Chap 3 Ethics Independence and Corporate Governance)

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CHAPTER 3
Ethics, independence and corporate governance
LEARNING OBJECTIVES (LO)

3.1 Explain the nature and importance of professional ethics, and
describe the three main categories of ethical theory.
3.2 Outline the essence of the accounting bodies’ code of ethics.
3.3 Apply sound ethical decision-making techniques.
3.4 Explain the concept and importance of auditor independence.
3.5 Explain fee determination.
3.6 Explain the concept of corporate governance.
RELEVANT GUIDANCE
ASA 102 Compliance with Ethical Requirements when Performing

Audits, Reviews and Other Assurance Engagements
ASA 200/ISA 200 Overall Objectives of the Independent Auditor and the
Conduct of an Audit in Accordance with Australian
(International) Auditing Standards
ASQC 1/ISQC 1 Quality Control for Firms that Perform Audits and Reviews
Copyright © 2018. McGraw-Hill Australia. All rights reserved.
of Financial Reports and Other Financial Information,

Other Assurance Engagements and Related Services
Engagements
APES 110/IFAC Code of Ethics for Professional Accountants
APES 320 Quality Control for Firms
Gay, Grant E., and Roger Simnett. Auditing and Assurance Services in Australia, McGraw-Hill Australia, 2018. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/adelaide/detail.action?docID=5729228.
Created from adelaide on 2021-06-30 08:39:26.
CHAPTER OUTLINE
As discussed in Chapters 1 and 2 , the auditor is a member of a time-

honoured profession, and the status of the profession and the responsibilities
that accompany this status affect the audit and assurance services function and
the structure of the profession. The independent auditor is subject to regulation
imposed by the profession and by society in general. The imposition of ethical
standards on members by a profession is one aspect of this regulation.
This chapter outlines the nature and importance of ethics, and the
responsibilities imposed on auditors by the profession through the code of
professional ethics. One fundamental ethical requirement for an auditor is
independence. This chapter explains the concept of independence and how it is
supported by legislation and the ethical rules. The major threats to auditor
independence are explained. Also discussed is the concept of corporate
governance and the part played by audit committees in this function.
How this chapter fits into the overall auditing and assurance profession is
illustrated in Figure 3.1 , which is an expansion of part of the overall flowchart
provided in Chapter 1 .
FIGURE 3.1 Flowchart of auditing and assurance profession
Page 90
LO 3.1 Professional ethics and ethical theory
The nature and importance of professional ethics

Ethics are concerned with the requirements for the general wellbeing, prosperity, health
and happiness of people, and with things that promote or prevent them.
Paragraph 3(f) of the Supplemental Royal Charter of Chartered Accountants Australia and
New Zealand (Chartered Accountants ANZ) states that one of its principal objects is to do
all things that may advance the profession of accountancy, whether in relation to the
practices of public accountants or in relation to industry, commerce, education or the
public service. Similarly, paragraph 3(1) of the constitution of CPA Australia establishes
one of its objects as protecting, supporting and advancing the status, character and interests
of the accountancy profession generally. The Institute of Public Accountants (IPA) has
similar objectives. Community wellbeing includes the flourishing of business and industry.
The objectives of the accounting bodies support an environment of personal and corporate
integrity that promotes community wellbeing. This necessarily involves defining what is
right and what is wrong.
Chartered Accountants ANZ’s Royal Charter, CPA Australia’s constitution and the IPA’s
constitution give these bodies the power to prescribe high standards of practice and
professional conduct for their members, and to prescribe disciplinary procedures and
sanctions.
In practice, ethics require both knowledge of moral principles and skill in applying them to
problems and decisions. In addition, sound ethical practice presupposes the development in
individuals and society of the virtues or good habits that ensure the moral health of the
community.
Establishing codes of ethics and disciplinary rules does not necessarily create an ethical
culture in an organisation or business, nor does it ensure the moral integrity of its
individual members. It is necessary to promote not only competence in ethics but also the
personal qualities of responsibility and moral conscientiousness. Codes of ethics, rules,
regulations and laws do not have meaning or moral legitimacy in themselves. Rather, their
authority and legitimacy depend on whether they are perceived as helping to promote
people’s wellbeing. If rules are considered to be unjust, discriminatory or oppressive,
people are likely to disregard them or demand they be changed.
APES 110 indicates that the Code of Ethics for Professional Accountants does not Page 91
cover all aspects of ethical conduct and that members are expected to comply with
the spirit as well as the letter of the rules. They recognise that ethics are principally
attitudes of mind rather than compliance with written rules of conduct.
Society is governed by rules, regulations and laws. From an auditing viewpoint, this tends
to place the focus on ‘black letter’ law. However, it needs to be remembered that it is
always possible to question whether a rule is a good rule. Value judgments need to be made
as to whether rules are fair, whether they respect the rights of all parties and whether they
protect those parties who are unable to defend their rights. Sound statutory law must be
based on and consistent with common law and natural justice if it is to promote human
wellbeing.
Ethical theory
There are three main categories of ethical theory that will be discussed in this chapter:
teleological ethics, deontological ethics and virtue ethics.
Teleological ethics
Teleological ethics are also called consequential ethics because they deal with the
consequences or outcomes of actions. Generally, if the benefits of a proposed action
outweigh the costs, then the decision is considered morally correct. The most important
theory of teleological ethics is utilitarianism.
Jeremy Bentham (1784–1832) and John Stuart Mill (1806–73) are generally acknowledged
as having developed the theory of utilitarianism , which states that ethical decision
making should maximise the greatest good for the greatest number. This involves an
assessment of costs and benefits, not only in economic terms but also in terms of human
costs and benefits. Therefore, it involves a value judgment and needs to consider all the
stakeholders who will be affected by a decision. The outcomes are measured both in
economic terms and in psychological terms, such as pain and happiness. Therefore,
measuring and assigning a numeric value to the consequences of an action is often
difficult.
Deontological ethics
Deontological ethics are based on duties and rights. Duties are obligations and are
actions that a person is expected to perform, while rights are entitlements and are actions
that a person expects of others. These duties and rights are set down in rules that must be
followed regardless of the consequences. Hence, deontological ethics are also sometimes
called non-consequential ethics. Deontological ethics are particularly important to auditors
in understanding their duties based on the ethical rules of the accounting bodies.
Immanuel Kant (1724–1804) placed high value on personal rights and personal moral
autonomy, and the basis of his ethical theory was the principle of respect for persons. This
acknowledges the intrinsic value of all persons and recognises that we should not use
people to achieve our own ends. Further, we should recognise a duty of care to others, as
expressed in the golden rule or principle of reciprocity: ‘do unto others as you would have
them do unto you’.
This rule leads to the principle of beneficence, which advocates that we should do good to
others rather than harm. Kant suggested the categorical imperative as a universal ethical
law. This means that, when considering the validity of a rule, we need to consider whether
we would be happy to have this action applied in all similar circumstances regardless of the
consequences. This leads to the need for the principle of justice.
John Rawls (1957) argued that the fundamental idea underlying the concept of justice is
that of fairness. He argued that there are two principles that serve as the basis of justice and
fairness:
The first principle is that each person participating in a practice,

or affected by it, has an equal right to the most extensive liberty
compatible with a like liberty for all; and the second is that
inequalities are arbitrary unless it is reasonable to expect that they
will work out for everyone’s advantage and unless the offices to
which they attach, or from which they may be gained, are open to
all.
Thus, Rawls argued that ethical rules should seek equality and the maximum Page 92
degree of liberty that does not conflict with the liberty of others or increase
inequalities or disadvantage to others.
Virtue ethics
Virtue ethics , which date back to Aristotle, are concerned primarily with integrity,
which is an essential characteristic of an auditor. Virtue ethics focus on the person
undertaking the action. Virtues are personal qualities that enable us to do what is ethically
desirable, and generally include traits of character such as courage, fairness, honesty,
integrity, loyalty, courtesy and fidelity. Virtue ethics emphasise what makes up a morally
good person, but do not necessarily make it clearer what should be done to solve an ethical
conflict.
The relevance of these three ethical theories to the accounting bodies’ code of ethics and to
ethical decision making by auditors will be discussed later in this chapter.
QUICK REVIEW
1. The accounting bodies require their members to behave ethically.
2. Behaving ethically requires knowledge of moral principles and decision-
making skills.
3. Teleological ethics are based on ethical outcomes.
4. Deontological ethics are based on ethical duties and rights.
5. Virtue ethics are based on personal ethical qualities.
LO 3.2 Accounting bodies’ code of ethics
APES 110 Code of Ethics for Professional Accountants sets out the main ethical pronounc
ements for members of Chartered Accountants ANZ, CPA Australia and the IPA. ASA
200.14 (ISA 200.14) requires that auditors comply with relevant ethical requirements.
Further, ASA 102.5 and A1–A7 specifically require the auditor to comply with APES 110.
The code consists of the following three sections:
1. Part A: General Application of the Code Sections 100–150 set out the fundamental
principles of professional ethics and provide a conceptual framework for applying these
principles.
2. Part B: Members in Public Practice Sections 200–291 illustrate how the conceptual
framework is to be applied to specific situations in public practice.
3. Part C: Members in Business Sections 300–350 illustrate how the conceptual framework
is to be applied to specific situations in business.
The ethical rules play an important part in an auditor’s behaviour. The written code of
appropriate professional conduct is designed to enable members to arrive at the proper
conclusion when making ethical decisions. As a result, the ethical rules comment upon
different types of relationships faced by auditors and spell out some of the auditor’s
responsibilities. The preface to APES 110 states that compliance with the code is
mandatory for all members.
There are also a number of APES standards, not all of which are relevant to auditors but
which are mandatory for members of the three accounting bodies. In general, these
statements seek to promote the fundamental principle of ‘competence’.
The APES 200 series is applicable to all members of the accounting bodies and includes:
APES 205 Conformity with Accounting Standards
APES 210 Conformity with Auditing and Assurance Standards

APES 215 Forensic Accounting Services
APES 220 Taxation Services
APES 225 Valuation Services
APES 230 Financial Planning Services.
Page 93
The APES 300 series is applicable to members of the accounting bodies in public
practice and includes:
APES 305 Terms of Engagement
APES Dealing with Client Monies

310
APES Compilation of Financial Information

315
APES Quality Control for Firms

320
APES Risk Management for Firms

325
APES Insolvency Services

330
APES Reporting on Prospective Financial Information Included in a

345 Disclosure Document
APES Participation by Members in Public Practice in Due Diligence

350 Committees in Connection with a Public Document
The purpose of the code of ethics

A code of ethics is a formal and systematic statement of rules, principles, regulations or
laws developed by a community to promote its wellbeing and to exclude or punish any
undermining behaviour. Therefore, a code of ethics may serve several purposes. It may:
make explicit those values that may be implicitly required (for example, the underlying
core values or principles in sections 100–150 of APES 110, which are discussed later in
this chapter)
indicate how members should act towards one another (for example, the responsibilities
to professional colleagues exhibited through the protocol to be followed when
superseding another auditor (section 210 of APES 110) and permissible forms of
advertising (section 250 of APES 110), both of which are discussed in Chapter 5 .)
provide an objective basis for sanctions against people who violate the rules (for example,
disciplinary action under Chartered Accountants ANZ’s Supplemental Royal Charter,
CPA Australia’s constitution and the IPA’s constitution, discussed in Chapter 2 , or by
the Australian Securities and Investments Commission (ASIC)). A member’s behaviour
can be judged, in part, by reference to the rules laid down in APES 110. An established
code of ethics is one mechanism of self-regulation.
In addition, APES 110 communicates the profession’s responsible attitude of

accountability to the community at large.
Like many professional codes, the ethical rules of the accounting bodies endeavour to
promote standards of competence, proficiency and personal moral integrity in their
members. These qualities are similar to those that Thomson et al. (1976) referred to as
Aristotle’s intellectual and moral virtues. Aristotle’s intellectual virtues included science
(knowledge), techne (practical skill and competence, intelligence, judgment, understanding,
persistence and resourcefulness) and wisdom. His moral virtues included courage (loyalty
and integrity), temperance (discipline, friendliness, generosity, magnanimity,
communication and social skills) and justice. Thomson et al. indicated that these virtues
can be depicted as an arch, with intellectual values on one side and moral virtues on the
other. The keystone holding them together is the virtue of prudence or acquired practical
wisdom.
However, written codes of conduct should not be viewed as the panacea for the profession’s
ethical problems. As mentioned previously, these codes do not by themselves make people
behave ethically.
The virtues of an auditor

In line with the discussion of the professional status of an auditor in Chapter 2 , APES
110 section 100.1 states that a distinguishing mark of the audit profession is its acceptance
of the responsibility to act in the public interest . The public interest is defined as the
collective wellbeing of the community of people that the members serve. Therefore, the
auditing profession’s ‘public’ consists of clients, credit providers, governments, employers,
employees, investors, the business and financial community and others who rely on the
objectivity and integrity of the auditor. The public interest principle recognises that
conflicts occur between the various stakeholder interests and that when such conflicts
occur, the auditor’s primary responsibility is to the public interest, not to himself or herself
or to the client. Rather, the auditor is required to advance the interests of their Page 94
client, provided that it does not conflict with the obligation to safeguard the public
interest.
Further to the discussion in Chapters 1 and 2 regarding the fundamental ethical
principles that an auditor must follow, APES 110 section 100.5 sets out the following five
fundamental principles, shown in Figure 3.2 , that apply to all members.
FIGURE 3.2 Fundamental principles
These fundamental principles are discussed in more detail in sections 110–150 of APES
110:
1. Integrity Auditors should act with consistency, treating like cases in a like manner.
Honesty is an integral part of this value. The principle of integrity therefore imposes an
obligation on an auditor to be straightforward and honest in all professional and business
relationships and requires fair dealing and truthfulness. As a result, in accordance with
APES 110 section 110.2, an auditor should not be associated with any reports or other
communications that are false, misleading or recklessly prepared. Integrity is supported
by the ethical principle of respect for persons.
2. Objectivity In accordance with APES 110 section 120, auditors must be fair and must
not allow bias, conflict of interest or the undue influence of others to override their
objectivity. They need to maintain an impartial attitude and not represent vested interests
when auditing a financial report. Therefore, relationships that bias or unduly influence
the auditor’s professional judgment should be avoided. As fairness is an important
behavioural implication of this value, objectivity can be justified by the ethical principle
of justice.
3. Professional competence and due care Section 130.1 of APES 110 indicates that
auditors have a duty to attain and maintain their level of professional competence and
should only undertake work that they can expect to complete with professional
competence and due care in accordance with applicable technical and professional
standards. Auditors have a duty to maintain their level of competence throughout their
professional career through continuing professional development. Clearly, a client’s

interests cannot be adequately served by auditors who do not possess the necessary skills
for the tasks that they undertake. This requires appropriate training and supervision.
Accepting work for which the auditor is not competent could lead to damage to the client.
The maintenance of high standards of technical proficiency is designed to protect clients,
and so the value of competence and due care is supported by the ethical principle of
beneficence.
4. Confidentiality Auditors hold positions of trust and have access to many valuable and
private pieces of information in the course of their work. Section 140.1 of APES 110
indicates that they should respect the confidentiality of information obtained during the
course of their work and should not disclose such information to a third party without
authority or unless there is a legal or professional duty that is not prohibited by law to do
so, as outlined in section 140.7. However, as discussed in Auditing in the global news
3.1 , as a result of international developments and amendments to APES 110 in
September 2017, to include a new section 225, ‘Responding to non-compliance with laws
and regulations’ (NOCLAR), auditors now need to consider their reporting Page 95
obligations if they uncover or suspect illegal acts such as fraud, corruption,
bribery or money laundering during the course of their professional work. APES 110 now
permits accountants to set aside the principle of confidentiality where such illegal acts are
suspected. Where an auditor is considering disclosing confidential information of a client
without the client’s consent, on the basis that that disclosure is required by law or
professional requirements, they are strongly advised under section AUST 140.7.1 to first
obtain legal advice. This duty to protect the interests of clients means that confidentiality
reflects the ethical principle of beneficence.
5. Professional behaviour Section 150.1 of APES 110 indicates that auditors should
comply with relevant legislation and conduct themselves in a manner consistent with the
good reputation of their profession and refrain from any conduct that could bring
discredit to it. A good reputation is fundamental to the ability of the profession to
continue to enjoy its rights and privileges. Therefore, in addition to their duty to the
public interest and to their clients, auditors have a duty to the profession and must act in a
way that promotes the good reputation of the profession. Section 150.2 of APES 110
indicates that in marketing and promoting themselves auditors must not bring the
profession into disrepute by making exaggerated claims or by disparaging competitors.
Consequently, the value of professional behaviour can be justified by reference to the
ethical principles of beneficence and respect for persons.
3.1 Auditing in the global news ...
Confidentiality not a cover for illegal acts
A new standard issued today requires accountants to consider their

obligations if they uncover or suspect illegal acts such as fraud, corruption,
bribery or money laundering during the course of their professional work.
The ground-breaking standard in Australia adopts the new international

approach and permits accountants to set aside the principle of confidentiality
where illegal acts are suspected.
‘This standard encourages professional accountants to speak up where they

discover laws and regulations are not being adhered to—and identifies a
process to go through enabling accountants to raise concerns appropriately
without breaching other professional and ethical standards,’ APESB Chair,
The Honorable Nicola Roxon, said.
‘It is feared that, in the past, identifying potential illegal acts and raising the
alarm did not always prevail over confidentiality and other obligations to a
client or employer.’
The new standard, Responding to Non-Compliance with Laws and

