CONFLICTS OF INTEREST, BENEFICIAL SHAREHOLDING, FINANCIAL INVOLVEMENT WITH OR IN THE AFFAIRS OF CLIENTS, PERSONAL RELATIONSHIPS, AUDIT FEE, ETC

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The IFAC Code of Ethics for Professional Accountants gives a comprehensive
coverage of conflicts of interest. The Rules of Professional Conduct for Members
also cover the same topic. Excerpts of the sections in the IFAC Code are adapted
or reproduced in the following sections for clarity.

Loans and Guarantees

Ordinarily, banks and other financial institutions grant loans and advances to
their varied customers as part of their normal business. Members of the
assurance teams who are customers of such banks and other financial
institutions may be granted loans and advances in the ordinary course of
business. Loans and advances granted in the ordinary course of business may
not necessarily constitute a threat to the independence of the auditors, but there
are circumstances whereby such facilities granted may constitute a threat to
independence.

Loan to the Firm

A loan from, or a guarantee thereof, by an assurance client, that is, a bank or a
similar institution to the firm would not create a threat to independence,
provided:
(a) The loan is made under normal lending procedures, terms and
requirements; and
(b) The loan is immaterial to both the firm and the assurance client.
If the loan is material to the assurance client or the firm it may be possible,
through the application of safeguards, to reduce the self-interest threat created
to an acceptable level. Such safeguards might include:
(a) Involving an additional professional accountant from outside the firm;
or
(b) Network firm, to review the work performed.

Loan to a Member of the Assurance Team

A loan from, or a guarantee thereof, by an assurance client, that is, a bank or a
similar institution, to a member of the assurance team or their immediate
family would not create a threat to independence provided the loan is made
under normal lending procedures, terms and requirements. Examples of such
loans include:
(a) home mortgages;
(b) bank overdrafts;
(c) car loans; and
(d) credit card balances.
Deposits and brokerage accounts of a firm or member of the assurance team
with an assurance client.
In the same vein, deposits made by, or brokerage accounts of, a firm or a member
of the assurance team with an assurance client that is a bank, broker or similar
institution would not create a threat to independence provided the deposit or
account is held under normal commercial terms.
Examples of self-interest threat created that would be so significant that no
safeguard could reduce the threat to an acceptable level, unless the loan or
guarantee is immaterial to both the firm and the member of the assurance
team and the assurance client, are:
(a) If the firm, or a member of the assurance team, makes a loan to an
assurance client that is not a bank or similar institution, or guarantees
such an assurance client’s borrowing.
(b) if the firm or a member of the assurance team accepts a loan from, or
has borrowing guaranteed by, an assurance client that is not a bank or
similar institution.

Close Business Relationships with Assurance Clients

The Code of Ethics for Professional Accountants issued by the International
Federation of Accountants provides that:
“A close business relationship between a firm or a member of the assurance
team and the assurance client or its management, or between the firm, a
network firm and an audit client, will involve a commercial or common financial
interest and may create self-interest and intimidation threats”.
The following are examples of such relationships:
(a) Having a material financial interest in a joint venture with the assurance
client or a controlling owner, director, officer or other individual who
performs senior managerial functions for that client;
(b) Arrangements to combine one or more services or products of the firm
with one or more services or products of the assurance client and to
market the package with reference to both parties; and
(c) 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.

Case of an Audit Client

In the case of an audit client, unless the financial interest is immaterial and
the relationship is clearly insignificant to the firm, the network firm and the
audit client, no safeguards could reduce the threat to an acceptable level.

Case of Assurance Client which is not an Audit Client

In the case of an assurance client that is not an audit client, unless the financial
interest is immaterial and the relationship is clearly insignificant to the firm
and the assurance client, no safeguards could reduce the threat to an acceptable
level.
Consequently, in both these cases the only possible courses of action are to:
(a) Terminate the business relationship;
(b) Reduce the magnitude of the relationship so that the financial interest
is immaterial and the relationship is clearly insignificant; or
(c) Refuse to perform the assurance engagement.
Unless any such financial interest is immaterial and the relationship is clearly
insignificant to the member of the assurance team, the only appropriate
safeguard would be to remove the individual from the assurance team.

