4.1 MIA By-Law (on Professional Conducts and Ethics) Fundamental Principles of Professional Ethics Comprehensive requirements of and application of:Integrity, objectivity and independenceProfessional duty of confidentialityDue care (skill, diligence and expeditiousness)Areas of controversy (the principal companies)

Requirements of Companies Act 1965 (as amended)Section 9 (1): Independence of Auditors Prohibited from acting/accepting an appointment as auditor if; - indebted to the co./related co. > RM2500 - an officer of the co. - a partner, employer or employee of an officer of the company - a partner, or employee of an employee of an officer of the company

Requirements of Companies Act 1965 (as amended)Prohibited from acting/accepting an appointment as auditor if;a shareholder of a corporation whose employee is an officer of the company responsible for or if he is the partner, employer or employee of a person responsible for keeping the members register or the register of debenture-holders of the company

Requirements of Companies Act 1965 (as amended)Prohibited from acting/accepting an appointment as auditor if;An officer of a related corporation of the company or a person who has been an officer of the company or its related corporation at any time within the preceding 12 months.

Requirements of Companies Act 1965 (amended)Section 172 appointment and remuneration of auditorsSection 174 powers and duties of auditors as to reports on accounts

MIA By-Laws (Professional Conduct and Ethics)Fundamental PrinciplesIntegrityObjectivityProfessional competence and due careConfidentialityProfessional behaviour

MIA By-Laws (Professional Conduct and Ethics)IntegrityTo be sincere, honest and straightforward in his professional and business relationships.To protect integrity, he should not associate with any reports or statements that he believes is false, materially misleading or is furnished negligently.

MIA By-Laws (Professional Conduct and Ethics)ObjectivityThis principle requires the professional accountant to maintain an attitude of impartiality and not to allow biases to influence their objectivity in making professional judgement.A professional accountant is required to be fair, and be free of conflicts of interest in their professional work.

MIA By-Laws (Professional Conduct and Ethics)Professional competence and due careAs per the IFAC Code:This principle must cover two requirements: To maintain professional knowledge and skill at the level required to ensure competent services are provided, andTo act diligently in accordance with technical and professional standards

MIA By-Laws (Professional Conduct and Ethics)ConfidentialityTo refrain from: disclosing confidential information outside the firm or the employing organisation without proper and specific authorityUsing such confidential information to their personal advantage or the advantage of others

MIA By-Laws (Professional Conduct and Ethics)Confidentiality principle may be overruled:Disclosure is permitted by law and is authorised by the client or employerDisclosure is required by law; breach of law, evidence in court There is professional duty to disclose; to comply with quality review, inquiry by professional/regulatory body

MIA By-Laws (Professional Conduct and Ethics)Professional behaviourTo act in a manner consistent with the good reputation of the professionShould be law abiding, refrain from conduct/activities that might bring discredit to the professionIf convicted of a serious crime, membership may be revoked by the professional body

MIA By-Laws (Professional Conduct and Ethics)Professional independenceTied to the fundamental principle of objectivityAs per the IFAC Code, it covers 2 aspects;Independence of mindIndependence in appearance

MIA By-Laws (Professional Conduct and Ethics)Independence of mindA conclusion is rendered without being affected by influences that compromise professional judgementIndependence in appearance The avoidance of facts and circumstances that are so significant that a reasonable and informed third party would reasonably conclude the integrity, objectivity or professional scepticism had been compromised.

The Conceptual Framework ApproachExtended to all fundamental ethical principles.Professional accountants to apply whether in public practice, business or employment.To identify any threats to compliance with fundamental principles.

The Conceptual Framework ApproachProfessional accountant has an obligation to: identify circumstances, relationships or interests that may create a threat to compliance with fundamental ethical principles.Evaluate the significance of the threat when such a threat has been identified.

The Conceptual Framework ApproachProfessional accountant has an obligation to: if the identified threat is considered significant, apply suitable safeguards to eliminate or reduce the threat to an acceptable level.

The Conceptual Framework ApproachThreats to compliance:Self-interest threatSelf-review threatAdvocacy threatFamiliarity threatIntimidation threat

The Conceptual Framework ApproachSafeguards to address threats to compliance:Safeguards created by the profession, legislation or regulation.Safeguards in the work environment.

