Chapter 4 deals with professional ethics and the ACCA's ethical code.
The ACCA's ethical code is based on the code that has been developed by the IESBA, the International Ethics Standard Board for Accountants. And what you have here, based on the screen, is what's called the framework, the ethical framework. And what it's really saying is you've got certain fundamental principles, and these fundamental principles can be under threat. And what you have to do is, having identified or anticipated these threats, then you put into place some safeguards, which will reduce the threats to what's called an acceptable level. It can sometimes be very difficult to remove threats altogether, but you get them down to an acceptable level. So, a way of thinking about this, what principles do we want to follow? Where are the threats and what are the safeguards? The safeguards is a kind of fore warned is fore armed. If you know where danger or threat is coming from, you might be able to avoid that pretty well entirely or if you can't avoid it when it happens you perhaps know how you could fight it how you could reduce its importance.
so first of all the fundamental principles here and there are five of them and you have to know the words really these are very important ethics comes up really quite frequently it's ethics is regarded as being extremely important in professional firms of accountants it is what allows you really to be able to charge or earn relatively high fees people are paying for ethics if they cannot trust what you're saying if they reckon that some sort of report you produce on them no one else is going to believe it what are they paying for? So all the big bodies of accountants, CIMA, ICAW, ACCA and so on, they all rank ethics as being extremely important.
First of all, the word integrity here, it almost means honesty, but it means slightly more than honesty. Integrity Of course means not telling lies, but it also means standing up for what you believe is true. So if you as the auditor say one thing and the finance director is arguing hard against you and you still think the finance director is wrong, then the person with integrity will not cave in, will not just kind of surrender. Integrity also means not being frightened to ask difficult questions or not been frightened to look. So if your suspicions are aroused about something in the financial statements, you are not acting with integrity if that suspicion is then ignored or you simply hope for the best. Once you see that something might possibly be wrong, integrity requires you to follow that up and really to get evidence one way or the other.
Professional competence and due care. This means that auditors have to spend, for example, enough time on the audit and we'll see that this can be an interesting balance with the fees you're getting and so on. You must on the audit put people who are sufficiently well qualified with sufficient experience that they will do a decent audit. It also means that if you were approached by, let's say, an insurance company and you had no previous experience of auditing an insurance company you have to ask yourself can you do a proper professional job with care? can you do that properly? because if you can't then maybe you should say no to that audit.
confidentiality, whether as auditors whether as student auditors whether as an accountant working In a company as say the chief accountant or the assistant accountant or the wages department, auditors are privileged to have all sorts of very confidential information made known to them. You see other people's salaries, you see budgets, you see the year's results before they're published. All accountants and indeed all of these fundamental principles apply to not just auditors but to all members of ACCA and all student members as well but you have to be confidential you have to maintain confidentiality, the conditions where you can break confidentiality are first of all with the client's permission so it would be perfectly okay for you to show the client's bank manager perhaps a budget, a forecast, provided the client allowed you to do that. Secondly, if there is a legal duty for you to disclose information. For example, in the UK, if you suspect a client of money laundering, then there is a legal duty for you to inform the authorities. Secondly, if there is a professional right to disclose the information, maybe in your own defence. So perhaps your client is taking you to court, the client is claiming that you didn't do a very good audit. You'd be allowed to take your audit files into court to show the work you did on a client and so on, to defend yourself. And there's one final situation, which is actually quite a difficult one. and this is disclosing information if it is in the public interest to do so. So what should you do if you found that a client was, for example, paying below the minimum wage rate? In the UK there's a legal minimum wage rate. And you're auditing the wages and you see the client is paying below that. Should you disclose that to the authorities? and in the UK, no you shouldn't because it's unlikely to be in the public interest. What would happen, and it's not the auditor's job to be a policeman, however, what would happen if you were auditing a client and your client was a pharmaceutical manufacturer, and in the course of your audit you saw some reports of clinical trials which showed that a new pharmaceutical had very dangerous side effects and you know that your client had hidden those bad reports so that you are running the risk, or the client is running the risk of injuring seriously many people who takes this new drug. is it in the public interest then, to disclose that information and we might all think yes it is, because you could be saving lives here. But the trouble is with a concept like public interest, it's not cut and dried. Auditors do not necessarily have the legal background to decide that and what you do then is to take legal advice. You could also phone the ACCA for advice on ethics.
Professional behavior. Professional behavior means you should comply with the law. and to avoid any action which discredits the profession. For you, the action that's most likely to discredit the profession is poor advertising. If you were to advertise, you know, cheaper audits, or advertise we guarantee to save you tax, or advertise saying we're the best auditors, these other two firms are rubbish. This is bringing the profession into disrepute, and that would run you up against the ethical code.
