related Services (ISRSs) as the
standards to be applied on related services, as it considers
appropriate
• International Standards on Review Engagements (ISREs) as the
standards to be applied to the review of historical financial
information.

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 US Auditing Standards
US Generally Accepted Auditing Standards (US
GAAS)

• American Institute of Certified Public Accountants

(AICPA) via the Auditing Standards Board (ASB)

• Securities & Exchange Commission (SEC)

• Sarbanes-Oxley Act 2002 established:

– Public Company Accounting Oversight Board (PCAOB)

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Requirements for ACCA qualification

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 Requirements US CPA Licensee

Educational requirement – 150 credits to sit exams

Uniform examination requirement

Experience requirement – Average 2years

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 Requirements Canadian CPA

Educational requirement – BSc & specific courses

Evaluation (includes final exam)

Experience requirement – Minimum 30 months

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Certified Accountants Encouraged to Conduct
Themselves at a High Level

Qualifying GAAS/ISA and

examination interpretations Continuing
education
requirements
Quality
control
Conduct of
Legal
Audit firm liability
Peer
personnel
review

Division of
Code of Audit firms
IFAC, PCAOB
Professional
and SEC
Conduct

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PROFESSIONAL ETHICS

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 What Are Ethics?

Ethics can be defined broadly as

a set of moral principles or values.

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Illustration 3.1
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 Why People Act Unethically

The person’s ethical standards are different

from those of society as a whole.

The person chooses to act unethically.

In many instances, both reasons exist.

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 Rationalizing
Unethical Behavior

Everybody does it.

If it’s legal, it’s ethical.

Likelihood of discovery and consequences

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 Ethical Dilemmas

An ethical dilemma is a situation a person

faces in which a decision must be made
about appropriate behavior.

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 Legal but Unethical
• Give examples on matter that may be legal but
unethical

• Give example of ethical dilemma in audit firm.

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 Resolving Ethical Dilemmas
• Obtain the relevant facts
• Identify the ethical issues from the facts.
• Determine who is affected.
• Identify the alternatives available to the
person who must resolve the dilemma.
• Identify the likely consequence of each
alternative.
• Decide the appropriate action.

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 Actual Case
“Staff at KPMG are 'embarrassed' and some even
'regret their decision to join' the Big Four firm, after the
US regulator (SEC) slammed the firm with a $50m fine
for cheating in professional exams and massaging audit
results to avoid regulator fallout”

Extracted from Accountancy Daily 28 June 2019

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THE PURPOSE AND CONTENT
OF THE ICAJ CODE OF ETHICS

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Code of Ethical conduct for ICAJ
members – Sections of the Code

Ethics applicable to all

Professional accountants

Ethics applicable to members in

Public practice

Ethics applicable to members not

in Public practice
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Code of Ethics - Relevant Sections
• S1 – Integrity & Objectivity
Independence

Applicable to all • S2 – Resolution of Ethical Conflict

accountants & • S3 – Professional Competence
those in public
• S4 – Confidence
practice
• S9 – Independence
• S11 – Fees & Commission

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 Integrity & Objectivity
1.1 Integrity implies not merely honesty but fair
dealing and truthfulness.

The principle of objectivity imposes the

obligation on all members as professional
accountants to be fair, intellectually honest
and free of conflicts of interest.
Enron Case (shredded documents)

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 Confidentiality
4.1 Members have an obligation to respect the
confidentiality of information about a client’s or
employer’s affairs acquired in the course of
professional services.

The duty of confidentiality continues even after

the end of the relationship between the member
and the client or employer.

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 Confidentiality & Disclosure
Instances where confidentiality is secondary:
i. When disclosure is authorized by the client
ii. When disclosure is required by law
iii. When there is a professional duty or right to
disclose
Wedtech Case (slush fund and forged invoices)

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 Independence – perception & reality
Independence means taking an unbiased viewpoint in
performing audit tests.

9.1 Members in public practice when undertaking a

reporting assignment, should be and appear to be free of
any interest which might be regarded, whatever its actual
effect, as being incompatible with integrity, objectivity
and independence.

