Chapter 13: The Code of Professional Ethics and the Accountancy

Act of 2004

A distinguishing mark of the accounting profession is the acceptance of its

responsibility to the public. As professionals, the accountants' responsibility
is not exclusively to protect the interest of their clients or employers.
Instead, the interest of the public must always be their paramount concern.

In today's modern environment, many segments of society are increasingly

dependent for decision-making on information for which they have no
control. They turn to professional accountants for assistance in assessing the
reliability of some of this information. Every failure by an accountant to
comply with professional standards makes it difficult for the profession to
maintain the reputation for integrity, objectivity, and competence that it has
acquired over its many years of service to the public.

In order to maintain public trust and confidence in the accountancy

profession, professional accountants must adhere to standards of ethical
conduct; standards of conduct that embody and demonstrate integrity,
objectivity, and concern for the public (rather than self-) interest.

The Philippine Institute of Certified Public Accountants (PICPA) being a

member of the International Federations of Accountants (IFAC) is obliged and
committed to support the work of IFAC. The Code of Ethics for Professional
Accountants in the Philippines is based on the IFAC Code of Ethics for
Professional Accountants.

The Code of Ethics for Professional Accountants in the Philippines is divided

into four parts. Part 1 establishes fundamental principles of professional
ethics and provides a conceptual framework that professional accountants
shall apply. Part 2, 3 and 4 describe how the conceptual framework applies in
certain situations and provide examples of appropriate safeguards that
address threats to compliance with fundamental principles. Part 2 applies to
professional accountants in business while Part 3 and 4 apply to professional
accountants in public practice. This book will not cover Part 2 but will focus
the discussion only on those provisions that are relevant to CPA's in Public
Practice.

PART 1: Complying with the Code, Fundamental Principles and Conceptual

Framework

PART 2: Professional Accountants in Business

PART 3&4: Professional Accountants in Public Practice

◆ COMPLYING WITH THE CODE

A professional accountant's responsibility is not exclusively to satisfy the

needs of an individual client or employing organization. Although it is true
that accountants have responsibilities to their clients or employers, the
interest of the public should always be their paramount concern. Compliance
with the Code of Ethics enables the professional accountants to meet their
responsibility to act in the public interest. In circumstances where laws or
regulations preclude professional accountants from complying with certain
parts of the Code, those laws and regulations prevail. The professional
accountant, however, is required to comply with all other parts of the of the
Code.

FUNDAMENTAL PRINCIPLES

In acting in the public interest, professional accountants have to observe a

number of prerequisites or fundamental principles.

Integrity

A professional accountant should be straightforward and honest in

professional and business relationships. Integrity implies not merely honesty
but it requires being brave enough to fight for what you believe in. Not telling
lies is honesty, but a man of integrity will always be willing to speak out and
ask difficult questions when the circumstances warrant. Therefore, if the CPA
believes that the financial statements are materially misleading, the CPA is
not acting with integrity if he remains silent or disclaims an opinion on the
financial statements. The principle of integrity requires the CPA to stand up
for what he believes is true.

A professional accountant should not be associated with information where

he believes that the information contains incorrect, incomplete or misleading
statements.

Objectivity

The principle of objectivity imposes the obligation on all professional

accountants to be fair, intellectually honest and free of conflicts of interest. A
professional accountant should be fair and should not allow prejudice or bias,
conflict of interest or influence of others to override objectivity.

CPAs in public practice may render audit, tax, and management advisory
services. Others may prepare financial statements, perform internal auditing
services, and serve in financial and management capacities in industry,
education, and government. Regardless of service or capacity, CPAs should
maintain objectivity, and avoid any subordination of their judgment when
rendering professional services.

Professional Competence and Due Care

A professional accountant should not undertake any engagement or accept

an employment which he cannot reasonably expect to discharge with
professional competence. A professional accountant should continually strive
to improve his knowledge and skills to ensure that a client or employer
receives the advantage of competent professional service based on up-to-
date developments in practice, legislation and techniques.

Professional competence is divided into two separate phases:

1. Attainment of professional competence through formal education,

professional examination and a period of experience.
2. Maintenance of professional competence by being aware of all the
developments affecting the profession and adopting a program to
ensure quality in the performance of professional services.

Moreover, the professional accountant should apply knowledge, skills and

experience with due professional care. Due care encompasses the
responsibility to perform professional services in accordance with technical
and professional standards, carefully, thoroughly and on a timely basis. A
professional accountant should take steps to ensure that those working
under the professional accountant's authority in a professional capacity have
appropriate training and supervision

Confidentiality

A professional accountant should respect the confidentiality of information

acquired during the course of performing professional services and should
not use or disclose any such information without proper and specific
authority or unless there is a legal or professional right or duty to disclose.

Confidentiality is not only a matter of disclosure of information. Accountants

who acquire information in the course of performing services shall neither
use nor appear to use that information for personal advantage or for the
advantage of a third party.

However, confidential information may be disclosed under the following

circumstances:

1. Disclosure is permitted by the client or employer;

2. Disclosure is required by law such as compliance with a subpoena issued

by a court in the course of legal proceedings; and

3. There is a professional duty or right to disclose confidential information.

For example, the professional accountant may disclose confidential
information to defend himself if sued by his client or employer. In addition, a
professional accountant may also disclose confidential information to comply
with the quality assurance review or any investigation conducted by the
Board of Accountancy (BOA).

