Auditing and Assurance Services in Australia - (Chapter 3 Ethics independence and corporate governance)

Page 89 CHAPTER 3
Ethics, independence and corporate governance LEARNING OBJECTIVES (LO) 3.1
Explain the nature and importance of professional ethics, and
describe the three main categories of ethical theory. 3.2
Outline the essence of the accounting bodies’ code of ethics. 3.3
Apply sound ethical decision-making techniques. 3.4
Explain the concept and importance of auditor independence. 3.5 Explain fee determination. 3.6
Explain the concept of corporate governance. RELEVANT GUIDANCE ASA 102
Compliance with Ethical Requirements when Performing
Audits, Reviews and Other Assurance Engagements ASA 200/ISA 200
Overall Objectives of the Independent Auditor and the
Conduct of an Audit in Accordance with Australian
(International) Auditing Standards ASQC 1/ISQC 1
Quality Control for Firms that Perform Audits and Reviews
of Financial Reports and Other Financial Information,
Other Assurance Engagements and Related Services Engagements APES 110/IFAC
Code of Ethics for Professional Accountants
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Created from cdu on 2020-08-04 20:19:46. CHAPTER OUTLINE As discussed in Chapters 1 and 2
, the auditor is a member of a time-
honoured profession, and the status of the profession and the responsibilities
that accompany this status affect the audit and assurance services function and
the structure of the profession. The independent auditor is subject to regulation
imposed by the profession and by society in general. The imposition of ethical
standards on members by a profession is one aspect of this regulation.
This chapter outlines the nature and importance of ethics, and the
responsibilities imposed on auditors by the profession through the code of
professional ethics. One fundamental ethical requirement for an auditor is
independence. This chapter explains the concept of independence and how it is
supported by legislation and the ethical rules. The major threats to auditor
independence are explained. Also discussed is the concept of corporate
governance and the part played by audit committees in this function.
How this chapter fits into the overall auditing and assurance profession is illustrated in Figure 3.1
, which is an expansion of part of the overall flowchart provided in Chapter 1 .
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FIGURE 3.1 Flowchart of auditing and assurance profession
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LO 3.1 Professional ethics and ethical theory
The nature and importance of professional ethics Ethics
are concerned with the requirements for the general wellbeing, prosperity, health
and happiness of people, and with things that promote or prevent them.
Paragraph 3(f) of the Supplemental Royal Charter of Chartered Accountants Australia and
New Zealand (Chartered Accountants ANZ) states that one of its principal objects is to do
all things that may advance the profession of accountancy, whether in relation to the
practices of public accountants or in relation to industry, commerce, education or the
public service. Similarly, paragraph 3(1) of the constitution of CPA Australia establishes
one of its objects as protecting, supporting and advancing the status, character and interests
of the accountancy profession generally. The Institute of Public Accountants (IPA) has
similar objectives. Community wellbeing includes the flourishing of business and industry.
The objectives of the accounting bodies support an environment of personal and corporate
integrity that promotes community wellbeing. This necessarily involves defining what is right and what is wrong.
Chartered Accountants ANZ’s Royal Charter, CPA Australia’s constitution and the IPA’s
constitution give these bodies the power to prescribe high standards of practice and
professional conduct for their members, and to prescribe disciplinary procedures and sanctions.
In practice, ethics require both knowledge of moral principles and skill in applying them to
problems and decisions. In addition, sound ethical practice presupposes the development in
individuals and society of the virtues or good habits that ensure the moral health of the community.
Establishing codes of ethics and disciplinary rules does not necessarily create an ethical
culture in an organisation or business, nor does it ensure the moral integrity of its
individual members. It is necessary to promote not only competence in ethics but also the
personal qualities of responsibility and moral conscientiousness. Codes of ethics, rules,
regulations and laws do not have meaning or moral legitimacy in themselves. Rather, their
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authority and legitimacy depend on whether they are perceived as helping to promote
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people’s wellbeing. If rules are considered to be unjust, discriminatory or oppressive,
people are likely to disregard them or demand they be changed.
APES 110 indicates that the Code of Ethics for Professional Accountants does not Page 91
cover all aspects of ethical conduct and that members are expected to comply with
the spirit as well as the letter of the rules. They recognise that ethics are principally
attitudes of mind rather than compliance with written rules of conduct.
