ETHICS, LEGAL LIABILITY AND CLIENT ACCEPTANCE

CHAPTER 2

ETHICS, LEGAL LIABILITY AND CLIENT ACCEPTANCE

SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES

Item LO Item LO Item LO Item LO Item LO Item LO Item LO True-False Statements

1. 1 3. 2 5. 2 7. 4 9. 4 11. 4 13. 5

2. 2 4. 2 6. 1 8. 4 10. 4 12. 5 14. 5

Multiple Choice Questions

15. 1 20. 2 25. 1 30. 2 35. 2 40. 3 45. 4

16. 2 21. 2 26. 1 31. 2 36. 2 41. 3 46. 5

17. 2 22. 3 27. 1 32. 2 37. 2 42. 4 47. 5

18. 2 23. 4 28. 2 33. 2 38. 3 43. 4

19. 2 24. 5 29. 2 34. 2 39. 3 44. 4

Short Answer Questions

48. 2,4,5 49. 1 50. 2 51. 2 52. 5

Essay Questions

53. 3 54. 4 55. 2

Case

56. 4,5

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SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE

Item Type Item Type Item Type Item Type Item Type Item Type Item Type Study Objective 1

1. TF 6. TF 15. MC 25. MC 26. MC 27. MC. 49. SA

Study Objective 2

2. TF 16. MC 20. MC 30. MC 34. MC 48. SA

3. TF 17. MC 21. MC 31. MC 35. MC 50. SA

4. TF 18. MC 28. MC 32. MC 36. MC 51. SA

5. TF 19. MC 29. MC 33. MC 37. MC 55. ES

Study Objective 3

22. MC 38. MC 39. MC 40. MC 41. MC 53. ES

Study Objective 4

• TF 9. TF 11. TF 42. MC 44. MC 48. SA 56. Ca

8. TF 10. TF 23. MC 43. MC 45. MC 54. ES

Study Objective 5

• TF 14. TF 46. MC 48. SA 56. Ca

13. TF 24. MC 47. MC 52. SA

Note: TF = True-False SA = Short Answer ES = Essay

MC = Multiple Choice Ca = Case

Ethics, legal liability and client acceptance 2 – 3

CHAPTER STUDY OBJECTIVES

• Describe the fundamental principles of professional ethics and list some of the

specific rules professional accountants are required to follow. Each of the three professional accounting bodies has a code of professional conduct and each has the same fundamental principles of professional ethics: integrity (being straightforward and honest); objectivity (not allowing personal feelings or prejudices to influence professional judgement); professional competence and due care (maintaining knowledge and skill at an appropriate level); confidentiality (not sharing information that is learned at work); and professional behaviour (upholding the reputation of the profession). There are also specific rules that incorporate the guiding ethical principles, and which are enforceable.Some of these rules concern: fees and pricing, advertising, contact with predecessor auditors, firm names, and professional contact.

• Define and explain auditor association and independence. Association is the term

used to indicate a public accountant’s involvement with financial information. Public accountants should not be associated with anything false and misleading; therefore, they should take care to communicate the level of their involvement with the information.Independence is the ability to make a decision that is free from bias, personal beliefs, and client pressures. An external auditor must not only be independent of their client, they must also appear to be independent of their client. Threats to auditor independence include self-interest, self-review, advocacy, familiarity, and intimidation threats. A self- interest threat can occur when an auditor has a financial interest in a client. A self-review threat can occur when an auditor must form an opinion on their own work or work done by others in their firm. An advocacy threat can occur when an auditor acts on behalf of their client. A familiarity threat can occur when there is a close relationship between the auditor and their client. An intimidation threat can occur when an auditor feels threatened by their client. Safeguards to auditor independence include the code of ethics, legislation, the establishment of audit committees by clients, client acceptance, and continuance procedures, partner rotation policies, and education within accounting firms.

• Explain the relationship between an auditor and key groups they have a

professional link with during the audit engagement. Auditors report to their clients’ shareholders. These are the owners who rely on the audited financial statements when evaluating the performance of their company. The board of directors represents the shareholders and oversees the activities of the company and its management. It is the directors’ responsibility to ensure that the financial statements being audited are fairly presented. The audit committee is responsible for liaising between the external auditor, the internal auditor, and those charged with governance to aid the board of directors in ensuring that the financial statements are fairly presented and that the external auditor has access to all records and other evidence required to form their opinion. The external auditor may use the work performed by the internal auditors after considering the function’s objectivity, technical competence and due professional care, and the effectiveness of communication between internal and external auditors.

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• Explain the auditor’s legal liability to their client, contributory negligence, and the

extent to which an auditor is liable to third parties. Contributory negligence is where a client is found to be negligent and to have contributed to the loss suffered by the plaintiff. To successfully sue an auditor, a plaintiff must prove that a duty of care was owed by the auditor, there was a breach of that duty, and a loss was suffered as a result of that breach. Several cases are discussed in the chapter in relation to an auditor’s liability to third parties. To establish that an auditor owes them a duty of care, a third party must now establish that the auditor was aware that the third party was going to use the financial statements and that the users relied on the financial statements for the purpose they were prepared.

• Identify the factors to consider in the client acceptance or continuance decision.

Factors to consider include the integrity of a client, such as the client’s, reputation and attitude to risk, accounting policies, and internal controls. An auditor will gain an understanding of the client through communication with the client’s previous auditor (in the case of a client acceptance decision), staff , management, and other relevant parties.The final stage in the client acceptance or continuance decision process involves the preparation of an engagement letter, which sets out the terms of the audit engagement to avoid any misunderstandings between the auditor and their client.