A professional accountant shall continue to comply with the principle of

confidentiality even after the end of the relationship between the accountant
and a client or employing organization. When changing employment or
acquiring a new client, the accountant is entitled to use prior experience but
shall not use or disclose any confidential information acquired or received as
a result of a professional or business relationship

Professional Behavior

A professional accountant should comply with relevant laws and regulations

and refrain from any conduct which might bring discredit to the profession.

Some laws or regulations might have provisions that differ from or go beyond
those set out in the Code of Ethics. The professional accountant needs to be
aware of those differences and comply with the more stringent provisions
unless prohibited by law or regulation

A professional accountant should not bring the profession into disrepute

when undertaking marketing or promotional activities. A professional
accountant should not:

➤ Exaggerated claims for the services offered by, or the qualifications or

experience of, the accountant; or

➤ Disparaging references or unsubstantiated comparisons to the work of

others.

CONCEPTUAL FRAMEWORK

It is impossible to define every situation that creates threats to compliance

with fundamental principles. Consequently, the code establishes a
conceptual framework approach that requires a professional accountant to

1. Identify threats to compliance with fundamental principles

2. Evaluate the significance of threats identified; and

3. Apply safeguards, when necessary, to eliminate the threats or reduce

them to an acceptable level.
This approach is aimed at assisting the professional accountants in
complying with ethical requirements and meeting their responsibility to act
in the public interest.

THREATS TO COMPLIANCE WITH FUNDAMENTAL PRINCIPLES

The circumstances in which the professional accountants operate may create

threats to compliance with fundamental principles. These threats may fall
into self-interest, self-review, advocacy, familiarity or intimidation threat.

Self-Interest Threat is the threat that a financial or other interest will

inappropriately influence the professional accountant's judgment or behavior.
Examples of circumstances that may create self-interest threats include:

➤ A direct financial interest or material indirect financial interest in a client;

➤ A loan or guarantee to or from a client or any of its directors or officers;

➤ Undue dependence on total fees from a particular client;

➤ Concern about the possibility of losing the engagement;

➤ Having a close business relationship with a client;

➤ Potential employment with a client; and

➤ Contingent fees relating to an engagement.

Self-Review Threats is the threat that a professional accountant will not

objectively evaluate the results of the previous judgment made or service
performed in forming a conclusion about the subject matter of the
engagement.

Examples of circumstances that may create self-review threats include:

➤ A member of the engagement team being, or having recently been, a

director or officer of the client;

➤ A member of the engagement team being, or having recently been, an

employee of the client in a position to exert direct and significant influence
over the subject matter of the engagement;
➤ Performing services for a client that directly affect the subject matter of
the engagement;

➤ Preparation of original data used to generate financial statements or

preparation of other records that are the subject matter of another
engagement;

➤ Reporting on the operation of financial systems after being involved in

their design or implementation; and

➤ The discovery of a significant error during re-evaluation of the work of the

professional accountant in public practice.

Advocacy Threat is the threat that a professional accountant will promote a

client's or employer's position to the point that the professional accountant's
objectivity is compromised.

Examples of circumstances that may create advocacy threats include:

➤ Dealing in, or being a promoter of, share or other securities in a client; and

➤ Acting as an advocate on behalf of client in litigation or in resolving

disputes with third parties.

Familiarity Threat is the threat that a professional accountant will promote a

client's or employer's position to the point that the professional accountant's
objectivity is compromised.

Examples of circumstances that may create familiarity threats include:

➤ A member of the engagement team having an immediate family member

or close family member who is a director or officer of the client;

➤ A member of the engagement team having an immediate family member

or close family member who, as an employee of the assurance client, is in a
position to exert direct and significant influence over the subject matter of
the engagement;

➤ A former partner of the firm being a director, officer of the client or an

employee in a position to exert direct and significant influence over the
subject matter of the engagement;
➤ Long association of a senior member of the engagement team with the
client; and

➤ Acceptance of gifts or preferential treatment, unless the value is clearly

insignificant, from a client, its directors, officers or employees.

Intimidation Threat is the threat that the professional accountant will be

deterred from acting objectively because of actual or perceived pressures,
including attempts to exercise undue influence over the professional
accountant.

Examples of circumstances that may create intimidation threats include:

➤ Being threatened with litigation;

➤ Being threatened with dismissal or replacement over a disagreement with

the application of an accounting principle; and

➤ Being pressured to reduce inappropriately the extent of work performed in

order to reduce fees.

◆SAFEGUARDS

A professional accountant shall evaluate any threats to compliance with the

fundamental principles. Both quantitative and qualitative factors must be
considered in evaluating the significance of a threat. Once a significant
threat has been identified and evaluated, appropriate safeguards should be
considered and applied as necessary.

Safeguards are actions or other measures that may eliminate threats or

reduce them to an acceptable level. The nature of the safeguards to be
applied will vary depending upon the circumstances. Consideration should
always be given to what a reasonable and informed third party having
knowledge of all relevant information including safeguards applied, would
reasonably conclude to be unacceptable. The consideration will be affected
by matters such as the significance of the threat, the nature of the
engagement and the structure of the firm.
Safeguards fall into two broad categories:

1. Safeguards created by the profession, legislation or regulation; and

2. Safeguards in the work environment.

The firm and the members of the assurance team should select appropriate
safeguards to eliminate or reduce threats, other than those that are clearly
insignificant, to an acceptable level.

Safeguards created by the profession, legislation or regulation, include the

following:

➤ Educational, training and experience requirements for entry into the

profession;

➤ Continuing education requirements;

➤ Corporate governance regulations;

➤ Professional standards and monitoring and disciplinary processes; and

➤ External review of a firm's quality control system.