Society is governed by rules, regulations and laws. From an auditing viewpoint, this tends
to place the focus on ‘black letter’ law. However, it needs to be remembered that it is
always possible to question whether a rule is a good rule. Value judgments need to be made
as to whether rules are fair, whether they respect the rights of all parties and whether they
protect those parties who are unable to defend their rights. Sound statutory law must be
based on and consistent with common law and natural justice if it is to promote human wellbeing. Ethical theory
There are three main categories of ethical theory that will be discussed in this chapter:
teleological ethics, deontological ethics and virtue ethics. Teleological ethics Teleological ethics
are also called consequential ethics because they deal with the
consequences or outcomes of actions. Generally, if the benefits of a proposed action
outweigh the costs, then the decision is considered morally correct. The most important
theory of teleological ethics is utilitarianism.
Jeremy Bentham (1784–1832) and John Stuart Mill (1806–73) are generally acknowledged
as having developed the theory of utilitarianism
, which states that ethical decision
making should maximise the greatest good for the greatest number. This involves an
assessment of costs and benefits, not only in economic terms but also in terms of human
costs and benefits. Therefore, it involves a value judgment and needs to consider all the
stakeholders who will be affected by a decision. The outcomes are measured both in
economic terms and in psychological terms, such as pain and happiness. Therefore,
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measuring and assigning a numeric value to the consequences of an action is often difficult.
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Created from cdu on 2020-08-04 20:19:46. Deontological ethics Deontological ethics
are based on duties and rights. Duties are obligations and are
actions that a person is expected to perform, while rights are entitlements and are actions
that a person expects of others. These duties and rights are set down in rules that must be
followed regardless of the consequences. Hence, deontological ethics are also sometimes
called non-consequential ethics. Deontological ethics are particularly important to auditors
in understanding their duties based on the ethical rules of the accounting bodies.
Immanuel Kant (1724–1804) placed high value on personal rights and personal moral
autonomy, and the basis of his ethical theory was the principle of respect for persons. This
acknowledges the intrinsic value of all persons and recognises that we should not use
people to achieve our own ends. Further, we should recognise a duty of care to others, as
expressed in the golden rule or principle of reciprocity: ‘do unto others as you would have them do unto you’.
This rule leads to the principle of beneficence, which advocates that we should do good to
others rather than harm. Kant suggested the categorical imperative as a universal ethical
law. This means that, when considering the validity of a rule, we need to consider whether
we would be happy to have this action applied in all similar circumstances regardless of the
consequences. This leads to the need for the principle of justice.
John Rawls (1957) argued that the fundamental idea underlying the concept of justice is
that of fairness. He argued that there are two principles that serve as the basis of justice and fairness:
The first principle is that each person participating in a practice,
or affected by it, has an equal right to the most extensive liberty
compatible with a like liberty for all; and the second is that
inequalities are arbitrary unless it is reasonable to expect that they
will work out for everyone’s advantage and unless the offices to
which they attach, or from which they may be gained, are open to all.
Thus, Rawls argued that ethical rules should seek equality and the maximum Page 92
degree of liberty that does not conflict with the liberty of others or increase
inequalities or disadvantage to others.
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Created from cdu on 2020-08-04 20:19:46. Virtue ethics
, which date back to Aristotle, are concerned primarily with integrity,
which is an essential characteristic of an auditor. Virtue ethics focus on the person
undertaking the action. Virtues are personal qualities that enable us to do what is ethically
desirable, and generally include traits of character such as courage, fairness, honesty,
integrity, loyalty, courtesy and fidelity. Virtue ethics emphasise what makes up a morally
good person, but do not necessarily make it clearer what should be done to solve an ethical conflict.
The relevance of these three ethical theories to the accounting bodies’ code of ethics and to
ethical decision making by auditors will be discussed later in this chapter. QUICK REVIEW
1. The accounting bodies require their members to behave ethically.
2. Behaving ethically requires knowledge of moral principles and decision- making skills.
3. Teleological ethics are based on ethical outcomes.
4. Deontological ethics are based on ethical duties and rights.
5. Virtue ethics are based on personal ethical qualities.
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LO 3.2 Accounting bodies’ code of ethics
APES 110 Code of Ethics for Professional Accountants sets out the main ethical pronounc ements
for members of Chartered Accountants ANZ, CPA Australia and the IPA. ASA
200.14 (ISA 200.14) requires that auditors comply with relevant ethical requirements.
