Ethical standards required of auditors

The Auditing Practices Board (APB) has issued new standards governing the ethical conduct of auditors which commenced on 15 December, 2004 (Cosserat, 2004). The following lists the new Ethical Standards:

1.    Integrity, Objectivity and independence

These new ethical standards also include the fact that client’s must also facilitate policies new standards is that auditors of a control environment appoint an ethics partner. This position entails the review of the firm’s procedures and policies which regard to compliance and as such it provides the associated guidance for partners. The new Standards recognize that for smaller audit firms it might not be practical for an ethics partner to be designated.

The new Ethical Standards are a result of a number of international developments represented by either international organizations and or countries that have helped to bring about the changes to Standards. These are represented by the following:

a.    The United States legislation termed the Sarbanes-Oxley Act which lays down the independence requirements for auditors. In particular it addresses audit firms that audit SEC registrants or participant in significant parts of the foregoing.
b.    A report that is titled ‘Rebuilding Public Confidence in Financial Reporting’, which is an international perspective that was developed as a result of the commissioning by the IFAC of an independent group to address the preceding, and
c.    As a result of the publishing of the ‘Principles of Auditor Independence’ which was put forth by the International Organization of Securities Commissions.

The new Standards are what are termed ‘principles-based’ as opposed to ‘rules-based’. The preceding means that there are clear requirements as well as prohibitions. The key underpinning of this change provides for stricter compliance with the ‘spirit of intention’ and thus prevent the possibility of either a firm or person attempting to evade or avoid conformity with the rule. The effect of the foregoing helps to ensure compliance with ethical standards in that ‘intention’ covers a broader ethical parameter. In effect, one could avoid or evade breaking a rule, however the intent through either actions or the change in former action(s) could point to the definitive attempt to do so. This broader interpretation widens the scope of ethics and requires auditors to conduct their actions accordingly throughout the process. 

In a speech delivered by Douglas Carmichael at the AICPA National Conference on 12 December, 2003 (Carmichael, 2003) he sets forth the examples of ‘alleged’ audit failures of National Student Marketing in 1969, Penn Central in 1970 and Equity Funding in 1973 as instances whereby principle based auditing might have forestalled the problems. The foregoing is true of Enron’s collapse in 2001 and indicates that the broader scope or ethics afforded auditors under the principle based methodology provides better rules and guidance from which auditors can act.

2.    Financial, business, employment and personal relationships

This segment of the new Standards addressed the varied relationships that can and do exist between clients and audit firms and their staff. This limits the nature of relationships and threats to the objectivity and independence of audits and prohibits those which the APB believes that no effective safeguards can be introduced.

3.    Long association with the audit engagement

Associations of long duration poses potential threats, in particular with regard to those represented by publicly listed companies. Thus, the new Standards set forth the rotation of audit firm partners to introduce objectivity as well as independence. The new Standards sets that term as five (5) years as the continuous period limit as well as a break period of five (5) years for the rotation.

4.    Fees, economic dependence, remuneration and evaluation policies, litigation, gifts and hospitality

One important, and highly debated point is the requirement that no single client shall account for more than ten percent (10%) of an audit company’s annual fee. This figure is fifteen percent (15%) for non-publicly listed firms.

5.    Non-audit services provided to audit clients

This segment of the new Standards identifies the general approach to non-audit services and applies general principles to various specific non-audit aspects such as:

  • internal audit services
  • accounting services
  • information technology services
  • valuation services
  • recruitment and remuneration services
  • corporate services, and
  • tax services

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