Safeguards in the work environment consist of firm-wide safeguards and

engagement specific safeguards.

Firm-wide safeguards in the work environment may include:

➤ Leadership of the firm that stresses the importance of compliance with the
fundamental principles;

➤ Leadership of the firm that establishes the expectation that members of an

assurance team will act in the public interest;

➤ Policies and procedures to implement and monitor quality control of

engagements;

➤ Documented policies regarding the identification of threats to compliance

with the fundamental principles, the evaluation of the significance of these
threats and the identification and the application of safeguards to eliminate
or reduce the threats, other than those that are clearly insignificant, to an
acceptable level;
➤ For firms that perform assurance engagements, documented
independence policies regarding the identification of threats to
independence, the evaluation of the significance of these threats and the
evaluation and application of safeguards to eliminate or reduce the threats,
other than those that are clearly insignificant, to an acceptable level;

➤ Documented internal policies and procedures requiring compliance with

the fundamental principles;

➤ Policies and procedures that will enable the identification of interests or

relationships between the firm or members of engagement teams and
clients;

➤ Policies and procedures to monitor and, if necessary, manage the reliance

on revenue received from a single client;

➤ Usage of different partners and engagement teams with separate

reporting lines for the provision of non-assurance services to an assurance
client;

➤ Policies and procedures to prohibit individuals who are not members of an

engagement team from inappropriately influencing the outcome of the
engagement;

➤ Timely communication of a firm's policies and procedures, including any

changes to them, to all partners and professional staff, and appropriate
training and education on such policies and procedures;

➤ Designating a member of senior management to be responsible for

overseeing the adequate functioning of the firm's quality control system;

➤ Advising partners and professional staff of those assurance clients and

related entities from which they must be independent;

➤ A disciplinary mechanism to promote compliance with policies and

procedures; and

➤ Published policies and procedures to encourage and empower staff to

communicate to senior levels within the firm any issue relating to compliance
with the fundamental principles that concerns them.

Engagement specific safeguards may include:

➤ Involving an additional professional accountant to review the work done or
otherwise advise as necessary;

➤ Consulting an independent third party, such as a committee of

independent directors, a professional regulatory body or another professional
accountant;

➤ Discussing ethical issues with those charged with governance of the client;

► Disclosing to those charged with governance of the client the nature of

services provided and extent of fees charged;

➤ Involving another firm to perform or re-perform part of the engagement;

and

➤ Rotating senior assurance team personnel.

In addition to the above safeguards, professional accountants in public

practice may also be able to rely on safeguards that the client has
implemented. Safeguards within the client's systems and procedures may
include:

➤ When a client appoints a firm in public practice to perform an

engagement, persons other than management ratify or approve the
appointment;

➤ The client has competent employees with experience and seniority to

make managerial decisions;

➤ The client has implemented internal procedures that ensure objective

choices in commissioning non-assurance engagements; and

➤ The client has a corporate governance structure that provides appropriate

oversight and communications regarding the firm's services.

Although these safeguards could also reduce the threat to compliance with
fundamental principles, it is not possible for professional accountant to rely
solely on these safeguards to reduce threats to an acceptable level

In certain situations, no safeguards are available to eliminate or reduce the

threat to an acceptable level. Hence, the only possible actions would be to
eliminate the activities or interest creating the threat, or to refuse to accept
or continue the engagement.

◆ PROFESSIONAL ACCOUNTANTS IN PUBLIC PRACTICE

Part 3 of the Code of Ethics for Professional Accountants sets out

requirements and application material for professional accountants in public
practice when applying the conceptual framework. It does not describe all of
the facts and circumstances, including professional activities, interests and
relationships, that could be encountered by professional accountants in
public practice, which create or might create threats to compliance with the
fundamental principles. Therefore, the professional accountants in public
practice should be alert for such facts and circumstances in applying the
conceptual framework.

CONFLICTS OF INTEREST

A professional accountant in public practice should take reasonable steps

to identify circumstances that could pose a conflict of interest. For example,

a threat to objectivity may be created when a professional accountant in
public practice competes directly with a client or has a joint venture or
similar arrangement with a major competitor of a client. A threat to
objectivity or confidentiality may also be created when a professional
accountant in public practice performs services for clients whose interests
are in conflict or the clients are in dispute with each other in relation to the
matter or transaction in question.

Depending upon the circumstances giving rise to the conflict, safeguards

should ordinarily include the professional accountant in public practice:

➤ Notifying the client of the firm's business interest or activities that may
represent a conflict of interest, and obtaining their consent to act in such
circumstances; or

➤ Notifying all known relevant parties that the professional accountant in

public practice is acting for two or more parties in respect of a matter where
their respective interests are in conflict, and obtaining their consent to so
act; or

➤ Notifying the client that the professional accountant in public practice does
not act exclusively for any one client in the provision of proposed services
(for example, in a particular market sector or with respect to a specific
service) and obtaining their consent to so act.

Additional safeguards that should also be considered include:

➤ The use of separate engagement teams;

➤ Procedures to prevent access to information (e.g., strict physical

separation of such teams, confidential and secure data filing);

➤ Clear guidelines for members of the engagement team on issues of

security and confidentiality,

➤ The use of confidentiality agreements signed by employees and partners

of the firm; and

➤ Regular review of the application of safeguards by a senior individual not

involved with relevant client engagements.

Professional Appointment

Client Acceptance

Before accepting a new client relationship, a professional accountant in

public practice should consider whether acceptance would create any threats
to compliance with the fundamental principles. Potential threats to integrity
and professional behavior may be created if the client is involved in illegal
activities or if the client's owners or management lack integrity.