Further, ASA 102.5 and A1–A7 specifically require the auditor to comply with APES 110.
The code consists of the following three sections:
1. Part A: General Application of the Code Sections 100–150 set out the fundamental
principles of professional ethics and provide a conceptual framework for applying these principles.
2. Part B: Members in Public Practice Sections 200–291 illustrate how the conceptual
framework is to be applied to specific situations in public practice.
3. Part C: Members in Business Sections 300–350 illustrate how the conceptual framework
is to be applied to specific situations in business.
The ethical rules play an important part in an auditor’s behaviour. The written code of
appropriate professional conduct is designed to enable members to arrive at the proper
conclusion when making ethical decisions. As a result, the ethical rules comment upon
different types of relationships faced by auditors and spell out some of the auditor’s
responsibilities. The preface to APES 110 states that compliance with the code is mandatory for all members.
There are also a number of APES standards, not all of which are relevant to auditors but
which are mandatory for members of the three accounting bodies. In general, these
statements seek to promote the fundamental principle of ‘competence’.
The APES 200 series is applicable to all members of the accounting bodies and includes: APES 205
Conformity with Accounting Standards APES 210
Conformity with Auditing and Assurance Standards APES 215 Forensic Accounting Services APES 220 Taxation Services APES 225 Valuation Services
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The APES 300 series is applicable to members of the accounting bodies in public practice and includes: APES 305 Terms of Engagement APES Dealing with Client Monies 310 APES
Compilation of Financial Information 315 APES Quality Control for Firms 320 APES Risk Management for Firms 325 APES Insolvency Services 330 APES
Reporting on Prospective Financial Information Included in a 345 Disclosure Document APES
Participation by Members in Public Practice in Due Diligence 350
Committees in Connection with a Public Document
The purpose of the code of ethics A code of ethics
is a formal and systematic statement of rules, principles, regulations or
laws developed by a community to promote its wellbeing and to exclude or punish any
undermining behaviour. Therefore, a code of ethics may serve several purposes. It may:
make explicit those values that may be implicitly required (for example, the underlying
core values or principles in sections 100–150 of APES 110, which are discussed later in this chapter)
indicate how members should act towards one another (for example, the responsibilities
to professional colleagues exhibited through the protocol to be followed when
superseding another auditor (section 210 of APES 110) and permissible forms of
advertising (section 250 of APES 110), both of which are discussed in Chapter 5 .)
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provide an objective basis for sanctions against people who violate the rules (for example,
disciplinary action under Chartered Accountants ANZ’s Supplemental Royal Charter,
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CPA Australia’s constitution and the IPA’s constitution, discussed in Chapter 2 , or by
the Australian Securities and Investments Commission (ASIC)). A member’s behaviour
can be judged, in part, by reference to the rules laid down in APES 110. An established
code of ethics is one mechanism of self-regulation.
In addition, APES 110 communicates the profession’s responsible attitude of
accountability to the community at large.
Like many professional codes, the ethical rules of the accounting bodies endeavour to
promote standards of competence, proficiency and personal moral integrity in their
members. These qualities are similar to those that Thomson et al. (1976) referred to as
Aristotle’s intellectual and moral virtues. Aristotle’s intellectual virtues included science
(knowledge), techne (practical skill and competence, intelligence, judgment, understanding,
persistence and resourcefulness) and wisdom. His moral virtues included courage (loyalty
and integrity), temperance (discipline, friendliness, generosity, magnanimity,
communication and social skills) and justice. Thomson et al. indicated that these virtues
can be depicted as an arch, with intellectual values on one side and moral virtues on the
other. The keystone holding them together is the virtue of prudence or acquired practical wisdom.