Crazy Eddie Case (former employees & fees)

Enron Case (fees for auditors / provision of services)
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Figure 3.5
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 Self-Interest Threat
A Self-interest threat occurs as a result of the financial or
other interests of a professional accountant or of an
immediate or close family member;
Examples of circumstances:
– Undue dependence on total fees from a client.
– Having a close business relationship with a client.
– Potential employment with a client.
– Contingent fees relating to an assurance engagement.
– A loan to or from an assurance client or any of its
directors or officers (including long overdue fees)
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 PCAOB FINES PWC MEXICO $100,000 OVER
VIOLATION OF AUDITOR INDEPENDENCE
• The US Public Company Accounting Oversight Board (PCAOB) has
censured PwC, imposing a civil money penalty of $100,000 on the
firm. PwC SC, the auditor’s Mexican firm signed an engagement
letter with Banco Santander Mexico in June 2016. However, at least
six of PwC Mexico’s partners had personal financial relationships
with the bank.
• In addition to the fine, the PCAOB is requiring PwC to take
measures to establish, implement, and monitor policies and
procedures to provide reasonable assurance of compliance with
auditor independence requirements and with audit committee
communication requirements.
• The six partners were located in the office where the lead audit
engagement partner for the engagement primarily practiced, so they
were ‘covered persons’ and three of the six partners were in
prohibited debtor-creditor relationships with Banco Santander
Mexico.
Extracted from Int’l Accounting Bulletin 5/8/20191 - 38
 Self-Review Threat
Self-Review Threat occurs when a previous judgment needs
to be re-evaluated by the professional accountant
responsible for that judgment.
Examples of circumstances:
– Reporting on the operation of financial systems after
being involved in their design or implementation.
– Having prepared the original data used to generate
records that are the subject matter of the engagement.
– A member of the assurance team being, or having
recently been, a director or officer, or employee in a
position to directly influence the audit of that client.
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 Advocacy Threat
An Advocacy Threat occurs when a professional
accountant promotes a position or opinion to the
point that subsequent objectivity may be
compromised.

Examples of circumstances that create advocacy threats:

– Selling, underwriting or otherwise dealing in
financial securities or shares of an assurance
client;
– Acting as an advocate on behalf of an assurance
client in litigation or disputes with third parties.

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 Familiarity Threat
Familiarity Threat occurs when, by virtue of a close
relationship with an assurance client, its directors, officers or
employees, an auditor becomes too sympathetic to the client’s
interests.
Examples of circumstances that create advocacy threats:
❖ Immediate family member or close family member who is a
director, officer, or influential employee of the assurance
client;
❖ A former partner of the firm being a director, officer of the
assurance client or an employee in a position of significant
influence;
❖ Long association of a senior member of the assurance team
with the assurance client
❖ Acceptance of gifts or hospitality, unless the value is clearly
insignificant, from the assurance client, its directors, officers
or employees.

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 Intimidation Threat
Intimidation Threat occur when a professional
accountant may be deterred from acting objectively
by threats, actual or perceived

Examples of circumstances:
Being threatened with dismissal or replacement in
relation to a client engagement.
Being threatened with litigation.
Being pressured to reduce inappropriately the extent
of work performed in order to reduce fees.

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 Safeguards Against Threat to
Independence
Safeguards that may eliminate or reduce such threats to an
acceptable level fall into two broad categories:
1) Safeguards created by the profession, legislation or
regulation;
2) Safeguards in the work environment.

Examples include:
• Quality control procedures (eg separate teams doing accounting work from
those doing the audit)

• Audit Committee (auditor reporting directly to them)

• Partner rotation (PIE clients after 7 yrs and cool off for 2yrs)

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THE AUDITOR’S DUTY OF CARE TO
SHAREHOLDERS, CLIENT
COMPANY & 3RD PARTIES

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 Auditor’s Responsibilities
• The accountant in public practice has a duty to
report to the shareholders on the financial
statements.
• He must exercise reasonable skill and care
before he states his opinion.
• He must perform his duties for the client with
skill and care on all professional work
undertaken – auditing, accounting, taxation
services.

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 Duty of care to third parties
Liability to 3rd Party under certain conditions:
▪ Auditor must have been negligent (negligence issue)
▪ 3rd party must have suffered financial loss as a direct result
(causation issue)
▪ Auditor must have known of the ‘special relationship’ between
himself and the 3rd party or could reasonably be foreseen to rely on
the Auditor’s work
▪ 3rd party must be able to quantify loss (quantum issue)

Auditor’s Defense - the use of disclaimers

Cases
o Donoghue vs. Stephenson
o Hedley Byrne vs. Heller and Partners
o Caparo Industries plc vs. Dickman et al.
o Ultramares vs Touche
o Bannerman (www.scotcourts.gov.uk/opinionsv/mcf1807c.html)
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 Legal Terms Affecting Auditors’
Liability

Terms related to negligence and fraud:

Ordinary Gross
negligence negligence

Constructive
Fraud
fraud

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Actual case

Extracted from Bloomberg 4/7/2019

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Actual case cont’d

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