And finally, objectivity. You have to avoid bias, conflict of interest, undue influence. We'll see easy examples of where your objectivity could be under threat. Maybe if you own shares in a client, you want those shares to up in value. The way you get those shares to up in value is by reporting a good profit. And so you kind of divide it a little bit, maybe doing a good audit. asking for the profits to be brought down and a shareholder where you'd like the profits to go up to enrich yourself.
so these are fundamental principles what threats arise here. and there are five threats, remember there are five fundamental principles and five threats.
self-interest and we'll see examples of this but this is basically where you are potentially enriching yourself by doing something.
Self-review, that's when you're checking your own work and most of us aren't too good at that.
Familiarity, where you become friendly or perhaps are related to client staff.
Advocacy, where you are a kind of champion of the client maybe in raising finance
and intimidation. We'll see a couple of examples of potential intimidation. where the auditor is threatened really in some way to give perhaps some sort of report which they don't really believe in.
so here are examples of self-interest threats.
first of all financial, where the auditor owns shares in a client. this is really a No, no, something that should never be done. If you own shares in a client, even just a few shares in the client, this is enough to almost pollute this atmosphere of independence and integrity. It's easy to get rid of these shares, there's no reason why you should hold them at all. And what's important in many of these elements of ethics is not just to be ethical, but to be seen to be ethical, to be whiter than white and members of the audit staff should not hold shares in clients.
close business relationships. first one, employment. imagine you are a partner, senior partner in a firm of accountants, firm of auditors in the uk many partners retire at about 55 so they have you know got easily a decade of work left in them so to speak they don't just want to go to the golf course from now on so what they begin doing perhaps a couple of years before retirement they say to one of their clients you know I'll be retiring in a couple of years I'll be looking for perhaps a little part-time job you know and do you think there might be one with you? and there's a risk that they want to stay friendly with their client and to prevent that the rules basically are if you have been the auditor you leave your firm you cannot join a client firm until at least two years have passed. you can't have one of your co-partners on a client board, too close. family and personal relationships, I'm the auditor and let's say my brother is the finance director of a client. No, too close. You know, you want to maybe stay friendly with your brother. Maybe you are the younger one. Your brother's always been bullying you and now as finance director he's got the same almost psychological hold over you there. So brothers are out. Children will be out. You know, you're the auditor, your children are finance director or CEO of the company and so on, that's too close. What about cousins? What about second cousin three times removed or whatever these large families kind of go down to here? And there's no hard and fast rule. There is no list of allowed relatives and not allowed relatives. What happens if you're the auditor and your girlfriend was a finance director? So there's not even a legal relationship there. But of course the chances are that there is some sort of influence going on and you must be seen to be whiter than white and if there's any doubt at all about a close relationship then you should avoid it, get another partner perhaps to be in charge of that audit rather than you. You also have to be careful here that relationships can grow so if you think Very often an auditor will become a partner of a firm at about the age of 35. Very often someone will become chief accountant, maybe even finance director at the age of 35. Similar ages, similar backgrounds, probably children of similar ages. And so the auditor and the finance director get friendly and then they go round to each other's houses for a meal and they decide to go on holidays together with their families because their kids can play with others. And what started as being an independent relationship has grown closer and closer and closer and that's very dangerous indeed, and there are rules around which suggest that the auditor, the lead auditor as it's called for particular client should be moved just to break up this familiarity. Once you become familiar with something or someone then it's very difficult to maintain this professional skepticism. You often become too trusting.
Loans and guarantees can put the auditor under some difficulty. You take a loan from your client and the client says something like well you give me a clean audit report or I want my money back. If it's a loan from a bank and the bank is your client and the loan is on what's called normal terms you're not getting a cheap interest rate or something of that sort then it would be allowed but you'd still need to be cautious about it. but a loan from a client, a manufacturing client who doesn't normally make loans would be very peculiar indeed.
overdue fees, you're coming up to this year's audit and there's still a hundred thousand dollars owing on last year's audit you want that money to be paid, you don't want that client to go to liquidation so that hundred thousand becomes a bad debt You know there's a risk that what you will do is to give a soft audit, a favourable audit report, just to keep that client alive for another couple of months so you get last year's fees. What should you do if they're overdue fees? Well there's a saying in English, if you're in a hole, stop digging. So if you're owed money from last year's audit, don't even start this year's audit. This would be grounds for resigning. because you will not be able to do a good audit or what appears to be a good audit if you are held almost to ransom by these overdue fees
contingent fees, contingent fee how about the client says to you well the audit fee will be a hundred thousand or if you get a clean order report 200 000 so Depending on the sort of audit report you get, the fees go up or down. Obviously not right. Not allow that.
