Chapter 3 Ethics independence and corporate governance | Auditing and Assurance Services in Australia

lOMoAR cPSD| 47206071 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.
3.2Outline the essence of the accounting bodies’ code of ethics.
3.3Apply sound ethical decision-making techniques.
3.4Explain the concept and importance of auditor independence.
3.5Explain fee determination.
3.6Explain 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
Code of Ethics for Professional Accountants APES 110/IFAC
Quality Control for Firms APES 320 lOMoAR cPSD| 47206071 CHAPTER OUTLINE
As discussed in Chapters 1 and 2 , the auditor is a member of a timehonoured
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 .
FIGURE 3.1 Flowchart of auditing and assurance profession Page 90
LO 3.1 Professional ethics and ethical theory lOMoAR cPSD| 47206071
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
authority and legitimacy depend on whether they are perceived as helping to promote
people’s wellbeing. If rules are considered to be unjust, discriminatory or oppressive,
people are likely to disregard them or demand they be changed. lOMoAR cPSD| 47206071
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,
measuring and assigning a numeric value to the consequences of an action is often difficult. lOMoAR cPSD| 47206071 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. lOMoAR cPSD| 47206071 Virtue ethics
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 decisionmaking 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.
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. lOMoAR cPSD| 47206071
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 APES 230
Financial Planning Services. Page 93
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 lOMoAR cPSD| 47206071 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 .) provide an objective
basis for sanctions against people who violate the rules (for example, disciplinary action
under Chartered Accountants ANZ’s Supplemental Royal Charter,
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 lOMoAR cPSD| 47206071
(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 interest.
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. lOMoAR cPSD| 47206071
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.
4. Confidentiality 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 lOMoAR cPSD| 47206071
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.
3.1 Auditing in the global news ... lOMoAR cPSD| 47206071
Confidentiality not a cover for illegal acts
A new standard issued today requires accountants to consider their obligations if
they uncover or suspect illegal acts such as fraud, corruption, bribery or money
laundering during the course of their professional work.
The ground-breaking standard in Australia adopts the new international approach
and permits accountants to set aside the principle of confidentiality where illegal acts are suspected.
‘This standard encourages professional accountants to speak up where they
discover laws and regulations are not being adhered to—and identifies a process to
go through enabling accountants to raise concerns appropriately without
breaching other professional and ethical standards,’ APESB Chair, The Honorable Nicola Roxon, said.
‘It is feared that, in the past, identifying potential illegal acts and raising the alarm
did not always prevail over confidentiality and other obligations to a client or employer.’
The new standard, Responding to Non-Compliance with Laws and
Regulations (NOCLAR), comes into force on 1 January 2018—allowing time for
accountants to update their systems to comply with the standard. Individual firms
and accountants are urged to adopt this standard earlier where possible to meet international best practice.
The new standard will be incorporated into the Australian code APES 110 Code of
Ethics for Professional Accountants …
Source: Text extract from Media Release 30 May 2017.
Reproduced with the permission of the copyright owner, Accounting Professional & Ethical Standards Board Limited (APESB), Australia.
Further, as will be discussed in more detail later in this chapter, section 290 of APES 110
provides specific guidance on independence requirements for audit and review
engagements, while section 291 provides similar requirements for other assurance
engagements. Auditors should both be, and appear to be, free of any interest which might lOMoAR cPSD| 47206071
be regarded as incompatible with objectivity and integrity. Without independence, the
auditor’s opinion is worthless. Independence, however, can be easily compromised.
Objectivity, independence and technical standards equate with Aristotle’s Page 96
intellectual virtues. Honesty, integrity, confidentiality and ethical behaviour equate with
Aristotle’s moral virtues. Professional competence equates with what Aristotle called
prudence, or the practical wisdom necessary to apply abstract general principles to specific situations.
Auditors are both legally and morally accountable to their clients. Therefore, competence
in ethics is an important requirement of a good auditor. QUICK REVIEW
1. The ethical rules required to be followed by members of the accounting bodies
provide important guidance to members.