Case Involving an Interest Held by the firm or Member of the Assurance
Team or Their Immediate Family

In the case of an audit client, business relationships involving an interest held
by the firm, a network firm or a member of the assurance team or their
immediate family in a closely held entity when the audit client or a director or
officer of the audit client, or any group thereof, also has an interest in that
entity, do not create threats to independence provided:
(a) The relationship is clearly insignificant to the firm, the network firm
and the audit client;
(b) The interest held is immaterial to the investor, or group of investors; and
(c) The interest does not give the investor, or group of investors, the ability
to control the closely held entity.

Purchase of Goods and Services from an Assurance Client by the Firm
or a Member of the Assurance Team

The purchase of goods and services from an assurance client by the firm (or
from an audit client by a network firm) or a member of the assurance team
would not generally create a threat to independence provided the transaction
is in the normal course of business and on an arm’s length basis. However,
such transactions may be of a nature or magnitude so as to create a self-interest
threat. If the threat created is other than clearly insignificant, safeguards should
be considered and applied as necessary to reduce the threat to an acceptable
level. Such safeguards might include:
(a) Eliminating or reducing the magnitude of the transaction;
(b) Removing the individual from the assurance team; or
(c) Discussing the issue with those charged with governance, such as the
audit committee.

Family and Personal Relationships

The Code of Ethics for Professional Accountants issued by the International
Federation of Accountants further provides that:
“Family and personal relationships between a member of the assurance team
and a director, an officer or certain employees, depending on their role, of the
assurance client, may create self-interest, familiarity or intimidation threats.
It is impracticable to attempt to describe in detail the significance of the threats
that such relationships may create. The significance will depend upon a number
of factors including the individual’s responsibilities on the assurance
engagement, the closeness of the relationship and the role of the family member
or other individual within the assurance client. Consequently, there is a wide
spectrum of circumstances that will need to be evaluated and safeguards to be
applied to reduce the threat to an acceptable level as discussed below”.
When an immediate family member of a member of the assurance team is a
director, an officer or an employee of the assurance client in a position to exert
direct and significant influence over the subject matter of the assurance
engagement, or in such a position during any period covered by the
engagement, the threats to independence can only be reduced to an acceptable
level by removing the individual from the assurance team. The closeness of
the relationship is such that no other safeguard could reduce the threat to
independence to an acceptable level.
If application of this safeguard is not used, the only course of action is to
withdraw from the assurance engagement. For example, in the case of an audit
of financial statements, if the spouse of a member of the assurance team is an
employee in a position to exert direct and significant influence on the
preparation of the audit client’s accounting records or financial statements,
the threat to independence could only be reduced to an acceptable level by
removing the individual from the assurance team.
When a close family member of a member of the assurance team is a director,
an officer, or an employee of the assurance client in a position to exert direct
and significant influence over the subject matter of the assurance engagement,
threats to independence may be created. The significance of the threats will
depend on factors such as:
(a) The position, the close family member holds with the client; and
(b) The role of the professional accountant on the assurance team.
The significance of the threat should be evaluated and, if the threat is other
than clearly insignificant, safeguards should be considered and applied as
necessary to reduce the threat to an acceptable level. Such safeguards might
include:
(a) Removing the individual from the assurance team;
(b) Where possible, structuring the responsibilities of the assurance team
so that the professional does not deal with matters that are within the
responsibility of the close family member; or
(c) Policies and procedures to empower staff to communicate to senior levels
within the firm any issue of independence and objectivity that concerns
them.
In addition, self-interest, familiarity or intimidation threats may be created
when a person who is other than an immediate or close family member of a
member of the assurance team, has a close relationship with the member of
the assurance team and is a director, an officer or an employee of the assurance
client in a position to exert direct and significant influence over the subject
matter of the assurance engagement.
Therefore, members of the assurance team are responsible for identifying any
such persons and for consulting in accordance with firm procedures. The
evaluation of the significance of any threat created and the safeguards
appropriate to eliminate the threat or reduce it to an acceptable level, will
include considering matters such as the closeness of the relationship and the
role of the individual within the assurance client.
Consideration should be given to whether self-interest, familiarity or
intimidation threats may be created by a personal or family relationship
between a partner or employee of the firm who is not a member of the assurance
team and a director, an officer or an employee of the assurance client in a
position to exert direct and significant influence over the subject matter of the
assurance engagement. Therefore partners and employees of the firm are
responsible for identifying any such relationships and for consulting in
accordance with firm procedures. The evaluation of the significance of any
threat created and the safeguards appropriate to eliminate the threat or reduce
it to an acceptable level will include considering matters such as the closeness
of the relationship, the interaction of the firm professional with the assurance
team, the position held within the firm, and the role of the individual within
the assurance client.
An inadvertent violation of this section as it relates to family and personal
relationships would not impair the independence of a firm or a member of the
assurance team when:
(a) The firm has established policies and procedures that require all
professionals to report promptly to the firm any breaches resulting from
changes in the employment status of their immediate or close family
members or other personal relationships that create threats to
independence;
(b) Either the responsibilities of the assurance team are re-structured so
that the professional does not deal with matters that are within the
responsibility of the person with whom he or she is related or has a
personal relationship, or, if this is not possible, the firm promptly removes
the professional from the assurance engagement; and
(c) Additional care is given to reviewing the work of the professional.
When an inadvertent violation of this section relating to family and personal
relationships has occurred, the firm should consider whether any safeguards
should be applied. Such safeguards might include:
(a) Involving an additional professional accountant who did not take part
in the assurance engagement to review the work done by the member of
the assurance team; or
(b) Excluding the individual from any substantive decision-making
concerning the assurance engagement.