Appropriate safeguards may include obtaining knowledge and understanding

of the client, its owners, managers and those responsible for its governance
and business activities or securing the client's commitment to improve
corporate governance practices or internal controls.
Engagement Acceptance

A professional accountant in public practice should agree to provide only

those services that he is competent to perform. A self-interest threat to
competence and due care principle is created if the engagement team does
not possess, or cannot acquire, the competence necessary to properly carry
out the engagement.

Appropriate safeguards may include:

➤ Acquiring an appropriate understanding of the nature of the client's

business, the complexity of its operations, the specific requirements of the
engagement and the purpose, nature and scope of the work to be
performed;

➤ Acquiring knowledge of relevant industries or subject matters;

➤ Possessing or obtaining experience with relevant regulatory or reporting

requirements;

➤ Assigning sufficient staff with the necessary competencies;

➤ Using experts where necessary;

➤ Agreeing on a realistic time frame for the performance of the engagement;

and.

➤ Complying with quality control policies and procedures designed to provide

reasonable assurance that specific engagements are accepted only when
they can be performed competently.

Changes in a Professional Appointment

A professional accountant in public practice who is asked to replace another

professional accountant in public practice, or who is considering tendering
for an engagement currently held by another professional accountant in
public practice, should determine whether there are any reasons,
professional or other, for not accepting the engagement, such as
circumstances that threaten compliance with the fundamental principles. For
example, there may be a threat to professional competence and due care if a
professional accountant in public practice accepts the engagement before
knowing all the pertinent facts.
Appropriate safeguards may include:

➤ Discussing the client's affairs fully and freely with the existing accountant;

➤. Asking the existing accountant to provide known information on any facts

or circumstances, that, in the existing accountant's opinion, the proposed
accountant should be aware of before deciding whether to accept the
engagement; and

➤ When replying to requests to submit tenders, stating in the tender that,

before accepting the engagement, contact with the existing accountant will
be requested so that inquiries may be made as to whether there are any
professional or other reasons why the appointment should not be accepted.

A professional accountant in public practice will ordinarily need to obtain the

client's permission, preferably in writing, to initiate discussion with an
existing accountant. If the proposed accountant is unable to communicate
with the existing accountant, the proposed accountant should try to obtain
information about any possible threats by other means such as through
inquiries of third parties or background investigations on senior management
or those charged with governance of the client.

Second Opinions

A professional accountant in public practice who is asked to provide a second

opinion on the application of accounting, auditing, reporting or other
standards or principles to specific circumstances or transactions by or on
behalf of a company or an entity that is not an existing client may give rise
to threats to compliance with the fundamental principles. For example, there
may be a threat to professional competence and due care in circumstances
where the second opinion is not based on the same set of facts that were
made available to the existing accountant, or is based on inadequate
evidence. The significance of the threat will depend on the circumstances of
the request and all the other available facts and assumptions relevant to the
expression of a professional judgment.
Appropriate safeguards may include seeking client permission to contact the
existing accountant, describing the limitations surrounding any opinion in
communications with the client and providing the existing accountant with a
copy of the opinion. If the company or entity seeking the opinion will not
permit communication with the existing accountant, a professional
accountant in public practice should consider whether, taking all the
circumstances into account, it is appropriate to provide the opinion sought.

Fees and Other Types of Remuneration

Professional Fees

Professional fees should be a fair reflection of the value of the professional

services performed for the client, taking into account:

➤ The skill and knowledge required for the type of professional services
involved;

The level of training and experience of the persons necessarily engaged in

performing the professional services;

➤ The time necessarily occupied by each person engaged in performing the

professional services; and

➤ The degree of responsibility that performing those services entails.

The fact that one professional accountant in public practice may quote a fee
lower than another is not in itself unethical. Nevertheless, there may be a
self-interest threat to professional competence and due care created if 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.

Appropriate safeguards which may be adopted include:

➤ Making the client aware of the terms of the engagement and, in particular,
the basis on which fees are charged and which services are covered by the
quoted fee;
➤ Assigning appropriate time and qualified staff to the task;

➤ Adjusting the level of fees or the scope of the engagement; and

➤ Having an appropriate reviewer review the work performed.

Contingent Fees

Contingent fees may give rise to a self-interest threat to objectivity.

The significance of such threats will depend on factors including:

➤ The nature of the engagement;

➤ The range of possible fee amounts;

➤ The basis for determining the fee; and

➤ Whether the outcome or result of the transaction is to be reviewed by an

independent third party.

Appropriate safeguards may include:

➤ An advance written agreement with the client as to the basis of

remuneration;

➤ Disclosure to intended users of the work performed by the professional

accountant in public practice and the basis of remuneration;

➤ Quality control policies and procedures; and

➤ Review by an objective third party of the work performed by the

professional accountant in public practice.

Referral Fee or Commission

In certain circumstances, a professional accountant in public practice may

receive a referral fee or commission relating to a client. For example, where
the professional accountant in public practice does not provide the specific
service required, a fee may be received for referring a continuing client to
another professional accountant in public practice or other expert. A
professional accountant in public practice may receive a commission from a
third party (e.g., a software vendor) in connection with the sale of goods or
services to a client. Accepting such a referral fee or commission may give
rise to self- interest threats to objectivity and professional competence and
due care.

A professional accountant in public practice may, in certain circumstances,

also pay a referral fee to obtain a client. For example, where the client
continues as a client of a professional accountant in public practice but
requires specialized services not offered by the existing accountant. The
payment of such a referral fee may also create a self-interest threat to
objectivity and professional competence and due care.