2. Ethical rules cannot cover all aspects of ethical conduct.
3. Ethics are principally attitudes of mind.
4. The key ethical principles of the accounting bodies are public interest, integrity,
objectivity, professional competence and due care, confidentiality and
professional behaviour. In addition, independence is required for assurance engagements. LO 3.3 Applying ethics
Sound ethical practice requires responsible people with a critical understanding of sound
decision making based on fundamental ethical principles. This requires:
knowledge of the basic principles on which moral values and rules are based
competence in decision-making skills ability to choose appropriate policies and
decision procedures in different situations.
To act ethically is to act appropriately and responsibly in different situations, providing a
clear, coherent and reasoned justification for decisions and actions, based on commonly accepted values or standards. lOMoAR cPSD| 47206071
An auditor needs to combine ethical rules with skills in making decisions and setting
policies. As indicated by Leung and Cooper (1995, p. 32):
The complexity of the different ethical problems encountered by
accountants requires not only a good knowledge of a set of ethical
principles, but also the skills and competence to handle conflicting
roles and interests relating to accountancy practice.
Ethical decision-making models
A number of ethical decision-making models have been developed to assist in sound
ethical decision making, such as the American Accounting Association (AAA) model, the
Mary Guy model, the Laura Nash model and the Spiral model. As the basic steps in
problem solving are the same, the various ethical decision-making models have many
common features. The most widely used is the AAA model, where each case is analysed
using a seven-step model, shown in Exhibit 3.1 . However, these models should not be
followed slavishly but rather used as a framework for decision making, as indicated in
APES 110 section 100.18, which states that the key factors to be considered in ethical conflict resolution are: relevant facts ethical issues involved
fundamental principles related to the matter in
question established internal procedures alternative courses of action. Page 97 EXHIBIT 3.1
AMERICAN ACCOUNTING ASSOCIATION MODEL lOMoAR cPSD| 47206071 1. Determine the facts What? Who? Where? When? How?
What do we know or need to know that will help define the problem?
2. Define the ethical issues
List the significant stakeholders. Define the ethical issues.
3. Identify the major principles, rules and values
(For example, integrity, quality, respect for persons, profit)
4. Specify the alternatives
List the major alternative courses of action, including those that represent some
form of compromise or point between simply doing or not doing something.
5. Compare values and alternatives—see if clear decision
Determine whether there is one principle or value, or a combination, which is so
compelling that the proper alternative is clear.
6. Assess the consequences
Identify the short-term and long-term, positive and negative consequences for the
major alternatives. The common short-term focus on gain or loss needs to be
measured against the long-term considerations. This step will often reveal an
unanticipated result of major importance. 7. Make your decision
Balance the consequences against your primary principles or values and select the alternative that best fits.
Source: Langenderfer, H. Q., & Rockness, J. W. (1989). Integrating ethics into the accounting curriculum: issues,
problems, and solutions. Issues in Accounting Education. Spring, 58–69.
Ethical decision making also involves consideration of the three aspects of moral theory
discussed earlier in this chapter:
1. Fundamental principles and rules or rights and duties Deontological ethics focus on
the principles and causes, intentions and motives to be considered prior to action.
Fundamental ethical principles include the principle of beneficence (duty to do good to
or protect others), the principle of justice (duty to treat all people fairly) and the
principle of respect for persons (duty to respect the rights of other people). In an ethical
decisionmaking model this involves specifying the facts, including the stakeholders
involved, and identifying the ethical principles and the rights and duties of all parties.
2. Means, methods and the role of the agent Virtue ethics focus on the moral character of
the agent. The integrity and competence of the agent (auditor) are vital to their capacity
to act ethically. In an ethical decision-making model this involves identifying all the lOMoAR cPSD| 47206071
options available, considering possible outcomes and knowing the right means to
achieve your goals, based on intellectual and moral virtues.