Regulations (NOCLAR), comes into force on 1 January 2018—allowing time
for accountants to update their systems to comply with the standard.
Individual firms and accountants are urged to adopt this standard earlier
where possible to meet international best practice.
The new standard will be incorporated into the Australian code APES 110
Code of Ethics for Professional Accountants …
Source: Text extract from Media Release 30 May 2017.

Reproduced with the permission of the copyright owner, Accounting Professional & Ethical Standards
Board Limited (APESB), Australia.
Further, as will be discussed in more detail later in this chapter, section 290 of APES 110
provides specific guidance on independence requirements for audit and review
engagements, while section 291 provides similar requirements for other assurance
engagements. Auditors should both be, and appear to be, free of any interest which might
be regarded as incompatible with objectivity and integrity. Without independence, the
auditor’s opinion is worthless. Independence, however, can be easily compromised.
Objectivity, independence and technical standards equate with Aristotle’s Page 96

intellectual virtues. Honesty, integrity, confidentiality and ethical behaviour equate
with Aristotle’s moral virtues. Professional competence equates with what Aristotle called
prudence, or the practical wisdom necessary to apply abstract general principles to specific
situations.
Auditors are both legally and morally accountable to their clients. Therefore, competence
in ethics is an important requirement of a good auditor.
QUICK REVIEW
1. The ethical rules required to be followed by members of the accounting
bodies provide important guidance to members.
2. Ethical rules cannot cover all aspects of ethical conduct.
3. Ethics are principally attitudes of mind.
4. The key ethical principles of the accounting bodies are public interest,
integrity, objectivity, professional competence and due care, confidentiality
and professional behaviour. In addition, independence is required for
assurance engagements.
LO 3.3 Applying ethics
Sound ethical practice requires responsible people with a critical understanding of sound
decision making based on fundamental ethical principles. This requires:
knowledge of the basic principles on which moral values and rules are based
competence in decision-making skills
ability to choose appropriate policies and decision procedures in different situations.
To act ethically is to act appropriately and responsibly in different situations, providing a

clear, coherent and reasoned justification for decisions and actions, based on commonly
accepted values or standards.
An auditor needs to combine ethical rules with skills in making decisions and setting
policies. As indicated by Leung and Cooper (1995, p. 32):
The complexity of the different ethical problems encountered by

accountants requires not only a good knowledge of a set of ethical
principles, but also the skills and competence to handle conflicting
roles and interests relating to accountancy practice.
Ethical decision-making models

A number of ethical decision-making models have been developed to assist in sound
ethical decision making, such as the American Accounting Association (AAA) model, the
Mary Guy model, the Laura Nash model and the Spiral model. As the basic steps in
problem solving are the same, the various ethical decision-making models have many
common features. The most widely used is the AAA model, where each case is analysed
using a seven-step model, shown in Exhibit 3.1 . However, these models should not be
followed slavishly but rather used as a framework for decision making, as indicated in
APES 110 section 100.18, which states that the key factors to be considered in ethical
conflict resolution are:
relevant facts
ethical issues involved
fundamental principles related to the matter in question
established internal procedures
alternative courses of action.
Page 97
EXHIBIT 3.1 AMERICAN ACCOUNTING ASSOCIATION MODEL
1. Determine the facts

What? Who? Where? When? How?
What do we know or need to know that will help define the problem?
2. Define the ethical issues
List the significant stakeholders.
Define the ethical issues.
3. Identify the major principles, rules and values
(For example, integrity, quality, respect for persons, profit)
4. Specify the alternatives
List the major alternative courses of action, including those that represent some
form of compromise or point between simply doing or not doing something.
5. Compare values and alternatives—see if clear decision
Determine whether there is one principle or value, or a combination, which is so
compelling that the proper alternative is clear.
6. Assess the consequences
Identify the short-term and long-term, positive and negative consequences for the
major alternatives. The common short-term focus on gain or loss needs to be
measured against the long-term considerations. This step will often reveal an
unanticipated result of major importance.
7. Make your decision
Balance the consequences against your primary principles or values and select the
alternative that best fits.
Source: Langenderfer, H. Q., & Rockness, J. W. (1989). Integrating ethics into the accounting curriculum:
issues, problems, and solutions. Issues in Accounting Education. Spring, 58–69.
Ethical decision making also involves consideration of the three aspects of moral theory
discussed earlier in this chapter:
1. Fundamental principles and rules or rights and duties Deontological ethics focus on
the principles and causes, intentions and motives to be considered prior to action.
Fundamental ethical principles include the principle of beneficence (duty to do good to
or protect others), the principle of justice (duty to treat all people fairly) and the principle
of respect for persons (duty to respect the rights of other people). In an ethical decision-
making model this involves specifying the facts, including the stakeholders involved, and
identifying the ethical principles and the rights and duties of all parties.
2. Means, methods and the role of the agent Virtue ethics focus on the moral character of
the agent. The integrity and competence of the agent (auditor) are vital to their capacity
to act ethically. In an ethical decision-making model this involves identifying all the
options available, considering possible outcomes and knowing the right means to achieve
your goals, based on intellectual and moral virtues.
3. Ends or consequences Teleological ethics focus on the consequences of actions and
their outcomes relative to goals. If the ultimate end of human life is happiness, this
approach can translate into the utilitarian rule of always acting so that your action brings
the greatest amount of happiness to the greatest number of people. However, this must be
balanced by considering the rights of minorities. An assessment of the costs and benefits
for all stakeholders is required. In an ethical decision-making model this involves the
assessment of results in terms of achieving both short-term and long-term goals.
Page 98
QUICK REVIEW
1. An auditor needs to combine knowledge of ethical rules with skills in
ethical decision making.
2. There are several ethical decision-making models that can assist by
providing a framework for decision making.
3. The most commonly used ethical decision-making model is the American
Accounting Association model.
LO 3.4 Auditor independence
As mentioned earlier, for an audit or other assurance service to add credibility to a financial
report or other subject matter, an auditor needs to remain independent. Auditor
independence is critical to the orderly function of the capital markets, as it helps to build
the trust of various stakeholders in the financial information that has been audited. In
Australia, the requirement of independence for auditors has been reinforced through the
Corporations Act 2001 and the ethical rules of the accounting bodies.
Developments in auditor independence

Ramsay Report
Interest in the issue of audit independence was increased by speculation about what role, if
any, audit independence matters played in a number of high-profile corporate failures
during the first half of 2001. As a result, the federal government commissioned a report by
Professor Ian Ramsay on audit independence in Australia. The Ramsay Report, which was
issued in October 2001, examined Australia’s existing legislative and professional
requirements on the independence of company auditors and compared them with
equivalent overseas requirements. Where appropriate, the report proposed measures for
strengthening the Australian requirements.
The recommendations covered five key issues concerned either directly with audit
independence (employment relationships, financial relationships and provision of non-
audit services) or with matters designed to enhance audit independence (audit committees
and a board to oversee audit independence issues). These issues will be discussed later in
this chapter.
The Ramsay Report recommendations envisaged the continuation of the existing co-
regulatory regime under which some requirements are included in the corporations
legislation and others are in the ethical rules of the professional accounting bodies. The
federal government included many of the Ramsay Report recommendations in its CLERP 9
amendments to the Corporations Act 2001. The accounting bodies have likewise included
many of the Ramsay Report recommendations in their Code of Ethics for Professional
Accountants (APES 110).
IFAC independence rules
In addition, there have been a number of developments internationally, including the
release of new ethical rules by the International Federation of Accountants (IFAC) in its
Code of Ethics for Professional Accountants in November 2001. IFAC has adopted a
conceptual approach to independence that uses a framework built on principles for
identifying, evaluating and responding to threats to independence. As discussed in
Chapter 2 , international ethical standards are now issued by the International Ethics
Standards Board for Accountants (IESBA). These ethical provisions have been subject to
several revisions since their first issue.
APES 110
APES 110, which was first issued in June 2006, is based on the IFAC ethical rules, is
tailored to reflect Australian community expectations and takes into account the CLERP 9
amendments to the Corporations Act 2001. The independence requirements of APES 110
are discussed in detail later in this section.
Sarbanes–Oxley Act 2002 Page 99
In the US, in response to the collapse of Enron, WorldCom and other high-profile
businesses, the Sarbanes–Oxley Act of 2002 provides more stringent independence
requirements and more severe penalties for breaches. Among other things, it restricts
greatly the ability of auditors to provide non-audit services, mandates audit partner rotation
and strengthens the role of the audit committee.
The Sarbanes–Oxley Act 2002 affects not only US companies and US auditors, but any
audit firm actively working as an auditor of, or for, a publicly traded US company or its
subsidiary. Therefore, the Act covers any Australian audit firm that does the audit of a
subsidiary of a US-listed company or that of an Australian company that is listed on a US
stock exchange. During 2004, KPMG admitted providing non-audit services to National
Australia Bank in breach of the US Securities and Exchange Commission (SEC) rules,
after five staff were seconded to the bank. Even though this was permitted under Australian
rules, KPMG was required to step down as auditor of this client.
Joint Committee of Public Accounts and Audit
Due to the major corporate collapses both within Australia and overseas, the Joint
Committee of Public Accounts and Audit (JCPAA) resolved to review independent
auditing by registered company auditors. The committee issued its recommendations in
August 2002 in Report 391. Many of the Committee’s recommendations were consistent
with the Ramsay Report and many have been incorporated in the CLERP 9 amendments.
HIH Royal Commission
The major companies in the HIH Insurance Group were placed in provisional liquidation
on 15 March 2001. The deficiency of the group was estimated to be between $3.6 billion
and $5.3 billion. On 16 April 2003, the HIH Royal Commission issued its report, The
Failure of HIH Insurance, which contained 61 policy recommendations by Justice Owen,
covering corporate governance, financial reporting, auditing and regulation of the
insurance industry.
Corporate Law Economic Reform Program
In September 2002, the federal government issued a policy paper, CLERP 9, as part of its
Corporate Law Economic Reform Program, seeking stakeholder comments on proposals
for legislative amendments. The paper reviewed, among other things, auditor
independence. Following much discussion, stakeholder feedback, political debate and some
amendments, the Corporate Law Economic Reform Program (Audit Reform and Corporate
Disclosure) Act 2004 was passed by the Senate on 25 June 2004 and received Royal Assent
on 30 June 2004. The CLERP 9 legislation amends a number of Acts, including the
Corporations Act 2001. Some of the most significant changes introduced by the CLERP 9
amendments are to auditor appointment, independence and rotation requirements, which
are discussed below.
Legislative requirements
The Corporations Act 2001 has always contained some provisions which give formal
recognition to the need for auditor independence. The CLERP 9 amendments created a
general duty for the auditor to be independent and avoid conflicts of interest and to provide
a written declaration to directors confirming compliance with the auditor independence
requirements of the Corporations Act 2001. Other key provisions introduced through
CLERP 9 relate to restrictions on auditors being employed by an audit client, additional
specific requirements for appointment as an auditor, audit partner rotation for listed
companies and disclosure of non-audit services. The existing provisions relating to auditor
resignation, auditor removal, right of access to records and right to reasonable fees were
maintained.
Independence declaration
Section 307C requires an auditor to give the directors a written declaration to the effect
that, to the best of the auditor’s knowledge, there have been no contraventions of the
auditor independence requirements of the Corporations Act 2001 or of any Page 100
applicable code of professional conduct in relation to the audit, or that the only
contraventions have been those set out in the declaration. The directors’ report must
include a copy of the auditor’s independence declaration in accordance with section 298(1)
(c).
Conflicts of interest
It is a breach of the general auditor independence requirements under section 324CA for
the auditor to be aware of a conflict of interest situation in relation to the audit client and
not to take reasonable steps to ensure that the conflict of interest situation ceases to exist as
soon as possible. If, seven days after becoming aware of it, the conflict of interest situation
still exists, the auditor is required to notify ASIC. If the auditor is not aware of the conflict
of interest, but would have been aware if they had in place a quality control system
reasonably capable of making the auditor aware, the auditor will still be in contravention of
section 324CA.
Section 324CD indicates that a conflict of interest situation exists if:
the auditor or a professional member of the audit team is not capable of exercising
objective and impartial judgment in relation to the conduct of the audit
a reasonable person, with full knowledge of all relevant facts and circumstances, would
conclude that the auditor or a professional member of the audit team is not capable of
exercising impartial judgment in relation to the conduct of the audit.
When considering whether an auditor is capable of exercising objective and impartial