A professional accountant in public practice should not pay or receive a

referral fee or commission, unless the professional accountant in public
practice has established safeguards to eliminate the threats or reduce them
to an acceptable level. Such safeguards may include:

➤ Disclosing to the client any arrangements to pay a referral fee to another

professional accountant for the work referred;

➤ Disclosing to the client any arrangements to receive a referral fee for

referring the client to another professional accountant in public practice; and

➤ Obtaining advance agreement from the client for commission

arrangements in connection with the sale by a third party of goods or
services to the client.

A professional accountant in public practice may purchase all or part of

another firm on the basis that payments will be made to individuals formerly
owning the firm or to their heirs or estates. Such payments are not regarded
as commissions or referral fees for the purpose of this rule.

Marketing Professional Services

When a professional accountant in public practice solicits new work through

advertising or other forms of marketing, a self-interest threat to professional
behavior is created if services, achievements or products are marketed in a
way that is inconsistent with that principle.
Generally, any form of advertisement is allowed as long as the information
stated in the advertisement can be substantiated and it does not bring the
profession into disrepute. The Code prohibits the accountant from:

➤ Making exaggerated claims for services offers, qualifications possessed or

experience gained; or

➤ Making disparaging references to unsubstantiated comparisons to the

work of another.

Gifts and Hospitality

A professional accountant in public practice, or an immediate or close family

member, may be offered gifts and undue hospitality from a client. Such an
offer ordinarily gives rise to threats to compliance with the fundamental
principles. For example, self-interest threats to objectivity may be created if a
gift from a client is accepted; intimidation threats to objectivity may result
from the possibility of such offers being made public.

Appropriate safeguards should be considered and applied as necessary to

eliminate them or reduce them to an acceptable level. These may include:

➤ Being transparent with senior management of the firm or of the client

about offering or accepting an inducement.

➤ Registering the inducement in a log monitored by senior management of

the firm or another individual responsible for the firm's ethics compliance or
maintained by the client.

➤ Having an appropriate reviewer, who is not otherwise involved in providing

the professional service, review any work performed or decisions made by
the professional accountant with respect to the client from which the
accountant accepted the inducement.

➤ Donating the inducement to charity after receipt and appropriately

disclosing the donation, for example, to a member of senior management of
the firm or the individual who offered the inducement.

➤ Reimbursing the cost of the inducement, such as hospitality, received.

➤ As soon as possible, returning the inducement, such as a gift, after it was

initially accepted.
When the threats cannot be eliminated or reduced to an acceptable level
through the application of safeguards, a professional accountant in public
practice should not accept such an offer.

Custody of Client's Assets

A professional accountant in public practice should not assume custody of

client monies or other assets unless permitted to do so by law and, if so, in
compliance with any additional legal duties imposed on a professional
accountant in public practice holding such assets.

The holding of client assets creates self-interest threat to professional

behavior and may be a self interest threat to objectivity. To safeguard against
such threats, a professional accountant in public practice entrusted with
money (or other assets) belonging to others should:

➤ Keep such assets separately from personal or firm assets;

➤ Use such assets only for the purpose for which they are intended;

➤ At all times, be ready to account for those assets, and any income,
dividends or gains generated, to any persons entitled to such accounting;
and

➤ Make appropriate inquiries of the source of such assets comply with all
relevant laws and regulations relevant to the holding of and accounting for
such assets.

Responding to Non-Compliance with Laws and Regulations

A self-interest or intimidation threat to compliance with the principles of

integrity and professional behavior is created when a professional
accountant becomes aware of non-compliance or suspected non- compliance
with laws and regulations.

If the professional accountant identifies or suspects that non-compliance has

occurred or might occur, the accountant should discuss the matter with the
appropriate level of management and, where appropriate, those charged
with governance. The purpose of the discussion is to clarify the professional
accountant's understanding of the facts and circumstances relevant to the
matter and its potential consequences.

The accountant should ensure that the management has taken the
appropriate and timely actions in order to:

➤ Rectify, remediate or mitigate the consequences of the non- compliance;

➤ Deter the commission of the non-compliance where it has not yet

occurred; or

➤ Disclose the matter to an appropriate authority where required by law or

regulation or where considered necessary in the public interest.

The professional accountant should assess the appropriateness of the

response of management and, where applicable, those charged with
governance. Based on the actions taken by the client, the professional
accountant should determine if further actions are needed in the public
interest. The professional accountant may consider:

➤ Disclosing the matter to an appropriate authority even when there is no

legal or regulatory requirement to do so; or

➤ Withdrawing from the engagement and the professional relationship where

permitted by law or regulation.

The determination of whether to make such a disclosure to an appropriate

authority depends in particular on the nature and extent of the actual or
potential harm that is or might be caused by the matter to investors,
creditors, employees or the general public. For example, the professional
accountant might determine that disclosure of the matter to an appropriate
authority is an appropriate course of action if:

➤ The entity is engaged in bribery (for example, of local or foreign

government officials for purposes of securing large contracts).

➤ The entity is regulated and the matter is of such significance as to

threaten its license to operate.
➤ The entity is listed on a securities exchange and the matter might result in
adverse consequences to the fair and orderly market in the entity's securities
or pose a systemic risk to the financial markets.

➤ It is likely that the entity would sell products that are harmful to public
health or safety.

➤ The entity is promoting a scheme to its clients to assist them in evading

taxes.