3. Ends or consequences Teleological ethics focus on the consequences of actions and
their outcomes relative to goals. If the ultimate end of human life is happiness, this
approach can translate into the utilitarian rule of always acting so that your action brings
the greatest amount of happiness to the greatest number of people. However, this must
be balanced by considering the rights of minorities. An assessment of the costs and
benefits for all stakeholders is required. In an ethical decision-making model this
involves the assessment of results in terms of achieving both short-term and long-term goals. Page 98 QUICK REVIEW
1. An auditor needs to combine knowledge of ethical rules with skills in ethical decision making.
2. There are several ethical decision-making models that can assist by providing a
framework for decision making.
3. The most commonly used ethical decision-making model is the American
Accounting Association model.
LO 3.4 Auditor independence
As mentioned earlier, for an audit or other assurance service to add credibility to a
financial report or other subject matter, an auditor needs to remain independent. Auditor
independence is critical to the orderly function of the capital markets, as it helps to build
the trust of various stakeholders in the financial information that has been audited. In
Australia, the requirement of independence for auditors has been reinforced through the
Corporations Act 2001 and the ethical rules of the accounting bodies.
Developments in auditor independence Ramsay Report
Interest in the issue of audit independence was increased by speculation about what role,
if any, audit independence matters played in a number of high-profile corporate failures
during the first half of 2001. As a result, the federal government commissioned a report
by Professor Ian Ramsay on audit independence in Australia. The Ramsay Report, which
was issued in October 2001, examined Australia’s existing legislative and professional
requirements on the independence of company auditors and compared them with lOMoAR cPSD| 47206071
equivalent overseas requirements. Where appropriate, the report proposed measures for
strengthening the Australian requirements.
The recommendations covered five key issues concerned either directly with audit
independence (employment relationships, financial relationships and provision of
nonaudit services) or with matters designed to enhance audit independence (audit
committees and a board to oversee audit independence issues). These issues will be
discussed later in this chapter.
The Ramsay Report recommendations envisaged the continuation of the existing
coregulatory regime under which some requirements are included in the corporations
legislation and others are in the ethical rules of the professional accounting bodies. The
federal government included many of the Ramsay Report recommendations in its CLERP 9
amendments to the Corporations Act 2001. The accounting bodies have likewise included
many of the Ramsay Report recommendations in their Code of Ethics for Professional
Accountants (APES 110). IFAC independence rules
In addition, there have been a number of developments internationally, including the
release of new ethical rules by the International Federation of Accountants (IFAC) in its
Code of Ethics for Professional Accountants in November 2001. IFAC has adopted a
conceptual approach to independence that uses a framework built on principles for
identifying, evaluating and responding to threats to independence. As discussed in
Chapter 2 , international ethical standards are now issued by the International Ethics
Standards Board for Accountants (IESBA). These ethical provisions have been subject to
several revisions since their first issue. APES 110
APES 110, which was first issued in June 2006, is based on the IFAC ethical rules, is tailored
to reflect Australian community expectations and takes into account the CLERP 9
amendments to the Corporations Act 2001. The independence requirements of APES 110
are discussed in detail later in this section. lOMoAR cPSD| 47206071
Sarbanes–Oxley Act 2002 Page 99
In the US, in response to the collapse of Enron, WorldCom and other high-profile
businesses, the Sarbanes–Oxley Act of 2002 provides more stringent independence
requirements and more severe penalties for breaches. Among other things, it restricts
greatly the ability of auditors to provide non-audit services, mandates audit partner
rotation and strengthens the role of the audit committee.
The Sarbanes–Oxley Act 2002 affects not only US companies and US auditors, but any
audit firm actively working as an auditor of, or for, a publicly traded US company or its
subsidiary. Therefore, the Act covers any Australian audit firm that does the audit of a
subsidiary of a US-listed company or that of an Australian company that is listed on a US
stock exchange. During 2004, KPMG admitted providing non-audit services to National
Australia Bank in breach of the US Securities and Exchange Commission (SEC) rules, after
five staff were seconded to the bank. Even though this was permitted under Australian
rules, KPMG was required to step down as auditor of this client.