judgment, consideration needs to be given to past, current or possible relationships
between:
the auditor, audit firm, current or former audit firm member, audit company or any
current or former audit company director
the audited entity, its current or former directors or managers.
Former auditors
Section 300(1)(ca) requires the directors’ report for disclosing entities to include the names
of each officer who was formerly a partner or director of the audit firm or audit company
that is the entity’s current auditor and was a partner or director at a time when the audit
firm or audit company conducted an audit of the entity.
Section 324CI states that a member of an audit firm or director of an audit company who
was a professional member of an audit team cannot become a director, company secretary
or senior manager of an audit client or a related entity until two years after ceasing to be
with the audit firm or audit company concerned. This restriction also applies to review
partners under section 324CJ. In addition, section 324CK prohibits any more than one
former partner, at any time, from being a director, company secretary or senior manager
with an audit client. These restrictions on former auditors do not apply to small proprietary
companies.
Rotation of audit partners
Section 324DA requires that where an individual plays a significant role (generally this
would be lead or review partner) in the audit of a listed entity for five successive financial
years, the individual cannot play a significant role in the audit of that entity for at least
another two successive years although the APESB has proposed increasing this cooling-off
period from 2019 through proposed amendments to APES 110. In addition, an individual
cannot play a significant role for more than five out of seven successive financial years,
where the involvement is not in consecutive years. Small or regional audit firms may apply
to ASIC for an extension of the rotation period to seven years. In addition, section 324DAA
now allows directors of a listed company, or of a listed registered scheme, by resolution, to
grant an approval for a two-year extension to the five-year audit partner rotation
requirement provided the requirements of section 324DAB are met, that audit
independence and quality is not impaired. Further, if the listed company has an audit
committee, the audit committee must have also approved the extension.
Non-audit services Page 101
Under section 300(11B), the boards of all listed companies are required to provide a
statement in the annual report identifying all non-audit services provided by the audit firm,
the fee for each service and an explanation of why the provision of the service did not
impair independence. The board’s statement under section 300(11B) must be consistent
with the advice provided by the entity’s audit committee.
Auditors’ appointment
Section 308 of the Corporations Act 2001 indirectly attempts to promote audit
independence by requiring auditors to report to the members of the company rather than to
management, while section 327B requires that, for a public company, members be
responsible for the appointment of the auditor.
Individual auditors (section 324CE), audit firms (section 324CF) and audit companies
(section 324CG) are in breach of the specific independence requirements for audit
appointment if the auditor is engaged in audit activity at a time that a section 324CH(1)
relationship exists and the auditor is aware of the relationship and does not take all
reasonable steps to ensure that the auditor concerned does not continue to engage in audit
activity in those circumstances. The relationships set out in section 324CH(1) are quite
extensive and complex. The key relationships prohibited are the following:
An auditor, professional member of the audit team or immediate family member cannot
be an officer or audit-critical employee of the audited body or have held that position
within the previous 12 months, unless it is a small proprietary company. An audit-critical
employee is defined under section 9 as an employee who is able, because of his or her
position, to exert significant influence over a material aspect of the contents of the
financial report being audited, or the conduct or efficacy of the audit. Immediate family
member is defined under section 9 to be the person’s spouse, de facto spouse or family
member who is wholly or partly dependent on the person for financial support.
An auditor or professional member of the audit team cannot be an employer, employee, or
partner or employee of an employee, of an officer or audit-critical employee, unless it is a
small proprietary company.
An auditor or professional member of the audit team cannot provide remuneration to an
officer or audit-critical employee for acting as a consultant, unless it is a small

proprietary company.
have an asset that is an investment in the audited body; an asset that is a beneficial
interest in an investment in the audited body and have control over that asset; or an asset
that is a beneficial interest in an investment in the audited body that is a material interest.
Nor can an auditor or professional member of the audit team have an investment in an
entity that has a controlling interest in the audited body or a material beneficial interest in
an entity that has a controlling interest in the audited body.
owe an amount to the audited body, a related body corporate or an entity that the audited
body controls, unless it is a housing loan or commercial loan by a financial institution on
normal terms and conditions in the ordinary course of the audited body’s business; or an
amount owed for the purchase of goods and services of an audited entity on normal terms
and conditions.
be owed an amount by the audited body, a related body corporate or an entity that the
audited body controls under a loan, unless it is a loan to immediate family members of
the audit team that is incurred in the ordinary course of business.
owe an amount to the audited body, a related body corporate or an entity that the audited
body controls under a loan, unless it is made in the ordinary course of business on normal
terms and conditions.
be entitled to the benefit of a guarantee given by the audited body, a related body
corporate or an entity that the audited body controls in relation to a loan, unless it is given
in the ordinary course of business on normal terms and conditions.
Further statutory support is given to audit independence by sections 327B and Page 102
329, which attempt to reduce management’s influence on the auditor. Under

section 327B, an auditor is appointed until death, removal, resignation, ceasing to be
capable of acting as auditor or ceasing to act as auditor owing to a conflict of interest,
rather than being appointed annually.
Auditors’ removal or resignation
Under section 329, removal from office requires a resolution of the company at a general
meeting of which special notice has been given. The auditor is entitled to make a written
representation to all shareholders, at the company’s expense, and to speak at the general
meeting. A copy of the notice of removal must be sent to ASIC.
Further, while an auditor can resign, the auditor must have prior consent from ASIC, unless
it is a proprietary company (section 329(9)). The application for that consent must contain
reasons for the auditor’s request, and the auditor must notify the company of the
application (section 329(5)). If ASIC approves the resignation, it is effective from the date
specified in the notice of resignation, the date the consent was given or the date fixed by
ASIC, whichever occurs last (section 329(8)).
ASIC Regulatory Guide 26 sets out the policies and principles that influence ASIC in the
exercise of the power conferred on it by section 329(6) to consent to the resignation of
auditors . ASIC’s overriding concern is to ensure that the independence and integrity of
the audit function are maintained. The appointment of an auditor is primarily a matter for
the members. As a result, ASIC amended its requirements in 2015 and will not consent to a
resignation that does not take effect at the annual general meeting, unless adequate
disclosure of the resignation is made to members.
Further, ASIC will consent to a resignation that takes effect at the next annual general
meeting only if all of the following conditions apply:
ASIC believes that the auditor’s reasons for resignation are acceptable.
The auditor states that all section 311 matters have been reported to ASIC at the date of
the application and that any further such matters which come to their attention before
resignation will be reported.
There is confirmation by the proposed incoming auditor that they agree to be appointed
and that they reasonably expect to be able to complete an effective audit before the
reporting deadline.
The auditor states that there are no disputes with company management connected with
the relinquishment of office.
The auditor states that there are no ‘other circumstances’ connected with the
relinquishment of office which should be brought to ASIC’s attention.
Examples of such other circumstances are where:
the independence of the audit function is not being preserved

the outgoing auditor is aware that the resignation may be connected with ‘opinion
shopping’, which is discussed in Chapter 5 .
ASIC will consent to a resignation that does not take effect at the next annual general
meeting only if all of the above conditions apply and required disclosure requirements are
also met as follows:
If the public company is a disclosing entity, the company is required to give ASIC and
any relevant market operator for the company a continuous disclosure notice that
contains:
–
details of the outgoing auditor
–
details of the proposed incoming auditor and
–
the reason for the change of auditor.
If the public company is not a disclosing entity, the company is required to provide
members with this information:
–
by public notice displayed prominently on the company’s website
–
by email or
–
in writing.
Right of access to records Page 103
Section 310 provides further protection to the auditor by giving them the right of access at
all reasonable times to the accounting and other records and registers, and an entitlement to
require from any officer of the company such information and explanations as are required
for the purposes of audit.
Right to reasonable fees
Section 331 states that the auditor is entitled to receive reasonable fees and expenses for the
work carried out.
Collectively, these provisions assist an auditor to maintain actual and perceived

independence, and attempt to create, as far as possible, a suitable environment for an audit
process that is free from undue influence and obstruction. These provisions provide some
protection to the auditor in resisting management pressure. The practical effectiveness of
the provisions varies with the circumstances and the extent of management control.
Ethical requirements
A number of areas related to independence are not covered in the legislation. These
independence requirements have been provided for in the ethical rulings of the professional
accounting bodies. The overriding principle in the ethical rules is the reasonable person
test outlined in APES 110 section 290.6: would a reasonable and informed third party
having access to all relevant information consider that the auditor was independent?
The preface (AUST) to section 290 of APES 110 states that independence is a fundamental
concept to the profession and requires a member to approach their work with integrity and
objectivity. Independence requires that the auditor must both be, and be seen to be, free of
any interest that is incompatible with objectivity. Therefore, the ethical rules emphasise
that the auditor’s perceived independence is as important as the auditor’s actual
independence.
Perceived independence is described in APES 110 section 290.6 as ‘independence in appe

arance ’, and is the belief of financial report users that actual independence has
been achieved. It is this perception that is responsible, in part, for the credibility of the
auditor’s report. Users will not derive any assurance from the auditor’s work unless they
believe the auditor is independent.
Actual independence is described in APES 110 section 290.6 as ‘independence of min

d ’, and is the achievement of actual freedom from bias, personal interest, prior
commitment to an interest, or susceptibility to undue influence or pressure. Independence
cannot be achieved simply by the application of a series of rules or regulations alone;
rather, it is built upon the auditor’s belief in, and support for, the concept and its
application during audit engagements. Three factors that contribute to an independent
attitude of mind are:
1. integrity
2. objectivity
3. strength of character.
As indicated earlier, compliance with APES 110 is mandatory for all members of
Chartered Accountants ANZ, CPA Australia and the IPA, and the requirement for
compliance with the code has the force of law for audits conducted in accordance with the
Corporations Act 2001 through the requirements of ASA 200.14.
APES 110 section 290.10 requires the auditor to identify and evaluate threats to
independence and to respond by applying safeguards that eliminate the identified threats or
reduce them to an acceptable level.
Threats to independence may be categorised in accordance with the threats to fundamental

principles described in APES 110 sections 200.3–8, as indicated in Figure 3.3 and as
follows:
Self-interest threats—the possibility that the firm or individuals within it could Page 104
benefit from a financial interest in, or conflict with, an assurance client.
Self-review threats—the possibility that the firm or individuals within it would have to
re-evaluate their own work to form a judgment.
Advocacy threats—situations where the firm or individuals within it could promote the
audit client’s point of view in a manner that compromises objectivity.
Familiarity threats—the possibility that the firm or individuals within it have become
too sympathetic to the client’s interests.
Intimidation threats—the possibility that the firm or individuals within it may be
deterred from acting objectively by threats from the client concerning dismissal, litigation
or fees.
FIGURE 3.3 Threats to independence
Safeguards fall into the following two broad categories for an auditor under sections 200.9–
15:
Safeguards created by the profession, legislation or regulation, such as education,

professional standards, monitoring and disciplinary processes, and inspections and
review.
Safeguards within the work environment, including firm-wide safeguards, such as
policies and procedures to implement and monitor independence and quality control, and
engagement-specific safeguards, such as having a member who is not a member of the
assurance team review the assurance work or rotating senior assurance team personnel.
An auditor may also be able to rely partly on safeguards within the client’s systems and
procedures, such as competent employees and robust corporate governance structures.
The principles and rules set out in APES 110 allow an auditor to evaluate any circumstance
and to determine procedures and actions necessary to avoid or resolve those circumstances
that pose threats or risks to objectivity.
Quality control requirements for independence
APES 320.25–34 and ASQC 1.21–25 (ISQC 1.21–25) require that audit firms set up and
maintain an independence safeguarding system that is an integral part of the firm-wide
management and internal control. This safeguarding system, which encompasses all
aspects of independence and quality control, may include:
written independence policies that address current independence standards; threats to

independence, including familiarity when using the same assurance personnel on an
engagement over a long period; and related safeguards, including rotation of audit
engagement partners in accordance with section 290.151 of APES 110 and section
324DA of the Corporations Act 2001
active and timely communication of policies
appropriate procedures to be applied by partners and staff in order to meet independence
standards Page 105
documentation that summarises conclusions that have been drawn from the
assessment of threats to independence and the related evaluation of the independence risk
internal monitoring of compliance with safeguarding policies
written confirmation at least annually from all assurance practice personnel that they have
complied with the firm’s independence requirements.
In addition, to ensure that the audit firm is aware of independence issues, APES 320.26 and
ASQC 1.23 (ISQC 1.23) require that the audit firm establish policies and procedures that
include requirements for:
personnel to promptly notify the firm of any independence breaches of which they
become aware
the firm to promptly communicate any identified breaches of these policies and
procedures to:
–
the engagement partner who, with the firm, needs to address the breach
–
other relevant personnel in the firm and, where appropriate, the network, and those
subject to the independence requirements who need to take appropriate action
prompt communication to the firm, if necessary, by the engagement partner and other
relevant personnel of the actions taken to resolve the matter, so that the firm can
determine whether it should take further action.
The review process should include an annual review to be satisfied that each engagement
should continue having regard to identifying situations where independence may be at risk.
Where the review process indicates that an audit engagement should be continued only
with additional safeguards against loss of independence, the range of safeguards should be
subject to independent review by a partner unconnected with the engagement or as part of
any reciprocal external arrangements.
The system will apply to the engagement team and audit firm and to all other partners and
staff within the audit firm. There may be differing restrictions and requirements on
partners and staff within the firm depending on the nature of their work and their
relationship with the audit client or engagement team.
As discussed in Chapter 2 , network firms are defined as an entity under common

control, ownership or management with the audit firm or any entity that a reasonable
person would conclude was part of the firm nationally or internationally. For example, the
Big Four are all network firms, as are a number of mid-tier audit firms. Network firms are
required to be independent of audit clients of the other firms within the network, if a
financial report audit is being conducted.
Major threats to auditor independence

The Ramsay Report identified three major threats to auditor independence: auditor
employment relationships; financial and business relationships; and provision of non-audit
services.
Auditor employment relationships
The existence of employment relationships between an audit firm and an audit client can
give the impression that an auditor is not independent of the client, irrespective of the
actual situation. Consequently, legislators worldwide have tended to include provisions in
corporate legislation that prohibit or restrict employment relationships. The professional
accounting bodies have also amended their ethical codes to include prohibitions or
restrictions on employment relationships.
APES 110 section 290.142 prohibits a member of the assurance team from remaining a
member of the assurance team if they are employed by the client, as it creates too great a
self-interest, self-review and familiarity threat to independence. Further, APES 110 section
290.144 similarly prohibits any partner or employee of the audit firm serving as an officer
of the client.
Another concern is retired audit partners joining the boards of their audit clients
(commonly referred to as the alumni threat). The Ramsay Report noted that where this
occurs, it is often seen as a particular threat to the independence of the audit firm,
particularly if the former audit partner retains some financial arrangement with his or her
audit firm or continues to exercise influence with the audit firm.
In the US, the Independence Standards Board (2000) stated that the potential Page 106
threats to independence when professionals leave firms to join audit clients are
generally as follows.
That partners or other audit team members who resign to accept positions with audit
clients may not have exercised an appropriate level of scepticism during the audit process
prior to their departure.
That the departing partner or other professional may be familiar enough with the audit
approach and testing strategy so as to be able to circumvent them once he or she begins
employment with the client.
That remaining members of the audit team, who may have been friendly with, or
respectful of a former partner or other professional when he or she was with the firm,
would be reluctant to challenge the decisions of the former partner or professional and,
as a result, might accept the client’s proposed accounting without exercising appropriate
scepticism or maintaining objectivity.
If the former partner or professional has retirement benefits or a capital account with the
audit firm:
It may appear that ties between the audit firm and the partner or other professional have
not been severed . . . and the audit firm is in effect auditing the results of its own work.
If the retirement benefits of the former partner or other professional vary based on the
firm’s profits, then the former partner or other professional may be inclined to pay the
firm higher fees to inflate his or her retirement benefits . . .
[If the firm] is experiencing cash flow problems, the firm may be less rigorous in its audit
of the client’s financial statements in exchange for forbearance on the amounts owed to
the former partner or other professional.
In Australia, in the HIH Insurance case, it was noted that the chairman and the finance
director were former partners of HIH’s audit firm, Arthur Andersen. In addition, one of the
other directors, also a former Arthur Andersen partner, was previously the auditor of FAI
Insurance in the 1980s, before it became a subsidiary of HIH Insurance in 1998. The chair
of the HIH board was appointed 17 months after retiring from Andersen, the CFO the day
after he resigned from Andersen and the third partner five months after leaving Andersen.
In relation to the threat to independence when a retired audit partner joins the board of an
audit client, the Ramsay Report recommended that there be a mandatory period of two
years following resignation from the audit firm before a former partner of an audit firm
who is directly involved in the audit of a client can become a director of the client.
Although the HIH Royal Commission recommended extending this restriction to four
years, the two-year restriction has been adopted in section 324CI of the Corporations Act
2001. APES 110 section 290.137 requires that for public interest entities, subsequent to the
partner ceasing to be a key audit partner, the public interest entity must have issued an
audited financial report covering a period of not less than 12 months during which the
partner was not a member of the audit team, before the partner can become a director. A pu
blic interest entity means a listed entity, an entity defined by regulation or legislation
as a public interest entity, or an entity for which the audit is required by regulation or
legislation to be conducted in compliance with the same independence requirements that
apply to the audit of listed entities. Stricter independence requirements apply to public
interest entities.
Justice Owen also argued in the HIH Royal Commission Report that the cumulative effect
of three former partners on the HIH board affected the perception of independence to a
greater extent than one former partner would have done. Therefore, he considered it
appropriate to limit the number of former partners who can be appointed to the board or
senior management positions to one. This recommendation was effectively adopted in
section 324CK of the Corporations Act 2001, which prevents a former partner from being
an officer of an audit client, other than a small proprietary company, within a five-year
period of retirement if another former partner is already an officer.
Financial and business relationships
Investments in audit clients
In line with the Ramsay Report recommendations, section 290.104 of APES 110 prohibits
an auditor or their immediate family member from having a direct financial interest or a
material indirect financial interest in an audit client, as it creates too great a self- Page 107
interest threat. CLERP 9 imposed similar legislative restrictions through section