◆INDEPENDENCE

Independence in auditing means taking an unbiased viewpoint in the

performance of the examination and in the preparation of the report.
Independence is an essential element of the CPA profession. If the assurance
engagement is to enhance the credibility of an information, it is important
that users of this information perceive the professional accountant as being
objective and impartial. The professional accountant's report on the financial
statements will be of little or no value to che financial statement readers if
they are aware that the professional CPAs is not independent with respect to
the client.

There are two phases of independence; the independence of mind and the
independence in appearance. Independence of mind is the auditor's
perception of his own independence. A state of mind that permits the
expression of a conclusion without being affected by influences that
compromise professional judgment, allowing an individual to act with
integrity and exercise objectivity and professional skepticism.

Independence in appearance, on the other hand, refers to the public's

perception of the professional accountant's independence. It is the avoidance
of facts and circumstances that are so significant that a reasonable and
informed third person would reasonably conclude that the firm's integrity,
objectivity and professional skepticism had been compromised.

The Code of Ethics does not only require the professional accountants to
maintain independence in mental attitude, but it also requires professional
accountants to avoid circumstances which would cause the public to doubt
their independence.

Engagement Period

The members of the assurance team and the firm should be independent of
the assurance client during the period of the assurance engagement. The
period of the engagement starts when the assurance team begins to perform
assurance services and ends when the assurance report is issued, except
when the assurance engagement is of a recurring nature. If the assurance
engagement is expected to recur, the period of the assurance engagement
ends with the notification by either party that the professional relationship
has terminated or the issuance of the final assurance report, whichever
comes later.

In the case of a financial statement audit engagement, the engagement

period includes the period covered by the financial statements reported on
by the firm.

Independence Requirement

Not all services provided 'by professional accountants will require

independence. Independence is required only whenever the professional
accountant provides assurance services. For the purpose of applying the
principle of independence, assurance services can be classified into three
namely: audit and review services, non-audit assurance services and non-
audit assurance services with restrictions as to the distribution of the report.

➤ For financial statement audit or review engagements, the members of the

assurance team, the firm and network firms are required to be independent
of the audit client.

➤ For non-audit assurance engagements, where the distribution of the report

is not restricted, the members of the asstırance team and the firm must be
independent of the assurance client.

➤ For non-audit assurance engagements, where the distribution of the report

is restricted to specified users, the members of the assurance team must be
independent of the assurance client. In addition, the firm should not have
any material financial interest in an assurance client.

The independence requirements for audit and review engagements are the
same. Hence, any reference made to audit of financial statements in the
succeeding section about independence is also applicable to review of
financial statements conducted by a professional accountant.

Independence Interpretations and Rulings

It is impossible to describe all situations that could impair the CPA's

independence. The following independence interpretations and rulings,
however, may serve as guidelines to professional accountants:

Financial interest

In evaluating the significance of threat created by a financial interest, it is

important to determine materiality of the financial interest and the type of
financial interest.

When evaluating the type of financial interest, consideration should be given

to the fact that financial interests range from those where the CPA has no
control over the investment vehicle of financial interest held to those where
the CPA has control over financial interest or is able to influence investment
decisions. When control exists, the financial interest should be considered
direct. Conversely, when the professional accountant has no control over the
financial interest, the financial interest is considered indirect.

Any direct financial interest in an assurance client, whether material or

immaterial, impairs the CPA's independence. But in the case of an indirect
financial interest, the interest must be material in order to impair the CPA's
independence.

Loans and guarantees

A loan from, or a guarantee thereof by, an assurance client that is a financial

institution will not impair the CPA's independence provided the loan is:

➤ immaterial to both the firm and assurance client; or

➤ made under normal lending procedures, terms and requirements of the
financial institution.

A loan to or from an assurance client that is not a financial institution or a

guarantee of assurance client's borrowing will normally impair the CPA's
independence unless the amount of the loan or guarantee is immaterial to
the firm and assurance client.

Close Business Relationships

A close business relationship between a firm or a member of the assurance

team and the assurance client or its management, will involve a commercial
or common financial interest and may create self-interest and intimidation
threats. Examples of close business relationships are:

➤ Having a material financial interest in a joint venture with the assurance

client

➤ Arrangements to combine one or more services or products of the firm

with one or more services or products of the assurance client

➤ Distribution or marketing arrangements under which the firm acts as a

distributor or marketer of the assurance client's products or services, or the
assurance client acts as the distributor or marketer of the products or
services of the firm.

Close business relationship is considered an indirect financial interest and

therefore would impair the professional accountant's independence uriless
such financial interest is immaterial and the relationship is clearly
insignificant.

Family and personal relationships

It is impracticable to describe in detail the significance of threats that family

and personal relationships may create. In evaluating the significance of
threats created by family and personal relationships, the CPA should consider
the closeness of the relationship and the role of the family member within
the assurance client.
A self-interest, familiarity or intimidation threat is created when an
immediate family member of an assurance team member is an employee in
a position to exert significant influence over the subject matter of the
assurance engagement. Safeguards to eliminate these threats or reduce
them to an acceptable level include:

➤ Removing the individual from the assurance team; or

➤ Structuring the responsibilities of the assurance team so that the team

member does not deal with matters that are within the responsibility of the
immediate family member.

Recent service with an assurance client

Independence is impaired if, during the period covered by the assurance

report, a member of the assurance team had served as a director, an officer
or an employee of the assurance client in a position to influence the subject
matter, of the assurance engagement. Hence, a professional accountant
cannot issue an assurance report covering any period during which the he
was employed in a management capacity. To do so would violate the basic
concept that one cannot act independently in evaluating his or her own work.