Joint Committee of Public Accounts and Audit
Due to the major corporate collapses both within Australia and overseas, the Joint
Committee of Public Accounts and Audit (JCPAA) resolved to review independent
auditing by registered company auditors. The committee issued its recommendations in
August 2002 in Report 391. Many of the Committee’s recommendations were consistent
with the Ramsay Report and many have been incorporated in the CLERP 9 amendments. HIH Royal Commission
The major companies in the HIH Insurance Group were placed in provisional liquidation
on 15 March 2001. The deficiency of the group was estimated to be between $3.6 billion
and $5.3 billion. On 16 April 2003, the HIH Royal Commission issued its report, The Failure
of HIH Insurance, which contained 61 policy recommendations by Justice Owen, covering
corporate governance, financial reporting, auditing and regulation of the insurance industry. lOMoAR cPSD| 47206071
Corporate Law Economic Reform Program
In September 2002, the federal government issued a policy paper, CLERP 9, as part of its
Corporate Law Economic Reform Program, seeking stakeholder comments on proposals
for legislative amendments. The paper reviewed, among other things, auditor
independence. Following much discussion, stakeholder feedback, political debate and
some amendments, the Corporate Law Economic Reform Program (Audit Reform and
Corporate Disclosure) Act 2004 was passed by the Senate on 25 June 2004 and received
Royal Assent on 30 June 2004. The CLERP 9 legislation amends a number of Acts,
including the Corporations Act 2001. Some of the most significant changes introduced by
the CLERP 9 amendments are to auditor appointment, independence and rotation
requirements, which are discussed below. Legislative requirements
The Corporations Act 2001 has always contained some provisions which give formal
recognition to the need for auditor independence. The CLERP 9 amendments created a
general duty for the auditor to be independent and avoid conflicts of interest and to
provide a written declaration to directors confirming compliance with the auditor
independence requirements of the Corporations Act 2001. Other key provisions introduced through
CLERP 9 relate to restrictions on auditors being employed by an audit client, additional
specific requirements for appointment as an auditor, audit partner rotation for listed
companies and disclosure of non-audit services. The existing provisions relating to auditor
resignation, auditor removal, right of access to records and right to reasonable fees were maintained. Independence declaration
Section 307C requires an auditor to give the directors a written declaration to the effect
that, to the best of the auditor’s knowledge, there have been no contraventions of the
auditor independence requirements of the Corporations Act 2001 or of any Page 100
applicable code of professional conduct in relation to the audit, or that the only
contraventions have been those set out in the declaration. The directors’ report must
include a copy of the auditor’s independence declaration in accordance with section 298(1) (c). lOMoAR cPSD| 47206071 Conflicts of interest
It is a breach of the general auditor independence requirements under section 324CA for
the auditor to be aware of a conflict of interest situation in relation to the audit client and
not to take reasonable steps to ensure that the conflict of interest situation ceases to exist
as soon as possible. If, seven days after becoming aware of it, the conflict of interest
situation still exists, the auditor is required to notify ASIC. If the auditor is not aware of
the conflict of interest, but would have been aware if they had in place a quality control
system reasonably capable of making the auditor aware, the auditor will still be in
contravention of section 324CA.
Section 324CD indicates that a conflict of interest situation exists if:
the auditor or a professional member of the audit team is not capable of exercising
objective and impartial judgment in relation to the conduct of the audit a reasonable
person, with full knowledge of all relevant facts and circumstances, would conclude that
the auditor or a professional member of the audit team is not capable of exercising
impartial judgment in relation to the conduct of the audit.
When considering whether an auditor is capable of exercising objective and impartial
judgment, consideration needs to be given to past, current or possible relationships between:
the auditor, audit firm, current or former audit firm member, audit company or any
current or former audit company director