High percentage fees. What happens if you have got one very large client? Maybe 50% of your fees come from that large client. You will be frightened of losing that client. You probably won't survive financially if you lose that client.
And so what you must ensure is that, and again it's not laid down as a figure in most cases, what you must ensure is that you are not too reliant on one client for fees. You could afford to say no to that client if they want something, you could afford to lose that client, but maintain your integrity and your objectivity. For what is called public interest, companies public interest companies are typically listed companies or they could be charities where there's a lot of public interest almost high profile companies you want to put it like that it is suggested that a fee limit of 15% is there so no more than 15% of your total fees should come from one client for more than two consecutive years without you doing something about it. This is an example of where you are not eliminating threats altogether. There's still a threat, you know. You don't want to lose a client who takes away 8% of your fees. But the idea is you would live with that, you know. You've reduced that threat of fee loss to an acceptable level.
Low balling is where you go in trying to win clients by putting in a very low audit fee. It is of course recognised that people win audits on at least part the basis of fees that companies want good value audits. But what you must be careful and there's nothing wrong with competing on price with other auditors but what you must be able to do is really to convince people that for this low fee you are nevertheless doing a proper audit. If the fee was absurdly low you'd find it difficult to do that. Why would people think of putting in absurdly low fees? They aren't going to cover the costs. Well, their hope is that an audit gives a foot in the door. Once we have the audit, then we can offer taxation services, we may offer other advisory services and so on. And we'll make our money on taxation, we'll make our money on the other advisory services and the audit is just a loss leader. No. you should be able to say to people the audit fee is enough for us to be able to do a good audit just on the basis of that fee.
Gifts and hospitality. It is not that unusual at the end of an audit, especially if there's been a lot of time pressure, maybe for the client to invite the audit team out for a meal, a kind of celebratory end of Audit Meal. Are the auditors allowed to accept that? So let's say that the meal was at the local McDonald's restaurant. I don't think there's going to be any real clash on ethics there. I don't think anyone is going to sell their soul for a Big Mac. What would happen if it was at a nice, very nice, let's say, two Michelin star restaurant? trickier. what happens if it was at a very nice three michelin star restaurant which was i'm talking here about auditors based in europe but the restaurant was based in the caribbean and the client would fly you there would put you in a very nice hotel for a week because of course you need to get over the jet lag before you enjoy the nice meal and then fly you back and of course it would be business class. So here we have a kind of complete gradation from the meal at McDonald's which isn't really going to influence anyone very much up to something which is almost of absurd value being given. And again, it's the look of the thing. It looks as though you're being bribed. Similarly with gifts. When I was training to be an auditor, we had one client who made shirts. And the highlight of the audit is they would take you into their warehouse and they would offer the auditors their choice of three shirts at cost price which is probably about half what you'd buy in a shop and we were allowed to do that because really what you're saving on three shirts isn't going to probably make you change your mind and certain aspects of the audit. we also audited Ford Motor Company. Ford Motor Company sold to all its employees cars at cost price because it didn't want old ford cars in the car park, it wanted people to have nice newish ford cars, it's almost a kind of advertising process and they offered our auditing company the same deal for every employee, every employee could buy a ford car at cost price And that was not allowed because quite obviously the amount of saving, the materiality of the saving you would make on buying a car at cost price is huge. And it would be very difficult to defend that in any sort of a way. Basically, you're allowed to accept gifts and hospitality if there's something you don't really want. Once it becomes something desirable, you're not really allowed them.
Recruitment for the client. You recruit, let's say, a finance director or an accountant. This person turns out to be a bit of an idiot. And of course, you don't want to appear foolish. You don't want to admit to the client that this accountant who's preparing the financial statements, whom you suggested, recommended for the post, is actually no good. You want to cover up your own mistakes, and that wouldn't really be allowed.
Self-review threats. Self-review threats where you run the risk of checking your own business. So if you worked for a client and then moved over to be their auditor and then you were sent back to audit that client, there's a chance you will be auditing work that you've done. Not very good. The really common one for you here, really kind of dangerous one, is this one here. preparing accounting records and preparing financial statements. small firms often don't have an accountant who is sufficiently skilled to prepare the year-end accounts maybe not properly qualified doesn't know much about accruals and prepayments depreciation and how to value inventory and so on and sometimes these clients will ask their auditors to prepare the financial statements and then to audit them. And if it's a non-listed company that's okay provided one team does the preparation of the financial statements and an entirely separate team from the firm of auditors is going to do the audit. What you mustn't do is the auditor must not be the same person who did the preparation. We're all bad at checking our own work. If we make an error of principle, we simply repeat that. We get bored. There's maybe a thought that's mine, I've done it right, and it's quite hard to be sufficiently critical.