324CH(1), as discussed earlier.
Loans to and from audit clients
Also in line with the Ramsay Report recommendations, APES 110 sections 290.120–121
prohibit loans to or from audit clients that are not financial institutions unless they are
immaterial to the auditor and the institution, as they create too great a self-interest
threat. Fees from clients must be collected promptly. APES 110 section 290.220 indicates
that overdue fees may create a self-interest threat, especially if they are not paid before the
issue of a subsequent audit or review report. The auditor needs to consider whether they
might be regarded as being equivalent to a loan, which is prohibited under APES 110
section 290.121. Loans from or deposits with a financial institution are allowed under
sections 290.117–119 of APES 110 provided they are under normal lending procedures
and, if it is material, that there are adequate safeguards. CLERP 9 imposed similar
legislative restrictions through section 324CH(1), as discussed earlier.
Business relationships
The Ramsay Report recommended that an auditor should not be considered to be

independent if a member of the audit engagement team has a business relationship with the
client or any of its officers; or the audit firm has a business relationship with the client or
any of its officers which is not clearly insignificant to both the audit firm and the client.
A business relationship for this purpose does not include professional services provided by
the audit firm, or the audit firm or members of the audit engagement team being a
consumer in the ordinary course of business.
APES 110 section 290.123 points out that a close business relationship between the auditor
and the client will involve a commercial or common financial interest and may create self-
interest and intimidation threats.
Goods and services from clients
APES 110 section 290.125 indicates that the purchase of goods and services from an
assurance client would not generally constitute a threat to independence, provided the
transaction is in the normal course of business and on an arm’s length basis. Section
290.225 of APES 110 stipulates that gifts or hospitality beyond normal, insignificant social
courtesies should not be accepted, as they would create unacceptable self-interest and
familiarity threats.
Provision of non-audit services by auditors
The issue of whether audit firms should provide non-audit or other services to their audit
clients generates a wide range of views from stakeholder groups, ranging from calls for a
total prohibition of the provision of such services to claims that there is no evidence that
providing such services impairs independence. Audit independence studies examined
during the course of the Ramsay Report have reached different conclusions concerning
whether the provision of non-audit services impairs audit independence.
The growth of non-audit services for the largest audit firms has been substantial.
Arthur Andersen was the auditor for several high-profile companies that collapsed in the
1990s and early 2000s, such as Waste Management Inc., Enron and WorldCom in the US
and HIH in Australia. Arthur Andersen identified key issues that led to the collapses of
some of these companies, but the significant consulting fees, in most cases greater than the
audit fees, appeared to compromise the objectivity of their audit and their integrity.
Following an internal review at Arthur Andersen in 1992, generating sales by consulting
became the key measure of success for partners. It has been claimed that retaining the
consulting fees became the driving force for what Arthur Andersen would and would not
do in the audit.
A survey of Australia’s largest 100 listed companies released by ASIC in January 2002
showed that the provision of non-audit services in Australia was widespread, with just
under half (47 per cent) of fees to audit firms being for non-audit services.
The Panel on Audit Effectiveness (2000) noted that there were several arguments Page 108
both for and against auditors providing non-audit services to their clients. The
main argument for opposing the provision of non-audit services by auditors to their clients
is that when an audit firm provides non-audit services to a client it is serving two different
sets of clients: management in the case of non-audit services; and the audit committee, the
shareholders and all those who rely on the audited financial report in the case of the audit.
As a result, the audit firm is subject to conflicts of interest. On the other hand, the main
arguments supporting the provision of non-audit services by auditors to their clients are
that there is no solid evidence of any specific link between audit failures and the provision
of non-audit services; that non-audit services have been provided by audit firms to their
clients for many years; and that many non-audit services are both in the public interest and
beneficial to audit effectiveness. For example, a company may seek the assistance of its
auditors to correct control weaknesses identified during the audit.
However, it is generally agreed that there are some services that an audit firm cannot
provide to its client. For example, APES 110 section 290.162 indicates that an auditor must
not assume a management responsibility for an audit client. APES 110 section 290.160
provides the following examples of activities that would generally be considered a
management responsibility:
setting policies and strategic direction

hiring and firing employees
directing and taking responsibility for actions of the entity’s employees
authorising a transaction
controlling bank accounts or investments
determining which recommendations of the audit firm should be implemented
reporting to those charged with governance on behalf of management
taking responsibility for the preparation of the financial report
taking responsibility for the design, implementation and maintenance of internal control.
APES 110 also identifies a number of situations where specific safeguards may be required
and identifies examples of such safeguards. Some of these situations and safeguards are
summarised below. However, APES 110 must be referred to for a full explanation of these
matters. CLERP 9 supports the application of APES 110. The auditor’s independence
declaration under section 307C of the Corporations Act 2001 must indicate whether there
have been any breaches of the Code of Ethics for Professional Accountants.
The Ramsay Report (2001, p. 10) also recommended ‘mandatory disclosure through the
Australian accounting standards or the Corporations Act 2001 of non-audit services by
category of service, as well as the dollar amount of fees paid for these services’. This
proposal was adopted by CLERP 9, with section 300(11B) also requiring an explanation by
the board of why the provision of the services does not impair independence.
For auditors of US-listed companies or their subsidiaries, the Sarbanes–Oxley Act 2002
provides a much greater restriction on the provision of non-audit services and lists eight
types of services that are now unlawful if provided to a publicly held company by its
auditor: bookkeeping, information systems design and implementation, appraisals or
valuation services, actuarial services, internal audits, management and human resources
services, broker/dealer and investment banking services, and legal or expert services
related to audit services. It also has one catch-all category authorising the board to
determine by regulation any service it wishes to prohibit. Other non-audit services—
including tax services—require pre-approval by the audit committee on a case-by-case
basis. Pre-approved non-audit services must be disclosed to investors in periodic reports.
As a result of the push to strengthen the provisions relating to non-audit services, the
European Commission, in its October 2010 Green Paper Audit Policy: Lessons from the
Crisis, indicated that it would like to examine reinforcing the prohibition of non-audit
services by audit firms. The Green Paper put forward the view that, since auditors provide
an independent opinion on the financial health of companies, ideally they should not have
any business interest in the company being audited. Subsequently, in 2014, as indicated
later in this chapter in Auditing in the global news 3.2 , the European Page 109
Parliament voted to impose a cap on the provision of other services to audit clients
of 70 per cent of the average audit fee over the last three years and ban the provision of
certain tax, consultancy and advisory services.
Preparing accounting records and financial reports
A self-review threat exists where an auditor participates in the preparation of the audit
client’s accounting records or financial reports. The significance of the threat depends upon
the individual’s involvement in the preparation process and whether the client is a public
interest entity.
Appropriate services that may be offered by the auditor include technical assistance, for
example, on accounting standards or principles, disclosures, or appropriateness of controls,
assisting in the preparation of consolidated financial reports and proposing adjusting
journal entries. These services promote the fair presentation of the financial report and do
not generally threaten independence. For other accounting and bookkeeping services,
including payroll, the significance of the self-review threat is high and safeguards are
required if the service is offered.
For audit clients that are not public interest entities, APES 110 section 290.168 indicates
that the self-review threat from providing accounting or bookkeeping services on financial
information that forms the basis of the financial report is too high to allow the auditor to
undertake the service unless the assistance provided is solely of a routine or mechanical
nature. Examples of acceptable services include recording transactions the client has
authorised, posting coded transactions to a general ledger or preparing a financial report
based on the client’s trial balance.
For public interest audit clients, APES 110 sections 290.169–170 state that accounting or
bookkeeping services on financial information which forms the basis of the financial report
cannot be undertaken as there is no safeguard that reduces the threat to an acceptable level.
The only exception to this is where they are routine and mechanical and relate to a division
that is immaterial.
In no circumstances must the auditor originate, authorise or approve transactions on behalf

of an audit client.
Valuation services
A self-review threat exists whenever an auditor provides the audit client with valuation
services that result in the preparation of a valuation that is to be incorporated into the
client’s financial report.
APES 110 sections 290.175–6 state that the significance of the self-review threat is
considered too high to allow the provision of services where the valuation relates to
amounts that are material in relation to the financial report and where the valuation
involves a significant degree of subjectivity. In these circumstances the valuation service
should be refused or the auditor must withdraw from the audit.
In all other cases, the auditor may undertake the service only after considering whether
additional safeguards are needed to mitigate a remaining self-review threat. Such
safeguards may include using an expert team with different individuals (including
engagement partner) and different reporting lines to those of the audit engagement team.
The auditor should also obtain the audit client’s acceptance of their responsibility for the
results of the work.
Taxation
Services relating to taxation include compliance and advisory services that assist entities to
determine, plan and report on tax consequences related to their activities. Under section
290.179 of APES 110, tax return preparation would not create a threat to independence
provided that the client takes responsibility for the return. However, section 290.183
indicates that tax planning and other tax advisory services may create a self-review threat
where the advice will affect matters to be included in the financial report. The significance
of any such threat needs to be evaluated and appropriate safeguards applied.
Internal audit
Self-review threats may arise in certain circumstances where an auditor provides internal
audit services to an audit client. APES 110 sections 290.190–4 indicate that where the
auditor assists in the performance of an audit client’s internal audit activities or Page 110
undertakes outsourcing of some of these activities, the self-review threat needs to
be mitigated by safeguards. These safeguards include:
ensuring that the audit client at all times has responsibility for:
–
the overall system of internal control (that is, the establishment and maintenance of
internal controls, including the day-to-day controls and processes in relation to the
authorisation, execution and recording of accounting transactions)
–
determining the scope, risk and frequency of the internal audit procedures to be
performed and assessing their adequacy
–
ensuring a competent employee is responsible for the internal audit activities
–
considering and acting on findings and recommendations
the auditor not accepting the outcomes of internal auditing processes for statutory audit
purposes without adequate review.
Internal audit services that are appropriate with such safeguards include specialist
assignments on behalf of an audit client’s internal audit department and undertaking
internal audit procedures determined or approved by the entity.
Providing services that involve the audit firm having responsibility for devising,
undertaking and monitoring the whole of the internal audit activity or taking management
decisions in respect to internal audit activity should not be undertaken by the auditor.
Design and implementation of financial information

technology systems
The provision of services by the auditor to an audit client that involve the design and
implementation of financial information technology systems used to generate information
forming part of the audit client’s financial report may give rise to a self-review threat.
Section 290.199 of APES 110 indicates that the significance of the self-review threat is
considered too high to permit an auditor to provide such services unless:
the audit client acknowledges that they take responsibility for the overall system
the audit client appoints a senior employee to take all management decisions with respect
to the design and implementation
the audit client makes management decisions and evaluates the adequacy and results of
the design and implementation
the audit client is responsible for the operation of the system and information generated.
The auditor needs to consider whether additional safeguards are required to mitigate a
remaining self-review threat, in particular, whether services should only be provided by an
expert team with different individuals (including engagement partner) and different
reporting lines from those of the audit engagement team.
Temporary staff assignments
Lending staff, or secondments, to audit clients may create a self-review threat where the
individual is in a position to influence the preparation of the client’s accounts or financial
report. Section 290.140 of APES 110 indicates that safeguards that may be in place for any
temporary staff assignment include:
conducting an additional review of the work performed by the loaned staff member
not giving the loaned staff member audit responsibility for a function that they performed
during the temporary staff assignment
not including the loaned staff member as a member of the audit team.
Litigation support services
An advocacy threat exists whenever an auditor acts for the audit client in the resolution of a
dispute or litigation. Under section 290.202 of APES 110, a self-review threat may also
arise where such a service includes the estimation of the audit client’s chances in Page 111
the resolution of litigation, and thereby affects the amounts to be reflected in the
financial report.
The significance of both the advocacy and self-review threats is considered too high to
allow an auditor to act in the resolution of litigation that involves matters that would
reasonably be expected to have a material impact on the audit client’s financial report and
where a significant degree of subjectivity is inherent in the case concerned. The threats are
also considered too high to be capable of being reduced to an acceptable level through
safeguards when the role involves the auditor making managerial decisions on behalf of the
audit client.
Legal services
Legal services encompass a wide and varied range of roles. Work involving matters not
expected to have a material effect on the financial report is not considered to create a threat
to independence. Legal advice such as contract support, legal due diligence and
restructuring may create self-review threats, but APES 110 section 290.205 indicates that it
may be possible to reduce these threats to an acceptable level by implementing safeguards
such as using individuals not involved with the audit and ensuring the client takes
responsibility for decisions.
Advocacy work not material to the financial report may be undertaken if appropriate
safeguards are in place. These would include prohibiting audit firm individuals from
making managerial decisions on behalf of the client and using individuals who are not
involved with the audit for the legal work.
It is appropriate for the auditor to undertake dispute analysis, investigation and resolution
services for an audit client. However, this work should not be undertaken in relation to
matters with a material impact on the financial report.
Section 290.208 of APES 110 states that the auditor should not act as general counsel for
an audit client.
Recruiting senior management
Before accepting any engagement to assist in the recruitment of senior or key staff, the
auditor should assess the current and future threats to independence that may arise and
consider appropriate safeguards to mitigate such threats. Generally it is acceptable for the
audit firm to advertise for and interview candidates and produce a list of potential
candidates against a client’s specifications. APES 110 section 290.209 states that the
decision as to who should be engaged must always be taken by the audit client.
When recruiting staff to senior financial posts, the significance of threats to independence
is high. As such, the auditor should carefully consider whether there might be
circumstances under which even the provision of a list of potential candidates for such
posts may cause an unacceptable level of independence risk.
Corporate finance and similar activities
Corporate finance encompasses a wide and varied range of services. Safeguards that are
generally available to counter potential advocacy or self-review threats include:
prohibiting the auditor making managerial decisions on behalf of the client

using individuals not involved in the audit to undertake the work
ensuring that the auditor does not commit the audit client to a transaction or the terms of
a transaction.
Within these safeguards, services such as advice on corporate reorganisations or deal

structures may be appropriate services for the auditor to undertake, provided that the
auditor is able to reduce the risks to an acceptable level.
Promoting, dealing in or underwriting an audit client’s shares, including initial public

offerings, however, should not be undertaken, in accordance with APES 110 section
290.214, as the threats to independence are too great. This does not include preparing a
report as required by the Corporations Act 2001, for example, prospectus reporting.
Various threats to independence and potential breaches of APES 110 are illustrated
in Global example 3.1 .
Page 112
GLOBAL EXAMPLE 3.1 Independence
Exquisite Furniture Pty Ltd is a fast-growing company and has now become
by far your largest audit client. During the past year the services your firm
has provided have included completing the annual financial report audit,
preparing the company’s tax returns, deciding on the new computer system
to be installed and preparing an independent valuation of a major
investment to be included in the financial report. However, due to the need
for funds for its expansion, the company has not paid its audit fee for the
past two years.
As a result of the expansion, the chairman has asked that you serve as a
director for the current year, as he believes that your financial expertise will
be invaluable in assisting the company through some very difficult times. The
company’s constitution requires each director to hold a minimum of 100
ordinary shares in the company.
Required
Identify any professional standards and regulatory requirements that may

have been breached.
Solution
1. Although there is no information on the exact quantum of fees from

