Ethics, acceptance and continuance

Ethics is a fundamental concept that needs to be established in an auditing and accounting practice. It cannot merely be given lip service, and should lead to proactively managing the risk of ethical threats and breaches that could inappropriately influence the firm’s compliance with relevant ethical requirements. One of the occasions when ethics may be involved in audit considerations is when deciding whether to accept, or continue with client relationships and engagements. Quality, integrity and independence should be the overriding factors.

Firm-level considerations

ISQM 1 para 29 requires firms to establish quality objectives that address the fulfilment of responsibilities, in accordance with relevant ethical requirements, including those related to independence. Management must ensure that the firm and its personnel, and others, including the network, network firms, and individuals in the network or network firms, and service providers, who are subject to the relevant ethical requirements to which the firm and the firm’s engagements are subject, have a sound understanding of the following:

a. The relevant ethical requirements to which the firm and the firm’s engagements are subject
b. Fulfilment of their responsibilities, in relation to these relevant ethical requirements.

ISQM 1 para 30 requires firms to establish quality objectives that address the acceptance, and continuance of client relationships and specific engagements, ensuring that:

a. Judgments by the firm about whether to accept, or continue a client relationship or specific engagement are appropriate based on:

(i) Information obtained about the nature and circumstances of the engagement, and the integrity and ethical values of the client, which is sufficient to support such judgments

(ii)The firm’s ability to perform the engagement, in accordance with professional standards, and applicable legal and regulatory requirements.

b. The financial and operational priorities of the firm do not lead to inappropriate judgments about whether to accept, or continue a client relationship or specific engagement.

Engagement-level considerations

The engagement partner must understand relevant ethical requirements and take responsibility for other members of the engagement team being made aware of relevant ethical requirements that are applicable, given the nature and circumstances of the audit engagement, and the firm’s related policies or procedures. The engagement partner must remain alert throughout the audit engagement. If the engagement partner becomes aware that a threat to compliance with relevant ethical requirements exists, the engagement partner must evaluate the threat and take appropriate action. Similarly, actual breaches of relevant ethical requirements must be addressed by the engagement partner, in consultation with others in the firm. Before dating the audit report, the engagement partner must determine whether relevant ethical requirements, including those related to independence, have been fulfilled.

As it relates to acceptance and continuance decisions, the engagement partner must determine whether the firm’s policies or procedures have been followed, and that conclusions reached in this regard are appropriate. The firm must communicate issues to the engagement team when considering the acceptance of the engagement. Information obtained in the acceptance and continuance process should further be considered when planning and performing the audit engagement. If the engagement team later becomes aware of information that might have caused the firm to decline the audit engagement, had that information been known by the firm prior to accepting, or continuing the client relationship or specific engagement, the engagement partner must communicate this promptly to the firm, so that the firm and the engagement partner may take the necessary action.

Common concerns identified

Audit regulators have noted an increase in the number of deficiencies reported on relevant ethical requirements. Most of the findings reported relate to the independence of the auditor and/or audit firm, and translate to a failure in the firm’s controls to identify, and act appropriately to threats to independence. Inadequate documentation of independence considerations was noted, together with prohibited non-assurance services provided to audit clients; inadequate policies and procedures to identify and evaluate threats; failure to identify and address threats; and insufficient procedures to ensure compliance with partner rotation and cooling off periods. Annual independence declarations were not appropriately assessed to confirm that there were no independence matters that needed to be addressed, and processes were insufficient, as they were not able to identify an inappropriate appointment or inappropriate relations.

Due to inadequate identification, evaluation and resolution of independence threats, client relationships and engagements were accepted where the auditor’s independence was not intact. This could commonly be attributed to providing other non-assurance services in the current or preceding financial years, inadequately considering ‘long-standing’ relationships and the potential familiarity threats created, and prior and future employment with audit clients in positions of significant influence.

In summary

It is to be expected that ethical and independence threats surface from time to time. The important thing is for firms to be aware of this, and to ensure that the policies and procedures establish a framework for threats and breaches to be identified, evaluated and resolved in a timely manner. Accepting, or continuing with client relationships and engagements where an independence issue is present may lead to inappropriate audit reports and increased public scrutiny of the firm and profession.

LEAF can assist firms with the assessment of ethics, acceptance and continuance considerations through firm and engagement-level monitoring reviews, methodology design reviews, and staff training on the relevant requirements and procedures.

References

1. IAASB, ISQM 1: Quality management for firms that perform audits or reviews of financial statements, or other assurance or related services engagements
2.  IAAS, ISA 220 (Revised): Quality management for an audit of financial statements

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