Ethics Resources for Accounting Professionals

Case Study: Independence and Professional Integrity

Wendy and Mandy were close friends at university.

After graduation, Wendy started her own retail company, WW Co. Ltd., which had been expanding very fast and reporting a high annual turnover.

Mandy pursued a career in accountancy and became a partner in a CPA firm.

WW Co. Ltd. became one of the major accounts of Mandy's firm, contributing 25% of its revenue.

This year, WW Co. Ltd. was facing a very difficult position.

Apart from losing a few major customers, a significant loss was discovered after Mandy's firm completed the year-end audit.

Besides, during the audit some unusual transactions were identified which involved unnecessary complexity and which did not constitute the most logical or secured way to do business.

Wendy failed to provide information regarding the transactions upon Mandy's request.

Although the company had faced a challenging year, Wendy told Mandy that she was negotiating a big order.

If she could successfully apply for a line of credit with a bank to handle the order, WW Co. Ltd.'s position would turn around.

However, Wendy was worried that the bank would not grant credit facilities to WW Co. Ltd. in view of its current financial position.

Wendy suggested that Mandy should use whatever device she could to improve the reported financial position of WW Co. Ltd.

Wendy promised Mandy that she would be "rewarded" afterwards.

But if Mandy refused her request, she had no choice but to appoint another CPA firm next year.

What should Mandy do?

Mandy should make it clear to Wendy that although they were close friends and WW Co. Ltd. was an important client of her firm, no financial inducement or veiled threat would cause her to compromise her independence and professional integrity.

Mandy should refuse Wendy's offer of a "reward" and report it to the ICAC. Being offered an advantage for her misrepresentation of the financial position of WW Co. Ltd. was a breach of Section 9 of the POBO.

Being mindful at all times of the need to preserve client's confidentiality, Mandy might consult her fellow partners in considering alternative responses to this sensitive situation and clarifying her own personal responsibilities in the circumstances. In the event that there was no appropriate internal channel within her firm to facilitate this consultation, Mandy might consider seeking legal advice.

Mandy should explain to Wendy that it was inappropriate to use any "device she could to improve the financial position" and assure Wendy that she and her firm would try their best to help WW Co. Ltd. achieve its legitimate business objectives and work together to meet the challenges.

Mandy should first seek to ascertain whether Wendy's concerns about applying for credit facilities from banks are well-founded. They should consider questions such as:

Had the bank ever been approached and given any indication of the terms and conditions for making credit facilities available to WW Co. Ltd.?
How weak was WW Co. Ltd.'s financial position? Did the company have any fixed assets which could be offered as security for the new credit facilities? Would any related parties be prepared to guarantee the credit facilities on behalf of the company?
Did the company's financial forecasts indicate that, on an ongoing basis, and assuming the contract was won, the required credit facilities could be serviced and what cover was implied?
Were there any other sources of finance available to WW Co. Ltd.?

Mandy should explain to Wendy that with a well prepared case, the bank might well place greater reliance on WW Co. Ltd.'s forecast profitability and cash flows rather than on historical financial information, particularly if Wendy's belief that the company's position "would turn around" was a reasonable assessment. If financial forecasts were not available, Mandy could suggest WW Co. Ltd. to seek assistance from relevant professional service provider in preparing the forecasts and a proposal for credit facility to the bank. If Mandy's firm is engaged in reporting on WW Co. Ltd.'s financial forecasts, it should observe relevant independence and ethical requirements before accepting the engagement.

If Wendy was unwilling to change her position, Mandy should explain to her that a modified auditor's report would be issued if the audit team concluded – or was unable to obtain sufficient appropriate audit evidence to conclude – that WW Co. Ltd.'s financial statements as a whole were not free from material misstatement.

In the auditor's report, Mandy should describe the matter giving rise to the modified auditor's opinion in accordance with the relevant standard and requirement. To fulfil her statutory duty and requirement under the COE, Mandy should report suspicious transactions identified during audit to the Joint Financial Intelligence Unit.

Having fulfilled the statutory responsibility by reporting to the shareholders and relevant authorities, Mandy should consider whether withdrawal from the audit engagement of WW Co. Ltd. is necessary in light of the identified or suspected non-compliance. Upon resignation, Mandy should consider any professional and legal responsibilities to report on the reasons of withdrawal. For example, the Companies Ordinance (Cap. 622) requires the auditor to give a statement to the company on circumstances connected with the withdrawal that should be brought to the attention of the company's members or creditors.

In all circumstances, however, Wendy's actions in the face of WW Co. Ltd.'s current difficulties had seriously undermined her integrity. Mandy should retain a heightened degree of professional scepticism in all future dealings with Wendy and WW Co. Ltd., including reassessing the engagement risk associated with the decision to continue to serve this client.

Audit Fee - As the total fees from WW Co. Ltd. represented a significant proportion of the total fees of Mandy's firm or a significant proportion of the revenue from Mandy's clients, the dependence on WW Co. Ltd. and concern about losing WW Co. Ltd. created self-interest or intimidation threat. Safeguards should be applied to eliminate the threat or reduce it to an acceptable level. Examples of such safeguards may include:

reducing the fee dependency on WW Co. Ltd.;
having a professional accountant who did not take part in the audit engagement to review the work; or
regular independent internal or external quality reviews of the engagement.

Conflict of Interest - Conflict of interest situations might arise as Wendy and Mandy were close friends and WW Co. Ltd. was one of the major clients of Mandy's firm. Professional accountants should identify and evaluate the threats and relationships that might create a conflict of interest and implement safeguards, when necessary, to eliminate or reduce the threats to compliance with the fundamental principles to an acceptable level. For more information about the ways to handle conflict of interest situations and the possible consequences arising from the mishandling of conflict of interest, please refer to the "Topic of Interest" section in the article for "Financial Accountants".