Exquisite Furniture Pty Ltd, the fact that it is your largest client and is fast
growing suggests that there may be a fee dependence issue. APES 110
section 290.215 indicates that where the fees from one client constitute a
large proportion of a firm’s total fees, it may create a self-interest threat.
2. APES 110 section 290.218 states that where the fees for an audit client
remain unpaid for a long time it creates a self-interest threat that would
require adequate safeguards. Further, the auditor needs to consider
whether the unpaid fees have taken on the character of a loan, which, if
material, would be prohibited under section 290.121 of APES 110 due to self-
interest threats.
3. APES 110 section 290.179 states that tax return preparation is generally not
seen as a threat to independence.
4. APES 110 section 290.199 states that where the auditor is providing
services involving the design and implementation of information
technology systems, a necessary safeguard is that the audit client should
make all the management decisions regarding the design and
implementation process. In this case the auditor is deciding on the new
computer system, which is prohibited as it creates an unacceptable self-
review threat.
5. APES 110 section 290.175 states that preparing a valuation of matters that
are material to the financial report creates a self-review threat that cannot
be reduced to an acceptable level. Therefore, the auditor should not
prepare the valuation for use in the financial report of Exquisite Furniture
Pty Ltd.
6. If Exquisite Furniture Pty Ltd is a small proprietary company, you are not
specifically precluded from being a director under section 324CH of the
Corporations Act 2001. However, section 290.144 of APES 110 states that
being a director creates self-interest and self-review threats that no
safeguard could reduce to an acceptable level and so being a director of
Exquisite Furniture Pty Ltd is prohibited.
7. Section 290.104 of APES 110 and section 324CH of the Corporations Act
2001 state that an auditor should have no direct financial interest in an
audit client. The 100 ordinary shares would constitute a direct investment
and therefore would also create a threat so significant that you would not
be able to undertake the audit.
Rotation of audit firms Page 113
While, as discussed earlier, rotation of audit partners is required, the Ramsay Report did
not believe it appropriate to mandate rotation of audit firms. It concurred with the Audit
Review Working Party, which stated that ‘the anticipated cost, disruption and loss of
experience to companies is considered unacceptably high, as is the unwarranted restriction
on the freedom of companies to choose their own auditors’. This view was supported by
CLERP 9, so no requirement to rotate audit firms has been introduced into the
Corporations Act 2001.
However, more recently this proposal has again achieved momentum. In October 2010, the
European Commission in its Green Paper, discussed earlier in this chapter, stated that
‘situations where a company has appointed the same audit firm for decades seem
incompatible with desirable standards of independence’. It indicated that even when ‘key
audit partners’ are regularly rotated, the threat of familiarity persists. As a result, the Green
Paper concluded that mandatory rotation of audit firms—not just of audit partners—should
be considered. Subsequently, as indicated in Auditing in the global news 3.2 , the
European Parliament voted in April 2014 to implement wide-ranging reforms to the audit
profession, including mandatory audit firm rotation by listed companies every 10
years. However, there is also an option for EU member states to extend this rotation period
for a further 10-year period if a public tender is undertaken or a further 14 years if a joint
audit. These requirements came into force in June 2016 and many EU members have
adopted the additional 10-year option for tenders in their enabling legislation. Further, in
South Africa, the Independent Regulators Board for Audits announced in June 2017 that
mandatory audit firm rotation for public companies would be implemented from April
2023.
3.2 Auditing in the global news ...
EU audit changes
In a recent media release, Chartered Accountants ANZ outlined several
reforms to audit tenure and the provision of non-audit services by auditors
that were introduced by the European Parliament. These changes include:
the requirement for public companies to mandatorily rotate their audit firms

every 10 years, with a possible extension of a further 10 years if a public
tender is conducted after the first 10 years. For joint audits an extension
period of 14 years is possible
prohibiting loan agreements from including ‘Big Four auditor only’ clauses
as a condition of granting the loan to an entity
imposing a limit on the provision of non-audit related services to audit
clients to a maximum of 70 per cent of the average audit fee over three
years
banning the provision of certain tax, consultancy and advisory services by
auditors to their audit clients
establishing new rules governing what goes into auditors’ reports
establishing new rules ensuring greater oversight by the audit committee
and prescribing how auditors should engage with them
through the establishment of a permanent EU Committee, mandating
collaboration across audit regulators in the EU countries.
Source: Adapted from Chartered Accountants Australia and New Zealand, media release, April 2014.
Similarly, the Public Company Accounting Oversight Board (PCAOB) in the US issued a
concept release in August 2011 to solicit public comment on ways in which auditor
independence, objectivity and professional scepticism could be enhanced, including
through mandatory rotation of audit firms. However, in May 2014 the PCAOB said that it
is no longer pursuing a project to impose audit firm term limits on public companies,
although it noted that other countries were doing so.
Page 114
QUICK REVIEW
1. Actual and perceived independence are critical if an audit or other
assurance engagement is to add credibility to the subject matter
concerned.
2. As a result of CLERP 9, the Corporations Act 2001 contains a number of
provisions directed towards maintaining the auditor’s independence.
3. Detailed independence rules and guidance are provided in APES 110,
which is based on the IFAC Ethical Code and adopts a conceptual
approach to independence, based on identifying threats to independence
and implementing adequate safeguards.
4. The Ramsay Report reviewed audit independence requirements in
Australia and made recommendations to improve auditor independence,
many of which were implemented through CLERP 9 amendments to the
Corporations Act 2001 and revisions to APES 110.
5. The Sarbanes–Oxley Act 2002 in the US introduced stringent
independence requirements.
6. Although not required in Australia, mandatory rotation of audit firms has
been introduced recently in the European Union.
LO 3.5 Fee determination
The value of services performed by the auditor is determined by the inherent characteristics
of personal integrity and professional competence. Typically, professionals are not hired
primarily on the basis of the reasonableness of their fees. The client is chiefly concerned
with the calibre of services to be received. Nevertheless, the audit profession has argued
that vigorous competition, including some fee competition, is one of the realities of audit
practice today. However, the European Commission Green Paper referred to earlier
indicated that the audit market appears to be too concentrated in certain segments,
particularly large audits by the Big Four, and that this denies clients sufficient choice when
deciding on their auditors. Moreover, the Green Paper indicated that being an auditor of
large listed companies seems to create a reputational endorsement which then helps the
large audit firm to secure further high-profile audit engagements, and thus contributes to a
lack of dynamism in the audit market. To overcome this problem, the Green Paper
indicates that actions such as joint audits, audit firm rotation and audit fee tendering should
be considered.
The two primary determinants of the audit fee are the time required to perform the
necessary services properly and the rate to be charged for that time. Factors that
significantly influence the required time are the condition of the client’s records, the
availability of the client’s personnel for clerical assistance, the volume of the client’s
transactions and operations, the nature of the client’s business and the effectiveness of the
client’s internal control. The appropriate hourly rate reflects the full cost of operating an
audit firm. APES 110 section 240.1 indicates that members may quote whatever fee is
deemed to be appropriate, but threats to compliance with the fundamental principles such
as competence may arise where the fee quoted is so low that it may be difficult to perform
the engagement in accordance with applicable technical and professional standards for that
price. Therefore, the auditor needs to be able to demonstrate that appropriate time and
qualified staff are assigned to the audit.
As discussed earlier in this chapter, section 331 of the Corporations Act 2001 entitles the
auditor to reasonable fees and expenses for the work performed. As a result, it could be
argued that the fees from the practice should permit the auditor to:
remunerate the staff adequately to attract the highest calibre of young men and women to
the profession
maintain a respectable office with good working conditions, modern equipment and a
library suitable to enable the best work to be performed
undertake a fair share of public service activities for the community, profession and civic
organisations.
The auditor should not enter into fee arrangements that might compromise or appear to
compromise independence. Therefore, the fee for the audit must be commensurate with the
service provided. Recovery of costs incurred in one period should not be dependent upon
an expectation of recovery from fees for future audits or the provision of other Page 115
services to the client. Yet research such as De Angelo (1981) shows that the
fees for initial audits are often lower than for continuing audits. Low-balling occurs in a
tender situation when a bid price for audit services by an audit firm is quoted at an
unreasonably low level to win the tender, with any unrecovered audit costs recovered
subsequently through other services or by other means.
The hourly rate is naturally higher for members of the staff with greater skill and
experience. Rate determination, then, involves estimating the total annual cost of operating
a practice and estimating the total billable time in a year for the various levels of staff.
Fees must be commensurate with the work undertaken and be sufficient to enable
appropriate time to be spent by experienced staff. Fees charged for audit or assurance
services must not be calculated on a predetermined basis relating to the outcome or result
of the work. APES 110 section 290.222 prohibits contingency fees for assurance
engagements. Fees for other services, however, may be subject to a contingent fee. The
possibility of a self-interest or advocacy threat must be assessed in these circumstances and
safeguards applied as appropriate.
When total fees generated from an audit client represent a large proportion of the auditor’s
total fees, the real or perceived financial dependency on that audit client creates a self-
interest or intimidation threat. Under APES 110 section 290.215, the auditor must have
policies in place to ensure that the threat is negated or reduced to an acceptable level. For
public interest entities, APES 110 section 290.217 indicates that specific safeguards,
including undertaking independent reviews of the services provided, must be in place if
fees from an audit client exceed 15 per cent of the audit firm’s total fees. Similar
considerations must be undertaken in relation to the fees generated by individual audit
engagement partners and separate offices of the audit firm.
AASB 101 requires an audit client to disclose in the financial report the amount of fees
paid to the auditor, split between audit and non-audit services and disclosing separately the
nature and amount of each non-audit service.
Section 300(11B) of the Corporations Act 2001 now also requires directors to include a
statement identifying the fees for each non-audit service. These disclosures allow the audit
client and financial report users to understand the nature of the other services provided and
consider implications for the auditor’s objectivity based on comprehensive information.
QUICK REVIEW
1. Audit fees should be commensurate with the services provided.
2. Audit clients must disclose in the financial report the amount of fees paid
to the auditor, split between audit and non-audit services.
LO 3.6 Corporate governance
As a result of high-profile collapses in Australia and overseas, greater emphasis has been
placed on the need for proper corporate governance or management and the roles to be
played by directors, accountants and auditors. Corporate governance is the system by
which companies are directed and managed, and covers the conduct of the board of
directors and the relationship between the board, management and shareholders. Justice
Owen, in the HIH Royal Commission Report (2003), defined corporate governance as ‘the
framework of rules, relationships, systems and processes within and by which authority is
exercised and controlled by corporations’.
It is important to distinguish the roles played by different groups in corporate governance.

The board of directors is responsible to shareholders for the formulation of overall business
policies and strategies in the running of the company. Its duties generally include such
matters as:
taking responsibility for protecting the rights of shareholders

setting officers’ salaries
recommending dividends Page 116
authorising long-term borrowing, additional share issues and major capital projects
reviewing internal control
identifying and monitoring business risks.
The board of directors also has a clear role to play in approving the financial reports. In a
recent case (also discussed in Chapter 2 in relation to auditor’s liability), ASIC alleged
that the seven directors of Centro Properties Group and Centro Retail Group failed to
discharge their duties with due care and diligence in approving the financial reports for
Centro Properties Ltd, Centro Property Trust and Centro Retail Trust for the year ended 30
June 2007. ASIC also contended that the directors and the former chief financial officer
knew that the entities had very significant short-term interest-bearing liabilities, and should
have known that these liabilities were incorrectly classified as long-term in the 2007
financial reports. On 27 June 2011, the court handed down its decision, finding that all the
directors, including the non-executive directors, failed in discharging their duty to properly
approve the financial reports. ASIC chairman, Greg Medcraft, said the case highlighted the
danger of boards uncritically relying on management or the auditors. ‘Each member of the
board must bring and apply their own skills and knowledge when declaring financial
statements are true and fair,’ he said. ‘This is not a responsibility company boards can
delegate or merely rubber stamp. It’s not good enough for directors to just be present.’
The board of directors is normally composed of corporate executives, such as the chief
executive officer (CEO) and chief financial officer (CFO), known as executive directors;
representatives of large shareholders; and a number of external directors who are not part
of management, known as non-executive directors, to ensure a more objective evaluation of
management performance. Good corporate governance requires that there should
preferably be a majority of non-executive directors and that the chair should in principle be
separate from the CEO and should preferably be a non-executive director.
In addition, the ASX (Australian Securities Exchange) Corporate Governance Council

recommendations, which will be discussed later in this chapter, include a number of
requirements that relate to independent directors, as opposed to just non-executive
directors, and outline a number of factors that potentially operate to disqualify a director
from being classified as independent. A director may not be independent, even if they are
not currently part of management, if they:
are a substantial shareholder of the company or are directly associated with a substantial
shareholder
have been employed by the company in an executive capacity within the past three years,
or have been a director after ceasing to hold such employment
have been a principal of a material adviser or consultant to the company within the past
three years, or an employee materially associated with the service provided
have been a material supplier or customer of the company, or have been directly or
indirectly associated with a material supplier or customer
have a material contractual relationship with the company other than as a director of the
company
have served on the board for a period which could reasonably be perceived as materially
affecting the director’s ability to act in the best interests of the company
have an interest or relationship which could reasonably be perceived as materially
interfering with the director’s ability to act in the best interests of the company.
Ultimately, corporate governance tries to ensure that an entity operates at the highest level
of efficiency and effectiveness. Skills in ethical decision making are an important factor in
good corporate governance.
Organisation for Economic Co-operation and
Development
In April 1998, the Organisation for Economic Co-operation and Development (OECD)
developed a set of corporate governance standards and guidelines, which were endorsed by
OECD ministers in 1999 and reviewed and updated in 2004. The six key areas Page 117
covered by the OECD Principles of Corporate Governance are:
ensuring the basis for an effective corporate governance framework