However, written codes of conduct should not be viewed as the panacea for the profession’s
ethical problems. As mentioned previously, these codes do not by themselves make people behave ethically. The virtues of an auditor
In line with the discussion of the professional status of an auditor in Chapter 2 , APES
110 section 100.1 states that a distinguishing mark of the audit profession is its acceptance
of the responsibility to act in the public interest
. The public interest is defined as the
collective wellbeing of the community of people that the members serve. Therefore, the
auditing profession’s ‘public’ consists of clients, credit providers, governments, employers,
employees, investors, the business and financial community and others who rely on the
objectivity and integrity of the auditor. The public interest principle recognises that
conflicts occur between the various stakeholder interests and that when such conflicts
occur, the auditor’s primary responsibility is to the public interest, not to himself or herself
or to the client. Rather, the auditor is required to advance the interests of their Page 94
client, provided that it does not conflict with the obligation to safeguard the public
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Further to the discussion in Chapters 1 and 2
regarding the fundamental ethical
principles that an auditor must follow, APES 110 section 100.5 sets out the following five
fundamental principles, shown in Figure 3.2 , that apply to all members.
FIGURE 3.2 Fundamental principles
These fundamental principles are discussed in more detail in sections 110–150 of APES 110: 1. Integrity
Auditors should act with consistency, treating like cases in a like manner.
Honesty is an integral part of this value. The principle of integrity therefore imposes an
obligation on an auditor to be straightforward and honest in all professional and business
relationships and requires fair dealing and truthfulness. As a result, in accordance with
APES 110 section 110.2, an auditor should not be associated with any reports or other
communications that are false, misleading or recklessly prepared.Integrity is supported
by the ethical principle of respect for persons. 2. Objectivity
In accordance with APES 110 section 120, auditors must be fair and must
not allow bias, conflict of interest or the undue influence of others to override their
objectivity. They need to maintain an impartial attitude and not represent vested interests
when auditing a financial report. Therefore, relationships that bias or unduly influence
the auditor’s professional judgment should be avoided. As fairness is an important
behavioural implication of this value, objectivity can be justified by the ethical principle of justice. 3. Professional competence and due care
Section 130.1 of APES 110 indicates that
auditors have a duty to attain and maintain their level of professional competence and
should only undertake work that they can expect to complete with professional
competence and due care in accordance with applicable technical and professional
standards. Auditors have a duty to maintain their level of competence throughout their
professional career through continuing professional development. Clearly, a client’s
interests cannot be adequately served by auditors who do not possess the necessary skills
for the tasks that they undertake. This requires appropriate training and supervision.
Accepting work for which the auditor is not competent could lead to damage to the client.
The maintenance of high standards of technical proficiency is designed to protect clients,
and so the value of competence and due care is supported by the ethical principle of beneficence.
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Auditors hold positions of trust and have access to many valuable and
private pieces of information in the course of their work. Section 140.1 of APES 110
indicates that they should respect the confidentiality of information obtained during the
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course of their work and should not disclose such information to a third party without
authority or unless there is a legal or professional duty that is not prohibited by law to do
so, as outlined in section 140.7. However, as discussed in Auditing in the global news 3.1
, as a result of international developments and amendments to APES 110 in
September 2017, to include a new section 225, ‘Responding to non-compliance with laws
and regulations’ (NOCLAR), auditors now need to consider their reporting Page 95
obligations if they uncover or suspect illegal acts such as fraud, corruption,
bribery or money laundering during the course of their professional work. APES 110 now
permits accountants to set aside the principle of confidentiality where such illegal acts are
suspected. Where an auditor is considering disclosing confidential information of a client
without the client’s consent, on the basis that that disclosure is required by law or
professional requirements, they are strongly advised under section AUST 140.7.1 to first
obtain legal advice. This duty to protect the interests of clients means that confidentiality
reflects the ethical principle of beneficence. 5. Professional behaviour
Section 150.1 of APES 110 indicates that auditors should
comply with relevant legislation and conduct themselves in a manner consistent with the
good reputation of their profession and refrain from any conduct that could bring
discredit to it. Agood reputation is fundamental to the ability of the profession to
continue to enjoy its rights and privileges. Therefore, in addition to their duty to the
public interest and to their clients, auditors have a duty to the profession and must act in a
way that promotes the good reputation of the profession. Section 150.2 of APES 110
indicates that in marketing and promoting themselves auditors must not bring the
profession into disrepute by making exaggerated claims or by disparaging competitors.
Consequently, the value of professional behaviour can be justified by reference to the
ethical principles of beneficence and respect for persons.
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