The Conceptual Framework ApproachThreats and Safeguards Nine Categories of Specific Circumstances

Areas of ControversyLow-balling:Competition among public accounting firms for audit clients may lead to discounted audit fees.Intentional underbidding in order to obtain the audit and entering into lucrative management consulting services.

Areas of ControversyLow-balling:Audit time and extent of audit procedures may be decreased.Auditors integrity, objectivity and independence is compromised.

Areas of ControversyOpinion shopping:Clients seek views of other professional accountants, hoping the accountants will agree with the clients desired accounting policies.Clients may threaten to change auditors to influence accountants.

4.2 Liability of AuditorsLiability under the Companies Act /Statutory LawLiability under Common LawBreach of Contract and Negligence

Liability of AuditorsAuditors can be held liable under 2 classesof law:Common law Statutory law

Liability of AuditorsCommon law Case law developed over time.Legal opinions are issued.Legal principles become precedent for similar cases in future.

Liability of AuditorsStatutory lawWritten law enacted by the legislative arm of government.Establishes certain courses of conduct to be adhered to.

Liability of AuditorsAuditors liability to clients and 3rd partiesunder common law:Breach of Contract liability to clientsNegligence liability to clients and 3rd parties

Liability of AuditorsBreach of Contract liability to clientsFailure to carry out contractual arrangements with client, liable for breach of contract and/or negligence.If the client breaches obligations under the engagement letter, auditor is excused from his contractual obligations.

Liability of AuditorsNegligence liability to clients and 3rd partiessome act or omission which occurs because the person concerned has failed to exercise that degree of professional care and skill, appropriate to the circumstances of the case, which is expected of accountant and auditors.

Liability of AuditorsNegligence liability to clients and 3rd partiesIn an action for negligence against an auditor, the plaintiff must prove:The auditor owed a duty of care to the plaintiff.There is failure to act in accordance with that duty of care; a breach of duty of care.

Liability of AuditorsIn an action for negligence against an auditor, the plaintiff must prove:iii. There is causal relationship or connection between the auditors negligence and the plaintiffs damage.iv. The plaintiff suffered actual loss or damage.

Liability of AuditorsLiability under Common LawLiability to 3rd partiesCandler vs Crane, Christmas and Co.Hedley Byrne vs Heller and PartnersJEB Fasteners vs Marks Bloom and Co.Caparo Industries Plc. vs Dickman and OthersRoyal Bank of Scotland vs Bannerman Johnston Mc Clay and Others

Liability of AuditorsDuty of Care to 3rd PartiesCandler vs Crane, Christmas and Co.Reinforced the doctrine that 3rd parties, in the absence of a contractual relationship, were not entitled to recover financial damages resulting from an auditors negligence.

Liability of AuditorsDuty of Care to 3rd PartiesHedley Byrne vs Heller and PartnersThe courts held that the bank owed a duty of care to the plaintiff.

Liability of AuditorsDuty of Care to 3rd PartiesHedley Byrne vs Heller and PartnersThis case provides certain tests to be satisfied for extending the auditors duty of care to 3rd parties:The auditor must be aware that the f/s are to be used for a particular purpose.

Liability of AuditorsA known party was intended to rely on the f/s for that purpose.There must have been some conduct on the part of the auditor linking him to that party which indicates auditors understanding of that partys reliance.

Liability of AuditorsDuty of Care to 3rd PartiesJEB Fasteners vs Marks Bloom and Co.(1982)The courts decided that the auditors owed a duty of care to a 3rd party who was a prospective investor.

Liability of AuditorsIt was held that the auditors knew at the time the accounts were prepared that the co. needed outside financial support and ought reasonably to have foreseen that the takeover was a possible means of obtaining finance and that a person effecting a take-over might rely on those accounts.

Liability of AuditorsDuty of Care to 3rd PartiesCaparo Industries Plc. vs Dickman and Others3 necessary conditions/test must be met in order to establish whether a duty of care can be imposed:i. Whether the loss or damage was foreseeable.

Liability of Auditorsii. Whether there existed a relationship of proximity between the parties.iii. Whether it is fair, just and reasonable that the law should impose the duty of care on the one party for the benefit of the other.