Serving as an officer or director on the Board of Assurance Clients

Independence of the CPA is impaired if a partner or employee of a firm

serves as an officer or a director on the board of an assurance client.
However, serving as an honorary member on the board of a non-stock non-
profit organization that is an assurance client, will not impair the CPA's
independence provided that the membership is purely honorary and the
partner or employee of the firm does not participate in the management or
operations of the assurance client.

Entering Employment with a Client

A self-interest threat is created when an assurance team member

participates in the assurance engagement while knowing that he or she will,
or might, join the client at some time in the future. A firm should have
policies and procedures that require assurance team members to notify the
firm wher entering employment negotiations with an assurance client.
Examples of actions that might eliminate this threat or reduce it to an
acceptable level are:

➤ removing the individual from the assurance team; or

➤ having an appropriate reviewer review any significant judgments made by

that individual while on the team.

If an individual who was a key audit partner with respect to an audit client
that is a public interest entity joins the client as a director or officer or an
employee in a position to exert significant influence over the preparation of
the client's accounting records or the financial statements on which the firm
will express an opinion, independence is compromised unless, subsequent to
the individual ceasing to be a key audit partner:

➤ The audit client has issued audited financial statements covering a period
of not less than twelve months; and

➤ The individual was not an audit team member with respect to the audit of
those financial statements.

Similarly, if an individual who was the Senior or Managing Partner of the firm
joins an audit client that is a public interest entity as a director or officer,
independence is compromised, unless twelve months have passed since the
individual was the Senior or Managing Partner of the firm.

Long association with assurance clients

Using the same personnel and/ or lead engagement partner on an assurance

engagement for a long period of time may create familiarity threat.
Nevertheless, this threat can be reduced to an acceptable level by employing
adequate safeguards such as rotating the personnel and independent quality
reviews.

If a firm concludes that the level of the threat can only be addressed by
rotating the personnel, the firm should determine an appropriate period
during which the individual will not:

➤Be a member of the engagement team for the audit engagement;

➤ Provide quality control for the audit engagement; or

➤ Exert direct influence on the outcome of the audit engagement.

For audits of a public interest entities, an individual cannot act in any of the
following roles for a period of more than seven cumulative years (the "time-
on" period)

➤ The engagement partner;

➤ The quality control reviewer; or

➤ Any other key audit partner role.

In addition to the "time-on" period requirement, the Code of Ethics also

requires a professional accountant to serve a cooling-off period of at least
five years, three years or two years depending on the individual's role on an
audit engagement.

The Code of Ethics sets out stringent restrictions during the cooling- off
period, which prevents the partner from:

➤ Being involved in the audit engagement including quality control review;

➤ Consulting with the engagement team on matters affecting the audit

engagement;

➤ Leading or coordinating the professional services provided by the firm to

the audit client, or overseeing the relationship of the firm with the audit
client; or

➤ Providing non-assurance services to the audit client that would result in

frequent interaction with senior management

Provision of Accounting and Bookkeeping Services to an Audit Client

Providing an audit client with accounting and bookkeeping services, such as

preparing accounting records and financial statements, creates self-review
threat if the firm subsequently audits the financial statements. Accordingly, a
professional accountant should not provide accounting and bookkeeping
services to an audit client.
On the other hand. accounting and bookkeeping services that are routine or
mechanical in nature can be provided to an audit client so long as:

➤ the audit client is not a public interest entity; and

➤ any self-review threat created is reduced to an acceptable level.

Examples of these services that require little to no professional judgment

include:

➤ Preparing payroll calculations or reports based on client- originated data

for approval and payment by the client.

➤ Recording recurring transactions for which amounts are easily

determinable from source documents or originating data, such as a utility bill
where the client has determined or approved the appropriate account
classification.

➤ Calculating depreciation on fixed assets when the client determines the

accounting policy and estimates of useful life and residual values.

➤ Posting transactions coded by the client to the general ledger.

➤ Posting client-approved entries to the trial balance .

➤ Preparing financial statements based on information in the client-approved

trial balance and preparing related notes based on client-approved records.

Provision of Technical Assistance to an Audit Client

In some instances, an audit client might request technical assistance on

matters relating to financial and regulatory reporting. For example the client
may request assistance in transitioning from one financial reporting
framework to another. Such services do not usually create threats provided
the professional accountant does not assume a management responsibility
for the client.

In addition, the auditor and the client management may have discussions
about:

➤ The application of accounting standards or policies and financial statement

disclosure requirements.
➤ The appropriateness of financial and accounting control and the methods
used in determining the stated amounts of assets and liabilities.

➤ Proposing adjusting journal entries.

These activities are considered to be a normal part of the audit process and
do not usually create threats as long as the client is responsible for making
decisions in the preparation of accounting records and financial statements.

Provision of Valuation Services to an Audit Client

A valuation comprises the making of assumptions with regard to future

developments, the application of appropriate methodologies and techniques,
and the combination of both to compute a certain value, or range of values,
for an asset, a liability or for a business as a whole.

A CPA firm shall not provide a valuation service to an audit client if the
valuation service would have a material effect, individually or in the
aggregate, on the financial statements on which the firm will express an
opinion.

Provision of Administrative Services to an Assurance Client

Administrative services involve assisting clients with their routine or

mechanical tasks within the normal course of operations. Such services
require little to no professional judgment and are clerical in nature. Examples
of administrative services include:

➤ Word processing services.

➤ Preparing administrative or statutory forms for client approval.

➤ Submitting such forms as instructed by the client.

➤ Monitoring statutory filing dates, and advising an audit client of those

dates.
Providing administrative services to an assurance client does not normally
create a threat to compliance with the fundamental principles.

