MGAD10H3 Chapter Notes - Chapter 2: External Auditor, Financial Statement, Legal Liability

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Chapter 2: Ethics, Legal Liability, and Client Acceptance
2.1 The Fundamental Principles of Professional Ethics
generally speaking, ethics are the standards of behaviour that promote human welfare or the overall public “good”
Integrity
integrity the obligation that all members of the accounting professional bodies be straightforward and honest
members should not be associated with information that is materially false or misleading
Objectivity
objectivity the obligation that all members of the professional bodies not allow their professional feelings or
prejudices to influence their professional judgment
members should be unbiased and not allow a conflict of interest or influence of others to impair their decision process
Professional competence and due care
professional competence the obligation that all members of the accounting professional bodies maintain their
knowledge and skill at a required level
due care the obligation to complete each task thoroughly, document all work, and finish on a timely basis
Confidentiality
confidentiality the obligation that all members of the professional bodies refrain from disclosing information that is
learned as a result of their employment to people outside of their workplace
an exception is made where a client has allowed this disclosure to occur or where there is a legal requirement to
disclose such information
members are also not allowed to use information to their advantage or to the advantage of another person that has been
gained as a result of their employment and is not publicly available
Professional behaviour
professional behaviour the obligation that all members of the professional bodies comply with rules and regulations
and ensure that they do not harm the reputation of the profession
2.1.1 Specific rules incorporating the principles of professional ethics
a fee can be provided only when requested by the potential client
fee quotes cannot be provided to a client without adequate knowledge of the work to be performed
fee quotes cannot be significantly lower than the fees charged by a predecessor firm
advertising must be in good taste and it cannot be false or misleading or make unsubstantiated claims
2.2 Association and Independence
association occurs when a public accountant is involved with financial information
there are 3 ways in which association can happen:
1. when the public accountant performs a service or consents to the use of his or her name implying that a service
was performed with the information
2. when a third party indicates, without the consent of the public accountant, that he or she is associated with the info
3. when a third party assumes that the public accountant is associated with the information
independence the ability to act with integrity, objectivity, and professional scepticism
it is fundamental to every audit and must be adhered to by every auditor who provides assurance services
it is the responsibility of those charged with governance (the board of directors and management) in a company to
ensure that the financial statements meet these requirements
it is the responsibility of the external auditor to form an opinion on the fair presentation of the financial statements
there are two forms of independence:
o Independence of mind is the ability to act with integrity, objectivity, and professional scepticism. It is the ability to
make a decision that is free from bias, personal beliefs, and client pressures. Independence of mind is also referred
to as actual independence.
o Independence in appearance is the belief that independence of mind has been achieved. It is not enough for an
auditor to be independent of mind; they must also be seen as independent. Auditors must consider their actions
carefully and ensure that nothing is done to compromise their independence both of mind and in appearance.
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2.2.1 Threats to independence
the rules of professional conduct identify 5 key threats to auditor independence
they are self-interest, self-review, advocacy, familiarity, and intimidation threats
self-interest threat can occur when an accounting firm or its staff has a financial interest in an assurance client
self-review threat can occur when the assurance team needs to form an opinion on their own work or work
performed by others in their firm
advocacy threat can occur when a firm or its staff acts on behalf of its assurance client
familiarity threat the threat that can occur when a close relationship exists or develops between the assurance firm
(staff) and the client (staff)
intimidation threat can occur when a member of the assurance team feels threatened by client staff or directors
reporting issuer public company with market capitalization and a book value of total assets greater than $10 million
some of the additional requirements to ensure auditor independence for reporting issuers include the following:
o audit partners must be rotated every 7 years, with a 5-year break from the audit engagement
o audit committee must pre-approve all services provided to the client by the firm
o audit partners may not be directly compensated for selling non-assurance services to the audit client
o when an engagement team member accepts employment in a financial reporting role with a client, the firm must
refrain from being the auditor of that client for at least 1 year from the date the financial statements were filed
with security regulators
2.2.2 Safeguards to independence
safeguards are mechanisms that have been developed by the accounting profession, legislators, regulators, clients, and
accounting firms, which are used to minimize the risk that a threat will surface and to deal with a threat when one
becomes apparent
Safeguards created by clients
corporate governance the rules, systems, and processes within companies used to guide and control
independent directors non-executive directors without any business or other ties to the company
Safeguards created by accounting firms
Threats to Independence
Safeguards to Independence
Self-interest threat
o policies and procedures within an accounting firm identifying any staff with financial interest in an
assurance client
o regular review of assurance and other fees earned from each client in comparison to total fees from all
assurance clients
o minimizing the provision of non-audit services to assurance clients
o policies and procedures prohibiting business relationships with clients
Self-review threat
o minimizing the provision of non-audit services to assurance clients
o when providing non-audit services, ensuring that the client is responsible for overseeing and guiding
that work and making any final decisions regarding the outcomes of that work
o having a cooling-off period before an audit partner can be employed in a senior role at an audit client
Advocacy threat
o policies and procedures prohibiting business relationships with clients
o policies and procedures prohibiting the representation of clients in any disputes or legal matters
o rotating staff assigned to clients so they do not spend too much time at any one client’s premises
Familiarity threat
o partner and staff rotation policies
o education regarding acceptance of gifts and hospitality from assurance clients providing examples of
what is and what is not acceptable
o procedures when assigning staff to assurance clients ensuring no close personal relationships exist
between assurance team members and client personnel
o education regarding socializing with client personnel
Intimidation threat
o avoidance of fee dependence
o appropriate corporate governance structures within clients, such as an audit committee, to liaise with
senior assurance team members and client management
o adherence to stringent procedures regarding the removal of assurance providers
2.3 The Auditor’s Relationships with Others
the key groups that the external auditor will have a professional link with are the client’s shareholders, the board of
directors, the audit committee, and the internal audit team
2.3.1 Auditors and shareholders
this means that the shareholders are acknowledged as the main recipients of the statements and the attached audit report
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Document Summary

Chapter 2: ethics, legal liability, and client acceptance generally speaking, ethics are the standards of behaviour that promote human welfare or the overall public good . Members should not be associated with information that is materially false or misleading. Objectivity integrity the obligation that all members of the accounting professional bodies be straightforward and honest. Confidentiality objectivity the obligation that all members of the professional bodies not allow their professional feelings or prejudices to influence their professional judgment. Members should be unbiased and not allow a conflict of interest or influence of others to impair their decision process. Members are also not allowed to use information to their advantage or to the advantage of another person that has been gained as a result of their employment and is not publicly available. 2. 1. 1 specific rules incorporating the principles of professional ethics. Independence of mind is the ability to act with integrity, objectivity, and professional scepticism.

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