Liability of AuditorsRoyal Bank of Scotland vs Bannerman Johnston Mc Clay and Others Impact on the auditors report in Malaysia.In this case, it was agreed that the auditors did not add to the audited/draft accounts any disclaimer of liability on their part to the plaintiffs.

Liability of AuditorsThe courts (in reference to the Caparo case), held that when the auditors did not disclaim their responsibility relating to the audited accounts, they could be held owing a duty of care to a 3rd party if they knew (or ought to have known) that the 3rd party would rely on the audited accounts for lending or investment decisions.

4.3 Quality Control for Audit of Historical Financial Information DefinitionLeadership responsibilities for quality on auditsEthical requirementAcceptance and continuance of client relationships and specific audit engagement Assignment of engagement terms Engagement performanceMonitoring

Quality Control for Audit of Historical Financial InformationDefinition a system that relates to the concepts of professional competence and the meeting of professional standards (technical and ethical) in providing professional services, so that audit failures and audit risks are reduced to an acceptably low level.

Quality Control for Audit of Historical Financial InformationQC must be addressed at the professional level, the firm level and also at the engagement level.

At professional level the role of accounting bodies is to establish technical and ethical standards.At the firm level an audit firm should have policies and procedures to monitor its own practice and quality of services provided.

Quality Control for Audit of Historical Financial InformationIFAC issued ISQC 1 and the revision of ISA 220 QC of professional work:

To establish standards and provide guidance on QC for assurance and related services and audit engagements separately.

Quality Control for Audit of Historical Financial InformationISQC 1 intended for all assurance and related services at the firm level.

ISA 220 provides QC standards that are applicable only for audit engagements (at engagement level)

Quality Control for Audit of Historical Financial InformationElements of QC - Firm Level

ISQC 1 requires an accounting firm to establish a system of QC designed to provide it with reasonable assurance that the following objectives are met:

1. Compliance with professional standards

Quality Control for Audit of Historical Financial Information 2. Compliance with applicable regulatory and legal requirements 3. Reports issued are appropriate in the circumstances

To achieve the 3 objectives, the following elements should be incorporated:1. Leadership responsibilities for quality within the firm

Quality Control for Audit of Historical Financial Information 2. Ethical requirements 3. Acceptance and continuance of client relationships and engagements 4. Human resources 5. Engagement performance 6. Monitoring

Quality Control for Audit of Historical Financial InformationElements of QC - Audit Engagements

ISQC 1 sets out elements of QC in areas where QC policies and procedures are required for the provision of audit services:1. Leadership responsibilities for Quality on Audits

Quality Control for Audit of Historical Financial Information 2. Ethical Requirements 3. Assignment of Engagement Team 4. Engagement Performance 5. Monitoring

4.4 Fraud and ErrorDefinition and characteristicsResponsibilities of management and Auditor in relation to fraud and errorReporting responsibilities

Fraud and ErrorFraud an intentional act by one or more individuals among management, employees or third parties, involving the use of deception to obtain an unjust or illegal advantage.Fraud in relation to financial audits can be classified as fraudulent financial reporting and misappropriation of assets.

Fraud and ErrorThe auditors responsibility is to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements, whether caused by error or fraud.

Fraud and ErrorManagement (directors of a company) is primarily responsible for the fairness of the companys financial statements.

Fraud and Error Due professional care; Professional ScepticismAuditor to conduct the audit with an attitude of professional scepticism; recognizing that circumstances may exist that cause the f/s to be materially misstated, whether due to fraud or error.

Fraud and Error Communication If the auditor encounters fraud or if non-compliance with laws and regulations during the course of audit, the auditor is required by the auditing standards to communicate to the appropriate level of management.

Fraud and ErrorMaterial misstatementsA difference between the amount, classification, or presentation of a reported financial statement item and the amount, classification, or presentation that would have been reported under approved accounting standards.

Fraud and ErrorThe omission of a financial statement element, account, or item.A financial statement disclosure that is not presented in accordance with approved accounting standards.The omission of information required to be disclosed in accordance with approved accounting standards.

Fraud and ErrorMaterial misstatements in f/s can result from error or fraud.Errors unintentional misstatements/omissions of amounts or disclosures. (pg.86)Fraud intentional misstatements. 2 types; i. Misstatements arising from fraudulent financial reporting. (pg.86) ii. Misstatements arising from misappropriation of assets. (pg.86)

Fraud and ErrorConditions Indicative of Material Misstatement Due to Fraud1.Management or other employees have an incentive or are under pressure that provides a reason to commit fraud.2.Circumstances exist that provide an opportunity for a fraud to be carried out.3.Those involved are able to rationalise committing a fraudulent act.