What about other work that you might be offered like taxation, internal audit services, corporate finance and so on? Various sorts of management consultancy jobs. Are auditors allowed to take those on? And here, this is supplying multiple service here, it's a controversial issue. In America it's now not allowed. If you're the auditor of a company, you're not allowed to do anything else for them really. in most of europe it is allowed because there are certain advantages to the client if you're doing the audit whilst your people are out there doing the audit they'll also do some work for the tax people you know look at the repairs and maintenance accounts to make sure that the proper expenses and so on in there can be an efficiency for the client But you have to be careful. You have to be careful that you don't begin checking your own work. So, for example, if you were to advise people on internal control and then you had to audit the internal control, you shouldn't really be doing that. There's too much self-review going on within that. So large firms with separate departments with taxation department separate from the IT department separate from the audit department separate maybe from the accounting department you're kind of allowed to do that. just to go back here, I should have said I said here that preparing accounts and records okay provided there are separate teams here but not if it's a listed company. A listed company, a company quoted on the stock exchange is going to be a big company. And if it's a big company, for goodness sake, they should have employees who are capable of recording the records and preparing the financial statements. And it's just too much danger there for the auditor in this company which is of public interest.
Familiarity threats. Here we have close relationship. I've talked about this already here. Become too sympathetic to members of the client firm so that the objectives and skepticism are lost. Become too trusting. ACCA has suggested the lead partner should be changed at least every five years on bigger audits. There's sometimes maybe two or three partners involved. The kind of and less lesser important partners should be moved on every seven years this prevents familiarity it's also good for the client because you get a fresh pair of eyes coming in you know we all have our blind spots and it could be that the partner who's been in charge for five years simply didn't see a problem but the new person coming in having to learn about the client and learn about the system may see all of this much more clearly As I say, whether or not there is a close relationship, it's a matter of judgment. By and large, no hard and fast rules.
Advocacy threats. Advocacy is where you, as the auditor, promote a particular point of view, and later on you don't want to change your mind, or don't want to be embarrassed by seeming to be changing your mind. An example here. would be maybe to recommend the firm to investors. So your client says, could you come along to a meeting? I'm going to be presenting to some potential new investors because I want to raise some money. Could you come along and give a little address to these potential investors saying what a good company I am and how safe the money is going to be? So you're advocating, you are putting very positive support there for your client. Now what happens next year if the client's results aren't so good? You as auditor are going to be deeply embarrassed if you have to admit that the results aren't so good and that you persuaded these investors to invest in a rather disappointing company. The danger there is that you will go a bit soft on the audit. You won't want to be proven wrong, so you'll be trying to get the profits up and up and up and up, so you don't look a fool. So you shouldn't put yourself in this position where your subsequent objectivity is compromised to make you appear as though you've been right.
And finally, we have got intimidation. where there's an actual perceived threat. The commonest way of experiencing this is probably actual or threatened litigation. A client says to me, Remember two years ago you didn't discover that fraud? and i've been thinking about it and i think you should have discovered it i think i would like to sue you, but of course, if we were to get a clean audit report we could probably forget all that. or maybe a client says to you, remember a year ago you put in the tax computation and we weren't dead sure about whether a certain item of expenditures was allowed for tax or not allowed for tax, but you put in the tax computation assuming it was allowed for tax, well you know, i'm finding it hard to sleep, my conscience is troubling me and i would like to write to the revenue authorities telling them that i think we got it wrong last year and that I got it wrong because you advised me. But of course, if we had a clean audit report, I would sleep well anyway. I wouldn't need to tell the revenue authorities about that. Thankfully, auditors don't often be subjected to too much physical intimidation. I did come across, thankfully it wasn't directed at me, but I came across one story of it. I won't tell you what country it was in case it embarrasses you. But this audit was, they had to see, they kept asking to see a particular contract and the finance director kept putting them off. And it was getting very close to the end of the audit and the audit manager says, I really have to see this contract. And the finance director said, right, would you come and see the chief executive officer? he'll talk to you about it and the auditor was shown into the chief executive officer's office huge office and all around the walls there were glass fronted display cabinets and what the chief executive officer was proudly displaying in these cabinets was guns, this ceo was a gun fanatic. And they kind of sat down opposite each other and the CEO said, I believe you need to see a contract. Yeah. And then the CEO said, do you know anything about guns? And he went over and he took a gun out, he brought it down and he opened it up and he said, look, here's where you put the bullets. here's where they come out now what was it about a contract you wanted to see? i'm not quite sure how it ended but i don't think any blood was spilt