Professional Ethics and Independence
Foundations
Professional Ethics and Independence
Syllabus tag: KASNEB CPA | Intermediate Level | CA24 Auditing and Assurance | Topic 2 Professional Ethics and Independence
Lesson objectives
By the end of this topic, you will be able to:
- State the five fundamental principles of the IESBA Code
- Identify the five categories of threat to independence
- Apply safeguards appropriate to each threat
- Distinguish independence of mind from independence in appearance
- Explain the limits of confidentiality
Why this matters
An audit opinion is worth nothing unless the reader believes the auditor was free to give a different one. Everything in this topic protects that belief.
The five fundamental principles
| Principle | Requirement |
|---|---|
| Integrity | Straightforward and honest in all professional relationships |
| Objectivity | No bias, conflict of interest or undue influence |
| Professional competence and due care | Maintain skill; act diligently to current standards |
| Confidentiality | Do not disclose or use client information improperly |
| Professional behaviour | Comply with law; avoid discrediting the profession |
A memory aid an examiner will accept: I-O-C-C-P.
Independence of mind and in appearance
Independence of mind is the state that allows an opinion to be given without being affected by influences that compromise judgement.
Independence in appearance is the avoidance of facts and circumstances so significant that a reasonable and informed third party would conclude that integrity or objectivity had been compromised.
Both are required, and the second is the harder test. An auditor may be entirely uninfluenced by a large fee from one client and still fail, because an informed outsider could not know that. The question is never only "was I objective?" but "could a reasonable observer believe I was?"
The five threats
| Threat | Arises when | Example |
|---|---|---|
| Self-interest | The firm has a financial interest in the outcome | Fee dependence, a shareholding in the client, an unpaid fee |
| Self-review | The firm audits its own work | Preparing the accounts it then audits, or a valuation it then tests |
| Advocacy | The firm promotes the client's position | Acting for the client in litigation or a share issue |
| Familiarity | Long or close association erodes scepticism | A partner on the same audit for many years; a relative in a senior client role |
| Intimidation | The firm is deterred from acting objectively | Threat of dismissal or litigation over a disagreement |
Practise identifying the threat by name. An examiner asks "identify the threat and suggest a safeguard", and a candidate who describes the situation without naming the category loses the first mark.
Safeguards
Created by the profession or legislation: education and training, continuing professional development, corporate governance rules, external review, and the disciplinary machinery of ICPAK.
Within the firm: rotation of the engagement partner, a second partner review of the opinion, separate teams for audit and non-audit work, quality control policies, and declining the engagement altogether.
Where no safeguard can reduce the threat to an acceptable level, the engagement must be declined or terminated. That is the answer an examiner wants for the extreme cases, and candidates too often propose an elaborate safeguard where resignation is the only correct response.
Specific situations
Fee dependence. Where total fees from one client are a large proportion of the firm's income, the self-interest threat is significant. Safeguards include reducing dependence, external quality review, and disclosure to those charged with governance.
Contingent fees for an audit are prohibited outright. A fee that depends on the outcome destroys objectivity by construction.
Unpaid fees from a prior period create a self-interest threat rather like a loan to the client, and should be settled before a new report is issued.
Preparing the accounts and then auditing them is a self-review threat. Permissible for some smaller entities with safeguards; prohibited for listed companies.
Gifts and hospitality may be accepted only where trivial and inconsequential.
Long association is met by rotating the engagement partner after the prescribed period for public interest entities.
:::checkpoint An audit client offers your firm a lucrative consultancy contract to design the very accounting system your team will audit next year. Name the threats, say which is dominant, and state whether any safeguard would make the engagement acceptable. :::
Confidentiality and its limits
Client information may not be disclosed without authority, nor used for personal advantage. The duty continues after the engagement ends.
Disclosure is permitted or required where:
- The client consents
- Law requires it — a court order, or reporting suspected money laundering
- There is a professional duty or right — defending against a disciplinary allegation, complying with a quality review, or responding to an ICPAK enquiry
Note the money laundering exception carefully. Reporting a suspicion is mandatory, and in many cases the client must not be told that a report has been made.
Conflicts of interest
Acting for two clients whose interests conflict — two parties to a takeover, for instance — threatens objectivity. Manage it by notifying both parties, obtaining consent, using separate teams with information barriers, and declining where the conflict cannot be managed.
:::checkpoint A junior in your firm mentions at a family gathering that a client is about to be acquired. A relative then buys shares in that client. Identify which principle was breached, by whom, and what the firm should now do. :::