Professional Ethics and Independence
Professional Ethics and Independence tests the ESAA code of ethics, which is aligned with the IESBA Code, and the additional independence requirements for audit engagements. The exam expects candidates to identify threats, evaluate their significance, apply safeguards, and decide when an engagement must be declined or terminated.
The conceptual framework
- The five threats are self-interest, self-review, advocacy, familiarity and intimidation.
- The auditor evaluates threats using the reasonable and informed third-party test and the facts and circumstances, not merely the label of the threat.
- Safeguards may be created by the profession, legislation, the firm or the client; if no safeguard reduces the threat to an acceptable level, the engagement must be declined.
- Independence has two components: independence of mind and independence in appearance.
Independence rules for audits
- A financial interest in the audit client, a loan to or from the client, or a close family relationship with a director creates a self-interest or familiarity threat that is generally prohibited.
- Providing bookkeeping, accounting, tax calculation or internal audit services to an audit client can create a self-review threat, especially for public interest entities.
- Long association of senior personnel requires rotation or other safeguards; fee dependency on one client requires evaluation.
- Contingent fees for audit work are prohibited because they create a self-interest threat.
Worked example
An audit partner is asked to prepare the client's annual tax return and also to audit the tax provision. Preparing the return is a non-assurance service. Because the partner would later audit the numbers he prepared, a self-review threat arises. For a listed client, the firm cannot rely on safeguards because the threat cannot be reduced to an acceptable level; the firm should decline the tax preparation or resign from the audit. For a non-listed client, safeguards might include using different personnel and independent review, but the firm must still evaluate the threat.
Traps that cost marks
- Treating a threat as acceptable because the fee is small or the client is important.
- Confusing independence of mind with independence in appearance.
- Applying safeguards to a prohibited non-assurance service for a public interest entity.
- Ignoring familiarity threats from long association or close personal relationships.
- Accepting a contingent fee for audit work.