Question

QUESTION 2: ETHICS, INDEPENDENCE & GOVERNANCE

You have been asked by Tian, a friend of yours, to help clarify a few matters relating to his new job. He has recently joined Zipit Ltd, a company listed on the New Zealand Stock Exchange, as an assistant accountant. He explains that GKPM, the company’s auditors arrived the previous week. As this is his first experience of being audited, there are a few things he does not understand. Knowing that you are studying auditing this year, he hopes you may be able to explain these matters to him:

i) Tian has had to spend a number of hours with Maya, one of the audit staff, explaining how their internal controls work. He has grown to really enjoy her company and is sure she feels the same, so he asked if she would like to go out to dinner with him. He was surprised when she replied that she had better not, as it may raise ethical issues.

ii) Tian has noticed a huge difference between Maya and John, another member of the audit team. Maya is polite and professional to those she deals with and is really knowledgeable and conscientious in her work. John however, is rude, inconsiderate and demanding; he also seems “clueless” about what he is auditing despite claiming to be an expert and is really careless and sloppy about how he does his work. He was also overheard at a party, discussing the amount of the salary paid to the Zipit Ltd managing director. Tian remarks that if anyone has ethical issues, it is John.

iii) Finally, Tian tells you that he attended a meeting yesterday, between Zipit Ltd’s accounting staff and the GKPM audit partner and manager. Zipit Ltd’s Chief Financial Officer, Ning is very keen for GKPM to assist with the implementation of a new accounting information system. Ning had already received quotes from two computer consulting firms for this work and informed the meeting that these quotes were equal to approximately double the annual audit fee. She has suggested that GKPM are better able to provide the necessary assistance – their audit knowledge and understanding of Zipit Ltd should mean greater efficiencies, lower costs and a better outcome, as the two computer consulting firms have no prior knowledge of Zipit Ltd. Tian was therefore surprised when James, the audit partner seemed hesitant about accepting this additional engagement. Tian is also puzzled as to why James insisted that the matter would have to be cleared by the Audit Committee before proceeding any further (Tian thought that the GKPM audit partner and manager were the audit committee).

Required: a) For each of the three matters described above, identify and explain which fundamental ethical principle(s) may be compromised. Your explanation should clearly identify the nature of any threats to ethical requirements.

b) Explain to Tian:

 What an Audit Committee is;

 Why James’s insistence on Audit Committee approval in (iii) above, is important for compliance with two particular ISA 220 Quality Control elements.

Answer 1

(a) Identification and explanation of fundamental ethical principles-

	Matter	Ethical concern	Nature of ethical principles being compromised
(a)	Tian asking Maya for outing	Objectivity and integrity and independence	The fundamental principle of ethics is objectivity and independence. By engaging in mutual relationship, Maya and Tian may have violated the fundamental pricinple of ethics of Professional Practice of audit
(b)	Disclose of salary of MD	client confidentiality	Confidentiality requires non-disclosure of any client related information. By discussiong MD salary, John violate these 3 principles and may attract ethical disciplinary action.
(c)	Asking auditor for the internal control work and auditor requesting Audit Committee approval	Legal requirement for audit committee clearance for any non-audit work	Most of the countries have legal requirement in place where any non-audit work is required to be cleared by the Audit Committee.

(b) Explanation-

Audit Committee- Audit committtee is a committe that is in charge of overseeing financial reporting and disclosure requirement. Committe consists of mostly independent directors and financial reporting by the companies required audit committee pre-clerance. Also, any non-audit work is required to be cleared by it. Auditor appointment and remuneration is required to be approved by it. In US, all public companies is required to have an audit committee in place. Mostly, it consists of 3 directors, 1 of whom is Chairman.

ISA 2200- As per ISA 2200, Quality control systems, policies and procedures are the responsibility of the audit firm. The firm has an obligation to establish and maintain a system of quality control to provide it with reasonable assurance that:

(i) The firm and its personnel comply with professional standards and applicable legal and regulatory requirements; and

(ii) Reports issued by the firm or engagement partners are appropriate in the circumstances.

Within the context of the firm’s system of quality control, engagement teams have a responsibility to implement quality control procedures that are applicable to the audit engagement and provide the firm with relevant information to enable the functioning of that part of the firm’s system of quality control relating to independence. Engagement teams are entitled to rely on the firm’s system of quality control, unless information provided by the firm or other parties suggests otherwise.

Any Non-audit work performed by the auditor is required to be approved by the Audit Committee as a regulatory approval compliance. Insitence on audit committee pre-approval is a necessary compliance requirement and ISA 2200- Quality control for an audit of financial statements requires the firm and engagement team to meet the legal requirements and place control, system in place.