the rights of shareholders and key ownership functions
the equitable treatment of shareholders
the role of stakeholders in corporate governance
disclosure and transparency
the responsibilities of the board.
United Kingdom
In the UK, the Committee on the Financial Aspects of Corporate Governance issued its
report in 1992. Known as the Cadbury Report, it advocated a code of best practice
designed to achieve high standards of corporate behaviour. The code has been endorsed by
the London Stock Exchange, which requires companies to publish a statement of
compliance with the code in their annual report.
The Cadbury Report stressed the importance of the annual audit, describing it as one of the
cornerstones of corporate governance. The report argued that audits are a reassurance to all
those who have a financial interest in the company, quite apart from their value to the board
of directors.
The Combined Code on Corporate Governance was revised and reissued by the Financial
Reporting Council in the UK in June 2006 and was appended to the London Stock
Exchange Listing Rules. It built on the Cadbury and Hampel reports. A revised version of
the code was issued in September 2014 as the UK Corporate Governance Code.
The code makes it clear that there is no prescribed form or content for a company’s
statement setting out how the various principles in the code have been applied. The
intention is that companies should have a free hand to explain their governance policies in
the light of the principles, including any special circumstances that have led to them
adopting a particular approach.
The guidance is based on the adoption by a company’s board of a risk-based approach to

establishing a sound system of internal control and to reviewing its effectiveness. This
should be incorporated by the company within its normal management and governance
processes. It should not be treated as a separate exercise undertaken to meet regulatory
requirements.
Australia
In Australia, a working group chaired by Henry Bosch (the Bosch Committee) put forward
a guide, Corporate Practices and Conduct, in 1991 with revised versions in 1993 and
1995. This guide was the first Australian attempt to set out corporate governance standards
of best practice. The guide considered the function of the public company board, its
structure, the role of company accountants and auditors, the conduct of directors, the role
of shareholders and codes of ethics.
While corporate governance is primarily the responsibility of the directors and senior
officers of a company or other organisation, accountants have an important part to play.
Accountants may hold directorships or management positions or may be involved in
auditing. Therefore, they are concerned with ensuring that internal control policies and
procedures are in place and working.
Auditors must inform management and directors about internal control problems. This
position is supported by the AWA case, which is discussed in Chapter 2 . However,
auditors cannot force these groups to act upon their recommendations, which can create
ethical dilemmas for the auditor. The problems that face an auditor in issuing a report on a
client’s internal control will be discussed in Chapter 13 .
Lynn (1996), a former chairman of the AUASB, has argued that corporate governance is
concerned with maintaining an appropriate accountability system. Management is
accountable to the board of directors for its actions and the board is accountable to the
owners for their supervision of management. The auditor attests to the credibility of the
financial information given to the owners, to enable them to assess the quality of the
stewardship being exercised on their behalf.
In Australia, several different groups have advocated the importance of corporate
governance.
Business community Page 118
The Business Council of Australia has indicated that codes of conduct have a role to play in
the area of corporate governance. It has recognised that accountants and auditors must
maintain their professionalism at all times and has strongly endorsed the accounting
bodies’ principles of independence. It has also recommended the adoption of a company
code of ethics.
The Australian Institute of Company Directors (AICD) is Australia’s professional

organisation for directors. It has as one of its goals to ‘be the recognised advocate for
corporate governance and directors’ issues’. Every member of the AICD is expected to
comply with the AICD’s code of conduct, as shown in Exhibit 3.2 .
EXHIBIT 3.2 AICD CODE OF CONDUCT
1. A director must act honestly, in good faith and in the best interests of the company
as a whole.
2. A director has a duty to use care and diligence in fulfilling the functions of office
and exercising the powers attached to that office.
3. A director must use the powers of office for a proper purpose, in the best interests
of the company as a whole.
4. A director must recognise that their primary responsibility is to the company’s
shareholders as a whole but should, where appropriate, have regard to the interests
of all stakeholders of the company.
5. A director must not make improper use of information acquired as a director.
6. A director must not take improper advantage of the position of director.
7. A director must properly manage any conflict with the interests of the company.
8. A director has an obligation to be independent in judgment and actions and to take
all reasonable steps to be satisfied as to the soundness of all decisions taken by the
board of directors.
9. Confidential information received by a director in the course of the exercise of
directorial duties remains the property of the company from which it was obtained
and it is improper to disclose it, or allow it to be disclosed, unless that disclosure
has been authorised by that company or the person by whom the information is
provided, or is required by law.
10. A director should not engage in conduct likely to bring discredit upon the company.
11. A director has an obligation, at all times, to comply with the spirit, as well as the
letter, of the law and with the principles of this code.
Source: Adapted from Code of Conduct, Australian Institute of Company Directors, September 2005.
Both the Business Council of Australia and the AICD are members of the ASX Corporate
Reporting Council, discussed below.
Investors
The Financial Services Council (FSC) represents the retail and wholesale funds
management and life insurance industries. FSC members’ investment in the domestic
market accounts for about 25 per cent of the capitalisation of the Australian Securities
Exchange.
The FSC has published Guidance Note No. 2.00 Corporate Governance: A Guide for
Investment Managers and Corporations (commonly known as the Blue Book). This
guidance note was published by the FSC to assist its members to pursue an active role in
monitoring the corporate governance responsibilities of the companies in which they
invest. These guidelines were first developed by fund managers in 1995, to address some of
the corporate excesses during the 1980s, and have become widely accepted by the
investment and corporate community as providing best practice guidelines for corporate
governance. The sixth edition was issued in June 2009. The first five guidelines in the
guidance note guide FSC members in determining their approach to corporate governance,
voting and other issues proposed by public companies in which they invest. The next 18
guidelines guide public companies in relation to a range of corporate governance Page 119
issues, including disclosure, board and board committee composition, non-
executive directors, board and executive remuneration policy and disclosure, and adoption
of a company code of ethics.
The FSC encourages corporations to disclose in their annual reports whether, and the way
in which, they comply with the FSC guidelines. Where a company does not comply with a
guideline, the FSC expects it to explain clearly to shareholders the circumstances of and
the reasons for its departure from that guideline.
Members of the FSC are bound by their own code of conduct, FSC Standard No 1 Code of
Ethics & Code of Conduct, which was updated in October 2016.
The Australian Shareholders Association (ASA) represents retail shareholder interests and
has indicated that its aim is to improve the standard of corporate governance and
directorship in Australia. Through its company monitoring program the ASA challenges
the appropriateness of public companies’ corporate governance practices and has pushed
for improvements in transparency, disclosure and director accountability.
Australian Securities Exchange

The Australian Securities Exchange convened the ASX Corporate Governance Council in
August 2002. Its membership consists of the ASX and 19 business and professional groups
with an interest in corporate governance and disclosure, and its goals are to:
produce best practice corporate governance principles and recommendations to guide

listed entities on the standards of corporate governance expected of them
review and, where necessary, suggest input into published guidance recommendations for
corporate governance practice in Australia, having regard where relevant to international
models
assist the ASX in building understanding of best practice on the part of listed companies,
including, where appropriate, formulating suggestions as to any necessary amendments to
listing rules and guidance notes
recommend to regulators and government where legislative amendment may be necessary
provide information on corporate governance to investors and the wider community
regularly review compliance with best practice.
In March 2003, the ASX Corporate Governance Council released its Principles of Good
Corporate Governance and Best Practice Recommendations. A substantially rewritten
second edition was released in 2007, and new recommendations on diversity and the
composition of the remuneration committee were added in a revised second edition in
2010. On 27 March 2014, a significantly revised and restructured third edition, to take
account of global developments in corporate governance, was released with eight
principles and 29 recommendations, as shown in Exhibit 3.3 .
ASX CORPORATE GOVERNANCE COUNCIL’S
EXHIBIT 3.3 CORPORATE GOVERNANCE PRINCIPLES AND
RECOMMENDATIONS
Principle 1: Lay solid foundations for management and oversight
A listed entity should establish and disclose the respective roles and responsibilities
of its board and management and how their performance is monitored and evaluated.
Recommendation 1.1: A listed entity should disclose:
(a) the respective roles and responsibilities of its board and management; and
(b) those matters expressly reserved to the board and those delegated to
management.
Recommendation 1.2: A listed entity should:
(a) undertake appropriate checks before appointing a person, or putting forward
to security holders a candidate for election, as a director; and
(b) provide security holders with all material information in its possession
relevant to a decision on whether or not to elect or re-elect a director.
Recommendation 1.3: A listed entity should have a written agreement Page 120
with each director and senior executive setting out the terms of their
appointment.
Recommendation 1.4: The company secretary of a listed entity should be
accountable directly to the board, through the chair, on all matters to do with the
proper functioning of the board.
(a) have a diversity policy which includes requirements for the board or a
relevant committee of the board to set measurable objectives for achieving
gender diversity and to assess annually both the objectives and the entity’s
progress in achieving them;
(b) disclose that policy or a summary of it; and
(c) disclose as at the end of each reporting period the measurable objectives for
achieving gender diversity set by the board or a relevant committee of the
board in accordance with the entity’s diversity policy and its progress
towards achieving them, and either:
1. the respective proportions of men and women on the board, in senior
executive positions and across the whole organisation (including how the
entity has defined ‘senior executive’ for these purposes); or

2. if the entity is a ‘relevant employer’ under the Workplace Gender Equality
Act, the entity’s most recent ‘Gender Equality Indicators’, as defined in and
published under that Act.

(a) have and disclose a process for periodically evaluating the performance of
the board, its committees and individual directors; and
(b) disclose, in relation to each reporting period, whether a performance
evaluation was undertaken in the reporting period in accordance with that
process.
(a) have and disclose a process for periodically evaluating the performance of its
senior executives; and
(b) disclose, in relation to each reporting period, whether a performance
evaluation was undertaken in the reporting period in accordance with that
process.
Principle 2: Structure the board to add value
A listed entity should have a board of an appropriate size, composition, skills and
commitment to enable it to discharge its duties effectively.
Recommendation 2.1: The board of a listed entity should:
(a) have a nomination committee which:
1. has at least three members, a majority of whom are independent
directors; and
2. is chaired by an independent director, and disclose:
3. the charter of the committee;
4. the members of the committee; and
5. as at the end of each reporting period, the number of times the committee
met throughout the period and the individual attendances of the members
at those meetings; or
(b) if it does not have a nomination committee, disclose that fact and the
processes it employs to address board succession issues and to ensure that
the board has the appropriate balance of skills, knowledge, experience,
independence and diversity to enable it to discharge its duties and
responsibilities effectively.
Recommendation 2.2: A listed entity should have and disclose a board skills
matrix setting out the mix of skills and diversity that the board currently has or is
looking to achieve in its membership.
(a) the names of the directors considered by the board to be independent
directors;
(b) if a director has an interest, position, association or relationship of Page 121
the type described in Box 2.3 (Factors relevant to assessing the

independence of a director) but the board is of the opinion that it does not
compromise the independence of the director, the nature of the interest,
position, association or relationship in question and an explanation of why
the board is of that opinion; and
(c) the length of service of each director.
Recommendation 2.4: A majority of the board of a listed entity should be
independent directors.
Recommendation 2.5: The chair of the board of a listed entity should be an
independent director and, in particular, should not be the same person as the CEO
of the entity.
Recommendation 2.6: A listed entity should have a program for inducting new
directors and provide appropriate professional development opportunities for
directors to develop and maintain the skills and knowledge needed to perform their
role as directors effectively.
Principle 3: Promote ethical and responsible decision making
A listed entity should act ethically and responsibly.

(a) have a code of conduct for its directors, senior executives and employees;
and
(b) disclose that code or a summary of it.
Principle 4: Safeguard integrity in financial reporting
A listed entity should have formal and rigorous processes that independently verify
and safeguard the integrity of its corporate reporting.
(a) have an audit committee which:
1. has at least three members, all of whom are non-executive directors and a
majority of whom are independent directors; and
2. is chaired by an independent director, who is not the chair of the board, and
disclose:
4. the relevant qualifications and experience of the members of the
committee; and
5. in relation to each reporting period, the number of times the committee met
throughout the period and the individual attendances of the members at
those meetings; or
(b) if it does not have an audit committee, disclose that fact and the processes it
employs that independently verify and safeguard the integrity of its
corporate reporting, including the processes for the appointment and removal
of the external auditor and the rotation of the audit engagement partner.
Recommendation 4.2: The board of a listed entity should, before it approves the
entity’s financial statements for a financial period, receive from its CEO and CFO a
declaration that, in their opinion, the financial records of the entity have been
properly maintained and that the financial statements comply with the appropriate
accounting standards and give a true and fair view of the financial position and
performance of the entity and that the opinion has been formed on the basis of a
sound system of risk management and internal control which is operating
effectively.
Recommendation 4.3: A listed entity that has an AGM should ensure that its
external auditor attends its AGM and is available to answer questions from security
holders relevant to the audit.
Principle 5: Make timely and balanced disclosure
A listed entity should make timely and balanced disclosure of all matters concerning
it that a reasonable person would expect to have a material effect on the price or
value of its securities.
(a) have a written policy for complying with its continuous disclosure
obligations under the Listing Rules; and
(b) disclose that policy or a summary of it.
Page 122
Principle 6: Respect the rights of security holders
A listed entity should respect the rights of its security holders by providing them with
appropriate information and facilities to allow them to exercise those rights
effectively.
Recommendation 6.1: A listed entity should provide information about itself and
its governance to investors via its website.
Recommendation 6.2: A listed entity should design and implement an investor
relations program to facilitate effective two-way communication with investors.
Recommendation 6.3: A listed entity should disclose the policies and processes it
has in place to facilitate and encourage participation at meetings of security
holders.
Recommendation 6.4: A listed entity should give security holders the option to
receive communications from, and send communications to, the entity and its
security registry electronically.
Principle 7: Recognise and manage risk
A listed entity should establish a sound risk management framework and periodically
review the effectiveness of that framework.
(a) have a committee or committees to oversee risk, each of which:

1. has at least three members, a majority of whom are independent directors;
and
2. is chaired by an independent director,and disclose:
3. the charter of the committee; Page 123
(b) if it does not have a risk committee or committees that satisfy (a) above,
disclose that fact and the processes it employs for overseeing the entity’s risk
management framework.
Recommendation 7.2: The board or a committee of the board should:
(a) review the entity’s risk management framework at least annually to satisfy
itself that it continues to be sound; and
(b) disclose, in relation to each reporting period, whether such a review has
taken place.
(a) if it has an internal audit function, how the function is structured and what
role it performs; or
(b) if it does not have an internal audit function, that fact and the processes it
employs for evaluating and continually improving the effectiveness of its risk
management and internal control processes.
Recommendation 7.4: A listed entity should disclose whether it has any material
exposure to economic, environmental and social sustainability risks and, if it does,
how it manages or intends to manage those risks.
Principle 8: Remunerate fairly and responsibly
A listed entity should pay director remuneration sufficient to attract and retain high
quality directors and design its executive remuneration to attract, retain and motivate
high quality senior executives and to align their interests with the creation of value
for security holders.
(a) have a remuneration committee which:
1. has at least three members, a majority of whom are independent directors;
and
2. is chaired by an independent director, and disclose:

(b) if it does not have a remuneration committee, disclose that fact and the
processes it employs for setting the level and composition of remuneration
for directors and senior executives and ensuring that such remuneration is
appropriate and not excessive.
Recommendation 8.2: A listed entity should separately disclose its policies and
practices regarding the remuneration of non-executive directors and the
remuneration of executive directors and other senior executives.
Recommendation 8.3: A listed entity which has an equity-based remuneration
scheme should:
(a) have a policy on whether participants are permitted to enter into transactions
(whether through the use of derivatives or otherwise) which limit the
economic risk of participating in the scheme; and
(b) disclose that policy or a summary of it.
Source: Corporate Governance Principles and Recommendations, 3rd edition, 2014, ASX Corporate
Governance Council. © Copyright 2017 ASX Corporate Governance Council Association of
Superannuation Funds of Australia Ltd, ACN 002 786 290, Australian Council of Superannuation
Investors, Australian Financial Markets Association Limited ACN 119 827 904, Australian Institute of
Company Directors ACN 008 484 197, Australian Institute of Superannuation Trustees ACN 123 284 275,
Australasian Investor Relations Association Limited ACN 095 554 153, Australian Shareholders’
Association Limited ACN 000 625 669, ASX Limited ABN 98 008 624 691 trading as Australian
Securities Exchange, Business Council of Australia ACN 008 483 216, , Chartered Accountants Australia
and New Zealand, CPA Australia Ltd ACN 008 392 452, Financial Services Institute of Australasia ACN
066 027 389, Group of 100 Inc, The Institute of Actuaries of Australia ACN 000 423 656, ABN 50 084
642 571,The Institute of Internal Auditors - Australia ACN 001 797 557, Financial Services Council ACN
080 744 163, Governance Institute of Australia Ltd ACN 008 615 950, Law Council of Australia Limited
ACN 005 260 622, National Institute of Accountants ACN 004 130 643, Property Council of Australia
Limited ACN 008 474 422, Stockbrokers Association of Australia ACN 089 767 706. All rights reserved
2015.
ASX Listing Rule 4.10.3 requires a statement disclosing the extent to which an entity has
followed the best practice recommendations of the ASX Corporate Governance Council. If
the entity has not followed all of the recommendations, it must identify the
recommendations it has not followed and give reasons for not following them. The
obligation is to explain to investors why an alternative approach is adopted; this is referred
to as the ‘if not, why not?’ obligation. If a recommendation has been followed for only part
of the period, the entity must state the period during which it was followed.
Each year the ASX reviews annual reports for compliance with Listing Rule 4.10.3. Recent
reviews show that entities have continued to improve their corporate governance reporting,
although there is still room for further improvement.
Australian Securities and Investments Commission
The Australian Securities and Investments Commission is involved primarily with

enforcing the provisions of the Corporations Act 2001 and related legislation, including
that relating to corporate governance. ASIC does not involve itself in the promulgation of
codes of ethics or corporate conduct. Rather, ASIC’s role is one of regulatory supervision
and enforcement.
Accounting bodies
All three accounting bodies are strong supporters of sound corporate governance
structures. They are all represented on the ASX Corporate Governance Council and have
issued a Best Practice Guide on Audit Committees.
Audit committees
One result of the focus on corporate governance that has affected the auditor has been the
setting up of audit committees. An audit committee is a subcommittee of the board of
directors or other governing body, comprising a majority of independent/non- Page 124
executive members of the governing body of an entity and representing owners
rather than management. Among other functions, it is usually assigned the oversight of the
financial reporting and auditing process, and the auditor’s major dealings with the
governing body will be through the audit committee, although the auditor will usually meet
with the full governing body at least once per year. An audit committee is therefore an
important component of corporate governance.
The third edition of Audit Committees: A Guide to Good Practice was issued by the
AUASB, the AICD and the Institute of Internal Auditors—Australia in 2017. The guide
highlights the key role that the audit committee can play in assisting the board of directors
in fulfilling its responsibilities in relation to corporate governance and overseeing an
entity’s financial reporting, internal control and risk management systems, and the internal
and external audit functions.
As seen earlier in this chapter, Recommendation 4.1 of the ASX Corporate Governance
Council’s Corporate Governance Principles and Recommendations indicates that listed
public companies should have an audit committee. Further, the top 500 companies must
also comply with the audit committee requirements of Listing Rule 12.7, which requires
that an entity that was included in the S&P/ASX All Ordinaries Index at the beginning of
its financial year is to have an audit committee during that year. For the top 300 companies,
the composition, operation and responsibility of the audit committee must comply with the
best practice recommendations of Principle 4 of the ASX Corporate Governance Council’s
Corporate Governance Principles and Recommendations. As a result, the proportion of
Australian listed companies with audit committees has increased from less than 50 per cent
in 1990 to nearly 100 per cent today, as indicated in the results of the ASIC surveillance
program. The number of audit committees in the public sector is also growing.
The Ramsay Report indicated that most stakeholders consulted during the preparation of
the report were of the view that requiring listed companies to have an appropriately
constituted audit committee would be a most effective way of enhancing the independence
of auditors of such companies.
An effective audit committee takes an active role in overseeing the company’s accounting
and financial reporting. The audit committee should maintain a direct line of
communication between the board of directors and the company’s auditors, permitting
open discussion of sensitive matters like controversial accounting issues, disagreements
with management, deficiencies in the design of internal control, failures in the operation of
internal control and difficulties encountered in performing the audit. The audit committee
normally discusses the general scope and timing of external audit work, although it does
not review the detailed audit program. The audit committee also normally involves itself in
the nomination of the external auditors, reviews the reasonableness of the audit fees and
considers how the provision of non-audit services affects the auditor’s independence.
The audit committee serves to strengthen the auditor’s independence by providing a

reference point, independent of executive management, to which problems of audit scope,
contentious issues and conflicts arising during the audit can be referred on a timely basis.
The external auditor, as an independent party with a detailed knowledge of the entity’s
financial affairs, is able to provide substantial input to the audit committee by reporting
relevant matters to it. Therefore, the external auditor is a major contributor to achieving an
effective audit committee. The external auditor should also assist the audit committee by
informing it of any developments such as legislative changes or new accounting standards.
QUICK REVIEW
1. There is an increasing emphasis on the importance of corporate
governance, with good corporate governance procedures being
advocated by many different groups.
2. While directors have the primary responsibility for corporate governance,

accountants and auditors have a role to play.
3. An important aspect of corporate governance is the role of the audit and
the audit committee.
Page 125
Summary
Ethics are concerned with what is good for the general wellbeing of individuals and the
community. Chartered Accountants ANZ, CPA Australia and the IPA have ethical rules to
help promote high ethical standards among their members. However, as ethics are attitudes
of mind, these rules cannot by themselves make auditors act ethically. An auditor needs an
ethical attitude, a good knowledge of ethical principles and ethical decision-making skills
to handle ethical conflicts. At the centre of the ethical rules of the auditing profession is the
need both to be, and to be seen as, independent.
Interest in audit independence has increased dramatically in recent times due to the spate of
corporate failures both in Australia and overseas and the impact of the global financial
crisis. As a result, we have seen the Ramsay Report into audit independence in Australia,
recommendations for audit reform from the JCPAA and the HIH Royal Commission,
amendments to the Corporations Act 2001 through CLERP 9, to strengthen auditor
independence, and the issue of a revised set of ethical rules, APES 110, which is based on
the international code of ethics issued by IFAC. APES 110 adopts a conceptual approach
that uses a framework based on identifying and evaluating threats to independence and
introducing safeguards to eliminate the threats or reduce them to an acceptable level. As a
result, the ability of auditors to provide non-audit services has been greatly reduced. This
has been reduced even further by the introduction of the Sarbanes–Oxley Act 2002 in the
US and the introduction of a cap on non-audit services and the banning of certain non-
audit services by the European Union in 2014. In addition, there have also been calls for
other means of improving auditor independence, such as strengthening the role of audit
committees and rotation of auditors. As a result, in 2014 the European Union passed
legislation that came into effect in 2016 requiring mandatory rotation of audit firms. A
similar proposal for the future adoption of such mandatory rotation was also adopted in
South Africa in 2017. However, the PCAOB in the US has decided against such a move.
The accounting bodies and the regulators have strongly supported the push for improved
corporate governance, including the establishment of audit committees. The number of
companies with audit committees is increasing steadily. Corporate governance is the set of
rules or procedures that ensure that a company is managed in the best interests of the
stakeholders. Ethical principles and skills in ethical decision making are important aspects
of corporate governance. Auditors have an important role to play in the corporate
governance process, through both the audit itself and reporting to the audit committee.
Key terms
actual independence
audit committee
code of ethics
confidentiality
corporate governance
deontological ethics
due care
ethical decision-making models
ethical pronouncements
ethics
independence
independence in appearance
independence of mind
integrity
low-balling
objectivity
professional behaviour
professional competence
public interest
public interest entity
reasonable person test
resignation of the auditor
teleological ethics
utilitarianism
virtue ethics
Page 126
References and additional readings

Accounting Professional & Ethical Standards Board (APESB) (2017) ‘Confidentiality not a
cover for illegal acts’, media release, 30 May, www.apesb.org.au/uploads/news/media
_release/30052017101427_MR_APESB_ NOCLAR_MAY_2017_FINAL.pdf ,
accessed 16 December 2017.
American Accounting Association (AAA) (1990) Ethics in the Accounting Curriculum:
Cases and Readings, AAA, Florida.
Auditing and Assurance Standards Board (AUASB), Australian Institute of Company
Directors (AICD) and Institute of Internal Auditors—Australia (2017), Audit
Committees: A Guide to Good Practice, 3rd edn, AICD, Sydney.
Australian Institute of Company Directors (2005), Code of Conduct, AICD, Sydney.
Australian Securities Exchange (ASX) Corporate Governance Council (2014) Corporate
Governance Principles and Recommendations, 3rd edn, June, ASX, Sydney.
Baker, R. (2009) ‘From member of the company to registered auditor: the role of the
external auditor in corporate governance’, Australian Accounting Review, March, pp.
24–32.
Bosch, H. (1995) Corporate Practices and Conduct, 3rd edn, Pitman Publishing,
Melbourne.
Chartered Accountants in Australia and New Zealand (2014) Supplemental Royal Charter
Chartered Accountants ANZ, Sydney.
Committee on Corporate Governance (1998) Committee on Corporate Governance: Final
Report (Hampel Report), European Corporate Governance Institute.
Committee on the Financial Aspects of Corporate Governance (1992) The Financial
Aspects of Corporate Governance (Cadbury Report), London Stock Exchange.
Corporate Law Economic Reform Program (2002) ‘Corporate disclosure: strengthening the
financial reporting framework’, Proposals for Reform: Paper No. 9 (CLERP 9),
September, Canberra.
CPA Australia, the Institute of Chartered Accountants in Australia and the National
Institute of Accountants (2013) Independence Guide, 4th edn, Joint Accounting Bodies,
Melbourne.
Davenport, L. and Dellaportas, S. (2009) ‘Interpreting the public interest: a survey of
professional accountants’, Australian Accounting Review, March, pp. 11–23.
De Angelo, L. (1981) ‘Auditor independence, low balling and disclosure regulation’,
Journal of Accounting and Economics, Vol. 3, pp. 113–27.
European Commission (EC) (2010) Audit Policy: Lessons from the Crisis (Green Paper),
October, EC, Brussels.

Financial Reporting Council (FRC) (2014) The UK Corporate Governance Code,
September, FRC, London.
Financial Services Council (FSC) (2009) Corporate Governance: A Guide for Investment
Managers and Corporations (Blue Book), May, FSC, Sydney.
Financial Services Council (2016) Code of Ethics & Code of Conduct, October, FSC,
Sydney.
Guy, M. (1990) Ethical Decision Making in Everyday Work Situations, Quorum Books,
New York, pp. 14–19.
HIH Royal Commission (2003) The Failure of HIH Insurance, HIH Royal Commission,
Canberra.
ICAEW (1999) Internal Control: Guidance for Directors on the Combined Code (Turnbull
Report), ICAEW, London.
Independence Standards Board (ISB) (2000) A Conceptual Framework for Auditor
Independence, Exposure Draft, November, ISB, New York.
Joint Committee of Public Accounts and Audit (JCPAA) (2002) ‘Review of independent
auditing by registered company auditors’, Report 391, August, Canberra.
Leung, P. and Cooper, B.J. (1995) ‘Ethical dilemmas in accountancy practice’, Australian
Accountant, May, pp. 28–33.
Lynn, R.S. (1996) ‘The role of the auditor in corporate governance’, Australian Accounting
Review, September, pp. 16–18.
Martinov-Bennie, N., Cohen, J. and Simnett, R. (2011) ‘The effect of affiliation on auditor
independence’, Managerial Auditing Journal, Vol. 26, No. 8, pp. 656–71.
Monem, R.M. (2011) ‘The One.Tel collapse: lessons for corporate governance’, Australian
Accounting Review, Vol. 21, No. 4, pp. 340–51.
Munro, L. and Buckby, S. (2008) ‘Audit committee regulation in Australia: how far have
we come?’ Australian Accounting Review, December, pp. 310–23.
Nash, L. (1981) ‘Ethics without the sermon’, Harvard Business Review, No. 59, pp. 79–90.
Organisation for Economic Co-operation and Development (OECD) (2004) Principles of
Corporate Governance, OECD, Paris.
Panel on Audit Effectiveness (2000) Report and Recommendations, Public Page 127
Oversight Board, Stamford, Connecticut.
Public Company Accounting Oversight Board (PCAOB) (2011) Concept Release on
Auditor Independence and Audit Firm Rotation, PCAOB Release No. 2011–006,
August.
Ramsay, I. (2001) Independence of Australian Company Auditors, Department of Treasury,
Canberra.
Rawls, J. (1957) ‘Justice as fairness’, Journal of Philosophy, Vol. 54, October, pp. 653–62.
Starke, J.G. (1991) ‘The protection of public service “whistleblowers”—part 1’, Australian
Law Journal, Vol. 65, No. 4, April, pp. 205–19.
Thomson, J.A.K., Tredennick, H. and Barnes, J. (1976) Aristotle’s Ethics, Penguin
Classics, Harmondsworth.
Review questions
Professional ethics and ethical theory

3.1 What is meant by the term ‘ethics’? LO 3.1
Accounting bodies’ code of ethics

3.2 What is the ‘public interest’ and how does it relate to the auditor’s code of
ethics? LO 3.2
3.3 What are the fundamental ethical principles for an auditor? LO 3.2
3.4 How has the issuing of ‘Responding to non-compliance with laws and
regulations’ (NOCLAR) affected the auditor’s duty of confidentiality?
LO 3.2
Applying ethics
3.5 Describe how ethical decision-making models can be used by auditors to
assist them in resolving ethical dilemmas. LO 3.3
Auditor independence
3.6 Explain the term ‘conflict of interest’ according to section 324CD of the
Corporations Act 2001. LO 3.4
3.7 Explain what is meant by actual and perceived independence, and explain
why both are important to the auditor. LO 3.4
3.8 Identify three requirements of policies and procedures designed to give an
audit firm reasonable assurance that it will be notified of breaches of
independence requirements. LO 3.4
3.9 List and briefly explain the five categories of threats to independence listed
in APES 110. LO 3.4
3.10 Explain the conflicting arguments as to why auditors should or should not be
allowed to provide non-audit services. LO 3.4

3.11 Why has rotation of audit firms not been mandated in Australia? Is this
consistent with what is happening elsewhere in the world? LO 3.4
Fee determination
3.12 Explain how the fee for an audit engagement may be determined. LO 3.5
3.13 Solicitors are able to accept contingency fee arrangements, so why can’t
auditors? LO 3.5
Corporate governance
3.14 Explain the characteristics of an audit committee and how it functions.
LO 3.6
3.15 Identify how an audit committee can be used as a means of improving
corporate governance. LO 3.6
Page 128
Discussion problems and case studies
Professional ethics and ethical theory

