Independence, Integrity And Objectivity 2019/1/18 Topic 11 : Independence, Integrity And Objectivity 2019/1/18 Week 1

2019/1/18 Meaning of Auditing Auditing (broadly defined): is an exercise whose objective is to enable the auditors to express an opinion whether the financial statement are prepared in all material respects, in accordance with an identified reporting framework (e.g. GAAP) or other criteria. Auditing (narrowly defined): is a written report on the examination of financial statements for an entity 2019/1/18 Week 1

Meaning of Independence 2019/1/18 Independent: ‘not subject to control by others, self-governing’ (Webster’s Dictionary) Accounting Independence: freedom from relationships which impair or appear to impair the ability of the accountant to exercise objectivity Objectivity is a state of mind and imposes upon an individual the obligation to be impartial, intellectually honest, and free of conflicts of interest Integrity is an element of character and is essential to the maintenance of public trust 2019/1/18 Week 1

Significance Of Audit Independence Independence is an essential auditing standard: adding credibility to financial statements Independence is vital to a successful audit practice Judgment of the auditor must not only be impartial and unbiased, but it must also appear to be so to any outside observer 2019/1/18

Significance Of Audit Independence 2019/1/18 Significance Of Audit Independence Independence is an essential auditing standard: adding credibility to financial statements Independence is vital to a successful audit practice Judgment of the auditor must not only be impartial and unbiased, but it must also appear to be so to any outside observer A small manufacturing company has asked a CPA firm to perform an audit. The company’s controller is the engagement partner’s mother-in-law. Would the firm be considered independent for purposes of accepting the audit engagement? 2019/1/18 Week 1

Independence Both In Fact And In Appearance 2019/1/18 Independence Both In Fact And In Appearance Independence in fact Increasing the value of an audit report Independence in appearance Making the public believe Mautz and Sharaf : Independence in appearance be extended to cover the whole profession Unless the public has confidence, individual members will not have the maximum opportunities for services 2019/1/18 Week 1

Mautz and Sharaf’s Three Dimensions Of Audit Independence 2019/1/18 Programming independence Freedom to develop audit programme Selection of audit techniques and procedures, amount of work to be performed Investigative independence Freedom to carry out audit investigations Selection of areas, activities, relationships and policies, and free access to all books, records, information Reporting independence Freedom to report audit findings Free from any feeling of loyalty or obligation to report facts Week 1

Relationships Among Independence, Integrity And Objectivity Fact Appearance INTEGRITY OBJECTIVITY Mind Behaviour 2019/1/18

Major Avenues For Ensuring Independence, Integrity And Objectivity 2019/1/18 Professional body e.g. HKSA Providing standards, guidelines and statements Quality review, disciplining and CPE programmes … CPA firms Audit procedures and compliance monitoring Job rotation, performance appraisal and declaration Corporate culture and code of conduct … Individual members 2019/1/18 Week 1

Actual or threatened litigation HKSA Statement 1.203 Fees : Undue dependence on a client Actual or threatened litigation Family and personal relationships with clients 2019/1/18

Actual or threatened litigation Relative size: obtain no more than 15% of gross fees from a single client Overdue fees: settle prior year’s fees before starting current year audit Pricing: charge reasonable fees to audit client Contingent fees: not allowed for an audit work HKSA Statement 1.203 Fees : Undue dependence on a client Actual or threatened litigation Family and personal relationships with clients 2019/1/18

Actual or threatened litigation Relationship: candor and full disclosure of all aspects of client’s business operations Litigations: client suing negligence against the auditor; auditor suing his client for outstanding fees Adversarial positions: client may be unwilling to disclose further information; auditor my be unable to continue the audit Significant factors: materiality of the litigation; the nature of the audit; and whether relates to a prior audit HKSA Statement 1.203 Fees : Undue dependence on a client Actual or threatened litigation Family and personal relationships with clients 2019/1/18

Actual or threatened litigation 2019/1/18 Including: serving for the same client for a number of years; close friendship; relationship by blood or marriage; and joint venture, partnership… Avoid existence of family and personal relationships between a member of the audit team and a director, an officer or certain employees, depending on their role, of the audit client Significant factors: the individual’s responsibilities on the audit team and the closeness of the relationship Safeguards: removing the individual from the audit team; structuring the responsibilities that auditors do not deal matters with their family members or close friends…. HKSA Statement 1.203 Fees : Undue dependence on a client Actual or threatened litigation Family and personal relationships with clients 2019/1/18 Week 1

Financial involvement with clients’ affairs Loans to and from clients HKSA Statement 1.203 Financial involvement with clients’ affairs Loans to and from clients Goods, services and hospitality 2019/1/18

Financial involvement with clients’ affairs Loans to and from clients Avoid direct or indirect financial/beneficial interests in audit clients by the partners, staff on the audit team and their family Interests include: shareholdings, beneficial interests in trusts, and trustee investments, but not an insurance or pension policy with a client insurance Co. Safeguards: dispose of the direct/indirect interest by the member or family members; or remove the member from the audit engagement HKSA Statement 1.203 Financial involvement with clients’ affairs Loans to and from clients Goods, services and hospitality 2019/1/18

Financial involvement with clients’ affairs Loans to and from clients 2019/1/18 HKSA Statement 1.203 Not acceptable: make a loan; accept a loan; or have borrowings guaranteed by a client unless the loan or guarantee is immaterial to both the firm or the member and the audit client Acceptable: the audit client is a bank or a similar institution and the loan is made under normal lending procedures, terms and requirements and the loan is immaterial to both the firm and the audit client Financial involvement with clients’ affairs Loans to and from clients Goods, services and hospitality 2019/1/18 Week 1

Provision of non-audit services to audit clients HKSA Statement 1.203 Provision of non-audit services to audit clients Other non-audit functions Conflicts of interests 2019/1/18 Members not in practice

Provision of non-audit services to audit clients Benefit: the greater the knowledge of the audit client’s business, the better the audit team will understand the client’s procedures and controls, and the business and financial risks that it faces However, providing non-audit services may create threats to the independence of the firm The following activities should be avoided: Authorizing, executing or consummating a transaction on behalf of the audit client Determining which recommendation of the firm should be implemented Reporting, in a management role, to those charged with governance HKSA Statement 1.203 Provision of non-audit services to audit clients Other non-audit functions Conflicts of interests 2019/1/18 Members not in practice

Provision of non-audit services to audit clients Not accept or continue a service in which there are conflicts of interests with the audit clients Avoid any material financial gain which accrues or likely to accrue to the practice other than in the form of fees, i.e., commission or other benefit from a third party by advising a client to pursue one course rather than another. Not serve two or more audit clients whose interests may be in conflict unless appropriate steps are taken Safeguards: different audit teams for different clients; policies to avoid leakage of confidential information between teams; regular review by a partner not involved with either client; or advise clients to seek independent advice HKSA Statement 1.203 Provision of non-audit services to audit clients Other non-audit functions Conflicts of interests 2019/1/18 Members not in practice

Provision of non-audit services to audit clients 2019/1/18 HKSA Statement 1.203 Litigation support: should be and be seen to be independent in giving evidence in a court of law Specialist valuation: not audit a client where specialist valuation of a product was carried out by the member or its associates Arbitration: act independently of the parties and issues involved Insolvency appointments: guidance on insolvency appointments Provision of non-audit services to audit clients Other non-audit functions Conflicts of interests Members not in practice Week 1