Fraud and ErrorThe Fraud Risk Identification Process Figure 3-4Fraud Risk Factors i. An incentive/pressure to perpetrate fraud. ii. An opportunity to carry out the fraud iii. An attitude/rationalisation to justify the fraudulent action.

Fraud and ErrorRisk Factors; Table 3-6 to Table 3-11

Response to Risk of Material Misstatements Due to Fraud1. Overall Response 2. Response at Assertion Level 3. Response to Management Override of Controls

Fraud and ErrorRisk of Fraud in Revenue Recognition

Reporting Responsibilities?

4.5 Corporate Governance and the External Auditor

Corporate Governance and the External AuditorObjective of Corporate Governance Importance of CGOutline good CG requirements relating to directors responsibilities Audit committee/structure and role of ACBenefits and drawbacks of audit committee

Corporate Governance and the External AuditorDefinition:Corporate Governance is the process and structure used to direct and manage the business and affairs of the company towards enhancing business prosperity and corporate accountability with the ultimate objective of realising long term shareholder value, whilst taking into account the interests of other stakeholders.

Corporate Governance and the External AuditorThe Principal Players in Corporate GovernanceInternal Players i. Board of Directors ii. Audit Committee iii. Internal Audit iv. Management

Corporate Governance and the External AuditorExternal Players i. Regulatory Authorities ii. Shareholders, Stakeholders iii. External Audit

Corporate Governance and the External AuditorGovernance StructureLevel 1 Oversight (board and committee)Level 2 Supervisory (senior mgmt.)Level 3 Operational (operational mgmt.) Level 4 Monitoring (audit, self-assessmt., consulting activities)

Corporate Governance and the External AuditorEffective Governance; Principles and Best Practices for BOD 1. Leadership 2. Stewardship 3. Control

Corporate Governance and the External AuditorSpecific Responsibilities of the BOD:To set corporate objectives, review, approve and guide corporate strategies and business plan, budgets and to monitor implementation.

Corporate Governance and the External AuditorTo oversee the mgmt. of co. business to ensure corporate performance.To oversee human resources mgmt., staff selection and compensation, performance monitoring of key personnel, succession planning and training programs are in place.

Corporate Governance and the External AuditorTo develop and implement investor relations programmes to effectively communicate with shareholders, other stakeholders and the public.To review the adequacy and integrity of the companys accounting and financial reporting systems, IC system, internal audit and systems for monitoring risk, financial control and compliance with laws and regulations.

Corporate Governance and the External AuditorTo select the CEO

To prescribe the internal guidelines setting out such matters and types of material transactions that require board approval.

Corporate Governance and the External AuditorAudit Committee - A committee of the full board, formally appointed by it to consider and report on matters relating to the financial reporting and governance processes, and audit of the organisation, and such other matters as are referred to it by the board.

Corporate Governance and the External AuditorAudit Committee StructureTo comprise no fewer than 3 members appointed by the board from amongst its members, majority of whom must be independent directors.Preferred practice all members appointed to the committee should be independent directors.

Corporate Governance and the External AuditorAt least 1 member of the AC must be a member of the MIA and if not, must have at least 3 years working experience and have passed the exams specified in Part-I of the 1st Schedule or be a member of one of the accountants associations specified in Part-II of the Accountants Act 1967.

Corporate Governance and the External AuditorRole of the Audit Committee to oversee the financial reporting and governance processes so as to:Assist directors in discharging their statutory duties and responsibilities.Monitor company activities.Increase public confidence in the credibility and objectivity of financial reporting.

Corporate Governance and the External AuditorSupport the audit function.Satisfy the BOD that adequate attention is being given to risk management.Satisfy the BOD that internal controls exist and are effective.Monitor disclosure requirements.

Corporate Governance and the External AuditorBenefits of the Audit Committee?

Corporate Governance and the External AuditorDrawbacks of the Audit CommitteeInterference in executive decisions on operational matters which will tend to undermine the authority of the BOD.ACs have no teeth.The full board is distanced from financial matters and the external auditor.