Preparation of Tax Return to an Audit Client

Tax return preparation services involve:

➤ Assisting clients with their tax reporting obligations by drafting and

compiling information, including the amount of tax due (usually on
standardized forms) required to be submitted to the tax authorities.

➤ Advising on the tax return treatment of past transactions and responding

on behalf of the audit client to the tax authorities' requests for additional
information and analysis (for example, providing explanations of and
technical support for the approach being taken).

Provision of taxation preparation services does not impair the CPA's

independence as long as the management takes responsibility for the returns
including any judgments made.

Current and Deferred Tax Calculations

Preparing calculations of current and deferred tax liabilities (or assets) for an
audit client for the purpose of preparing accounting entries that will be
subsequently audited by the firm creates a self-review threat. A professional
accountant may be allowed to provide this service to an audit client,
provided:

➤ the client is not a public interest entity; and

➤ appropriate safeguards are in placed to reduce the threat to an acceptable

level, such as using different personnel or having an appropriate reviewer to
review the audit worked or the service performed.

Assisting in the Resolution of Tax Dispute An advocacy threat is created when

the professional accountant represents the audit client in a resolution of a
tax dispute. Accordingly, a professional accountant should not represent an
audit client before a court in the resolution of a tax matter when the amounts
involved are material to the financial statements in which the professional
accountant will express an opinion,

Provision of legal services to assurance clients

When providing legal services to an assurance client, it is important to make

a distinction between advocacy services and advisory services.

Acting as an advocate of an audit client in the resolution of a dispute or

litigation where the amount involved is material to the financial statements
of an audit client will impair the CPA's independence. Hence, the firm should
not perform this type of service to an audit client.

On the other hand, legal services to support an audit client in the execution
of the transaction (e.g. legal advice, contract support, legal due diligence
and restructuring) will not impair the CPA's independence provided adequate
safeguards are employed.

In addition, independence is usually impaired when a CPA provides corporate

finance services to an assurance client. Hence, services such as promoting or
underwriting the, client's securities or consummating business transactions
in behalf of the client are not compatible with providing assurance services.

Recruiting Senior Management

The recruitment of a senior management for an assurarnice client will

normally impair the CPA's independence, especially if the firm makes the
ultimate hiring decisions. On the contrary, the firm could perform consulting
services such as reviewing the qualifications of the applicants and provide
advice on their suitability for the post.

Fees-Relative Size

When the total fees generated from an assurance client represent a large
proportion of the total fees of that firm, the dependence on that client and
concern about losing the client create a self-interest or intimidation threat.
Increasing the client base in the firm reduces dependence on a particular
client.
Where an audit client is a public interest entity and, for two consecutive
years, the total fees from, the client and its related entities represent more
than 15% of the total fees received by the firm expressing the opinion on the
financial statements of the client, the firm is required to:

1. Disclose to those charged with governance of the audit client the fact that
the total of such fees represents more than 15% of the total fees received by
the firm; and

2. Discuss whether either a pre-issuance or post-issuance review might be a

safeguard to address the threat created by the total fees received by the firm
from the client, and if so, apply it.

➤ Pre-issuance Review- Prior to the audit opinion being issued on the second
year's financial statements, a professional accountant, who is not a member
of the firm expressing the opinion on the financial statements, performs an
engagement quality control review of that engagement; or a professional
body performs a review of that engagement that is equivalent to an
engagement quality control review; or

➤ Post-issuance Review- After the audit opinion on the second year's

financial statements has been issued, and before the audit opinion being
issued on the third year's financial statements, a professional accountant,
who is not a member of the firm expressing the opinion on the financial
statements, or a professional body performs a review of the second year's
audit that is equivalent to an engagement quality control review.

Fees-overdue

The CPA's independence is impaired if, at the time of issuing the assurance
report, the prior year's professional fees due from the client remain unpaid.
Hence, the payment of such fees should be required before the assurance
report is issued.

Contingent fees

Contingent fees charged by a firm with respect to an assurance engagement

will impair the CPA's independence. Thus, a professional accountant should
not provide assurance services under an arrangement whereby no fees will
be charged unless specific findings are attained.

Fees are not to be regarded as contingent if these are:

➤ Fixed by a court or other public authority; or

➤ Determined based on the results judicial or government agency

proceedings.

Compensation and Evaluation Policy

A self-interest threat is created when an audit team member for a particular

audit client is evaluated on or compensated for selling non- assurance
services to that audit client. The level of the self-interest threat will depend
on:

➤ What proportion of the compensation or evaluation is based on the sale of

such services;

➤ The role of the individual on the audit team; and

➤ Whether the sale of such non-assurance services influences promotion

decisions.

Accordingly, a firm should not evaluate or compensate a key audit partner

based on that partner's success in selling non- assurance services to the
partner's audit client. This requirement does not, however, preclude normal
profit-sharing arrangements between partners of a firm.

Gifts and hospitality

Accepting gifts and hospitality from an assurance client creates a self-

interest, familiarity or intimidation threat. A professional accountant should
not accept gifts and hospitality from an assurance client, unless the value is
trivial and inconsequential.

Actual or threatened litigation

Litigation involving the firm and the client may create self-interest and
intimidation threats. The relationship between the CPA and the client must
be characterized by honesty, truthfulness and full disclosure. Such a
relationship may not exist when litigation places the CPA and the client's
management in an adversarial position.

Hence, CPA in litigation with a client must evaluate the situation to

determine whether the significance of litigation affects the client's
confidence in the auditor's independence.