3.16 EASY You are the staff training manager at a major audit firm. A new
graduate has asked you about the relevance of ethical theory to the ethical
rules that auditors are required to follow.
REQUIRED
Identify the three main categories of ethical theory and discuss their
relevance to an auditor. LO 3.1
Accounting bodies’ code of ethics

3.17 MEDIUM You are the auditor of Quick Step Ltd (QSL), a large manufacturing
company in Adelaide. Your audit firm has just received a court order to
produce to the Australian Securities and Investments Commission (ASIC)
certain documents relating to the most recent audit of QSL. You are aware
that some of these documents contain confidential information about QSL
and its operations.
REQUIRED
Explain how you would respond to ASIC’s request and why. LO 3.2
3.18 MEDIUM You have been asked by your audit client Blue Water Ltd to
prepare a report that analyses the potential acquisition of Ocean Pty Ltd. As
part of your analysis, you decide to verify the accuracy and completeness of
Ocean’s most recent cash flow statement. After reviewing a draft of your
preliminary analysis, the chief financial officer (CFO) of Blue Water, Jill
Symes, has asked you to focus your attention on Ocean’s sales and
profitability and to avoid the distraction of cash flow reporting. She suggests
that the acquisition will provide substantial future financial benefits to Blue
Water and that confusing the board with cash flow issues would not be
helpful to the acquisition or to the likelihood of your being asked to
undertake similar engagements in the future.
REQUIRED
List two threats that may exist in regard to compliance with the fundamental
principles of professional ethics, and identify the fundamental principles that
are at risk of being breached. LO 3.2
Applying ethics
3.19 HARD Larry and Joe are two audit seniors working for Sampson &
Associates. Both started employment with the audit firm around the same
time. They have mutual respect for each other; however, they have been
highly competitive since they commenced work together.
Larry has recently married and he and his wife are paying off their mortgage.
Joe is single with no commitments. They have both been seniors for almost
two years and are looking for promotion to audit supervisor. They are both
aware that there is only one supervisor position available.
Larry recently replaced Joe on the audit of Tower Ltd. The reason they were
both given for the change was that another assignment had arisen with a
long-time client of Joe’s. Once Larry had replaced Joe on the Tower audit,
he realised that the client had called the audit manager to say that they
were not impressed with Joe, as he had missed a number of issues within
the audit and was arriving at work late. The audit manager had not
discussed these comments with either Larry or Joe. After going through the
work that Joe had completed, Larry realised that Joe had performed an
excellent job, identifying a number of issues that he thought he might
possibly have missed. Furthermore, Larry suspects that Joe and the client
had a personality conflict, and that the client has misled the audit manager.
Larry realises that he can finish off the audit, resolve the issues and obtain a
good review from this assignment, which would help him in the promotion
stakes. He also knows that the audit manager is unlikely to bring the client’s
unsupported allegations to Joe’s attention.
REQUIRED Page 129
Work through this scenario using the American Accounting Association

decision-making model, and decide what action Larry should take. LO 3.3
Source: This question was adapted from the professional year program of the Institute of Chartered
Accountants in Australia, 1996 ethics 1 module.
Auditor independence
3.20 EASY ‘Auditors are responsible for the spate of major corporate collapses.
They have gotten too cosy with management, instead of protecting
shareholders and investors.’
REQUIRED
Explain whether you agree or disagree with this statement. Your response
should consider the role that lack of auditor independence may have
played in corporate failures. LO 3.4
3.21 EASY Your audit client Comfort Living Ltd has recently built a block of
apartments in a coastal resort area. The block consists of 25 two-bedroom
apartments, with indoor pool, gym and sauna facilities. Comfort Living
attracts investors via a timeshare scheme whereby investors buy one-week
timeshare allotments.
During the planning stage of the current audit of Comfort Living, Robyn
Renaldi, the CFO, approaches you to discuss the financial performance of
Comfort Living. Robyn tells you that while Comfort Living has more than 100
members and is ‘doing OK’, the scheme could do with more investors.
Robyn has asked you to promote Comfort Living to your other audit clients.
REQUIRED
Provide one key threat to independence in this scenario. LO 3.4
3.22 MEDIUM Newport & Associates (Newport) is a large audit firm with clients
located around Australia. During April 2018, Newport was successful in
obtaining a new client, Clear Diagnostics Ltd (CDL), which is one of
Australia’s leading providers of diagnostic imaging services and owns 30
diagnostic clinics across Australia.
Prior to the appointment of Newport as the auditor of CDL for the financial
year ended 30 June 2018, some preliminary analysis identified the
following information:
Alex Silver, one of the assistants at Newport intended to be part of the 30
June 2018 audit team, owns shares in CDL. Alex’s interest is not material
to him.
Newport was previously engaged by CDL to value its intellectual property.
The consolidated statement of financial position as at 30 June 2018
includes intangible assets of $25 million, which were valued by Newport
on 1 March 2018, following CDL’s acquisition of another diagnostic
imaging company. The intangibles are considered material to CDL.
REQUIRED
(a) Identify and explain any potential threats to Newport’s independence

as CDL’s auditor.
(b) Explain what action Newport should take, if any, to eliminate any
potential threats identified in (a).
(c) Identify an appropriate safeguard that Newport could implement to
reduce the risk of a similar independence threat occurring in the
future. LO 3.4
3.23 MEDIUM Regional Assurance Partners (RAP) is a three-partner audit and

assurance firm based in Sydney. The three partners are Bob, Finlay and
Shelley. RAP has been appointed as auditor of Exquisite Accessories
Limited (EAL), a metals processing firm. This is the first year that RAP is
undertaking the EAL audit.
The chief executive officer (CEO) of EAL is Ralph Trinket. Ralph’s wife is a
well-known jewellery designer who frequently produces pieces for fashion

shows and other high-profile media events. Ralph has been vocal about his
wife’s successful jewellery business and has offered to source some
exclusive and limited-edition pieces for the audit team.
Owen Jackson, the CFO, and Bob have been friends for many Page 130
years. Their families usually go on holiday together once a year,
and they frequently socialise with one another. Bob rates Owen very highly
as a CFO and he is confident that Owen will cooperate with the auditors.
Elspeth O’Keefe, a new audit manager at RAP, was previously employed by
EAL, and she prepared the EAL financial report for the period under audit.
REQUIRED
(a) Identify and explain three threats to independence for RAP when
performing the EAL audit.
(b) For each threat identified in (a), state what actions RAP needs to
implement to eliminate or reduce the threat to an acceptable level.
LO 3.4
Source: This question was adapted from the Chartered Accountants Program of Chartered
Accountants Australia and New Zealand, 2015 (2) audit and assurance module.
3.24 HARD You are an assurance services partner at Connor & Trainer (C&T), a
medium-sized audit firm in Brisbane. C&T was asked in March 2018 to
accept nomination as the auditor of Celestial Ltd, which operates in the
mining and resources sector. Prior to accepting the nomination, you wish to
ensure that you and your firm meet all the relevant independence
requirements under the Corporations Act 2001.
Before accepting the nomination, you have identified the following
situations:
1 Celestial currently has a vacancy on its board of directors and would
like a partner of C&T with expertise in business structures to fill the
vacancy. Experience in assurance services is preferred, but not
required.
2 Francesca Bonnici, a former assurance services manager of C&T, is
now the CFO of Celestial. She left C&T to take up her new role in
February 2017.
3 George O’Conner is a senior IT manager at C&T. Over the past two
years he has carried out several major projects for Celestial. George’s
daughter, Crystal, is a university student who lives at home and
recently purchased shares in Celestial using a small inheritance she
received from her grandfather.
REQUIRED
(a) For each of the independent situations listed above, consider
whether the requirements of the Corporations Act 2001 have been
met.
(b) Where the requirements have not been met, identify whether a
remedy is available that would allow C&T to accept the nomination.

LO 3.4
3.25 HARD Consider the following independent situations:

(a) Kelly Brown, sole proprietor of an audit firm, plans to establish a
separate business that will provide management consulting services.
She intends to operate both businesses simultaneously.
(b) Walter Patterson is the partner-in-charge of the audit of Cedar Ltd.
Over the years, he has become a golfing buddy of Cedar’s CEO, Tom
Phillips. During the current year Walter and Tom jointly purchased an
exclusive holiday house on the Gold Coast. The holiday house
represents more than 10 per cent of Walter’s personal wealth.
(c) Margaret White, sole proprietor of an audit firm, has provided
extensive advisory services for her audit client Ace Furniture Ltd. She
has interpreted financial reports, provided forecasts and other
analyses, counselled on potential expansion plans and counselled on
banking relationships.
(d) Swanson & Associates recently won the audit of Latest Fashions Ltd
(LFL), a large manufacturer of women’s clothing. Kyle Sutherland, one
of the partners in Swanson & Associates, had a substantial
investment in LFL prior to bidding on the engagement. In anticipation
of winning the engagement, Kyle placed his LFL shares in a blind
trust, where he would not know what action the trust had taken with
regard to any shares or other investments.
(e) Terry Hansen, a sole practitioner, audited Bright Lights Pty Ltd’s
financial report for the year ended 30 June 2017, and was issued
shares by the client as payment of the audit fee. Terry disposed of
the shares before commencing fieldwork planning for the audit of the
30 June 2018 financial report.
REQUIRED
For each situation, determine whether APES 110 has been Page 131
breached and explain your answer. LO 3.4
3.26 HARD You have recently joined the audit firm of Cameron, Casey &
Associates (CCA) and have been asked to review the firm’s audit clients to
ensure that the independence requirements of APES 110 are being met.
Your review has revealed the following:
(a) Shannon O’Brien is an audit manager at CCA. Bell Pty Ltd is an audit
client of CCA and has requested that Shannon help implement a new
control system, arrange interviews for Bell’s hiring of new personnel
and instruct and oversee the training of current personnel.
(b) Fortress Ltd requires an audit for the current year. However, Fortress
has not paid CCA the fees due for tax-related services performed
two years ago. Fortress has now issued CCA a promissory note for
the unpaid fees, and CCA has proceeded to provide the audit
services.
(c) CCA was recently appointed the auditor of Tasty Foods Ltd for the
year ended 30 June 2018. The senior-in-charge, Marshall Thompson,
and an assistant observed the inventory stocktake on 30 June. On

completion of the inventory observation, Carly Webster, Tasty Foods’
accountant, informed Marshall that the shipping supervisor had a
small gift for him and the assistant. Marshall asked Carly what the gift
was for, and Carly responded that they had always given small gifts of
food items to their previous auditors on completion of the inventory
observation. Marshall estimates that the value of the food is less than
$100.
(d) CCA audits a retirement village in which the parents of a member of
the firm, Judy Chung, own a unit. The unit is material to the parents’
net worth, and the member participates in the audit engagement.
REQUIRED
For each independent situation listed, state whether APES 110 has been
breached and justify your answer. LO 3.4
Fee determination
3.27 EASY In an attempt to reduce business costs, and given the current
competitive business environment, audit tendering is sometimes used for
large audits.
REQUIRED
Identify the advantages and disadvantages of audit tendering. LO 3.5
Corporate governance
3.28 MEDIUM Comfort Furniture Ltd is a long-established Australian company,
based in Melbourne, that manufactures office furniture. Started in 1985 as a
family-owned business, it expanded rapidly with branches around Australia
and was listed on the Australian Securities Exchange (ASX) in 1990. The
governance structure of Comfort Furniture includes seven directors, four of
whom are executive directors and three of whom are non-executive
directors. The four executive directors are Barry Gibson (CEO), Dawn
Thompson (CFO), Naomi Spears (marketing director) and Richard Carr (chief
information officer). The three non-executive directors are Sally Rogers
(who joined the board in 2015 as the independent chair), Brian Taber (a
widely recognised furniture designer) and Hamish McDonald (a solicitor
who has been on the board since Comfort Furniture was listed).
The Comfort Furniture board has three subcommittees: remuneration,
nomination and audit. The audit committee consists of Hamish McDonald
(chair), Richard Carr and Brian Taber.
REQUIRED
Provide three compliance concerns with the current structure of the audit
committee, according to the ASX’s Corporate Governance Principles and
Recommendations. Explain your answers. LO 3.6
3.29 HARD Young & Trendy Ltd, which recently listed on the ASX, was
established by Edward Dunn in 2012 to provide high-quality fashion
products based on the latest trends at reasonable prices. At the Page 132
June 2018 board meeting, Edward, who is currently the chair,
advised the rest of the board that he had just signed an agreement for
Young & Trendy to set up and run fashion-watch kiosks in large department
stores, in a major venture with Chic Handbags, a fashion handbag
manufacturer.
The board was stunned that this was the first that they had heard of the
venture, and the CFO, Peta Robinson, expressed concern that they had no
experience of this type of operation and that they knew nothing about Chic
Handbags. However, Edward said that it was a ‘done deal’ and that he was
confident of its success. He said he was very impressed with Alexandra
Solomon from Chic Handbags, with whom he had held several meetings to
discuss the project, and that he expected future sales arising from the
venture to be significant.
REQUIRED
Identify two key ASX Corporate Governance Council principles that have
been breached, and explain how Edward has breached them. LO 3.6

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Page 89

LEARNING OBJECTIVES (LO)

ASA 102 Compliance with Ethical Requirements when Performing

of Financial Reports and Other Financial Information,

APES 110/IFAC Code of Ethics for Professional Accountants

APES 320 Quality Control for Firms

As discussed in Chapters 1 and 2 , the auditor is a member of a time-

FIGURE 3.1 Flowchart of auditing and assurance profession

LO 3.1 Professional ethics and ethical theory

The nature and importance of professional ethics

The first principle is that each person participating in a practice,

APES 205 Conformity with Accounting Standards

APES 210 Conformity with Auditing and Assurance Standards

APES 215 Forensic Accounting Services

APES 220 Taxation Services

APES 225 Valuation Services

APES 230 Financial Planning Services.

APES 305 Terms of Engagement

APES Dealing with Client Monies

APES Compilation of Financial Information

APES Quality Control for Firms

APES Risk Management for Firms

APES Insolvency Services

APES Reporting on Prospective Financial Information Included in a

APES Participation by Members in Public Practice in Due Diligence

The purpose of the code of ethics

In addition, APES 110 communicates the profession’s responsible attitude of

The virtues of an auditor

FIGURE 3.2 Fundamental principles

professional career through continuing professional development. Clearly, a client’s

Conﬁdentiality not a cover for illegal acts

A new standard issued today requires accountants to consider their

The ground-breaking standard in Australia adopts the new international

‘This standard encourages professional accountants to speak up where they

The new standard, Responding to Non-Compliance with Laws and

Source: Text extract from Media Release 30 May 2017.

Objectivity, independence and technical standards equate with Aristotle’s Page 96

To act ethically is to act appropriately and responsibly in different situations, providing a

The complexity of the different ethical problems encountered by

Ethical decision-making models

conflict resolution are:

EXHIBIT 3.1 AMERICAN ACCOUNTING ASSOCIATION MODEL

1. Determine the facts

Developments in auditor independence

IFAC independence rules

Sarbanes–Oxley Act 2002 Page 99

Joint Committee of Public Accounts and Audit

HIH Royal Commission

Corporate Law Economic Reform Program

Section 324CD indicates that a conflict of interest situation exists if:

When considering whether an auditor is capable of exercising objective and impartial

Rotation of audit partners

Non-audit services Page 101

officer or audit-critical employee for acting as a consultant, unless it is a small

329, which attempt to reduce management’s influence on the auditor. Under

Auditors’ removal or resignation

Examples of such other circumstances are where:

the independence of the audit function is not being preserved

Right of access to records Page 103

Right to reasonable fees