Employment with Assurance Clients

“A firm or a member of the assurance team’s independence may be threatened
if a director, an officer or an employee of the assurance client in a position to
exert direct and significant influence over the subject matter of the assurance
engagement, has been a member of the assurance team or partner of the firm.
Such circumstances may create self-interest, familiarity and intimidation
threats particularly when significant connections remain between the
individual and his or her former firm. Similarly, a member of the assurance
team’s independence may be threatened when an individual participates in
the assurance engagement knowing, or having reason to believe, that he or
she is or may, join the assurance client some time in the future”. If a member
of the assurance team, partner or former partner of the firm has joined the
assurance client, the significance of the self-interest, familiarity or intimidation
threats created will depend upon the following factors:
(a) The position the individual has taken at the assurance client;
(b) The amount of any involvement the individual will have with the
assurance team;
(c) The length of time that has passed since the individual was a member
of the assurance team or firm; and
(d) The former position of the individual within the assurance team or firm.
The significance of the threat should be evaluated and, if the threat is other
than clearly insignificant, safeguards should be considered and applied as
necessary to reduce the threat to an acceptable level. Such safeguards might
include:
(a) Considering the appropriateness or necessity of modifying the assurance
plan for the assurance engagement; or
(b) Assigning an assurance team to the subsequent assurance engagement
that is of sufficient experience in relation to the individual who has
joined the assurance client.
In the course of their work, auditors may provide advice on sources of capital
that meet the client specifications or criteria, and provide structuring advice
and assist a client in analysing the accounting effects of proposed transactions.
Safeguards that should be considered include:
(a) Policies and procedures to prohibit individuals assisting the assurance
client from making managerial decisions on behalf of the client;
(b) Using professionals who are not members of the assurance team to
provide the services; and
(c) Ensuring the firm does not commit the assurance client to the terms of
any transaction or consummate a transaction on behalf of the client.

FEES AND PRICING

Fees - Relative Size

When the total fees generated by an assurance client represent a large
proportion of a firm’s total fees, the dependence on that client or client group
and concern about the possibility of losing the client may create a self-interest
threat”.
The significance of the threat will depend upon factors such as:
(a) The structure of the firm; and
(b) Whether the firm is well established or newly created.
(c) The significance of the threat should be evaluated and, if the threat is
other than clearly insignificant, safeguards should be considered and
applied as necessary to reduce the threat to an acceptable level. Such
safeguards might include:
(i) Discussing the extent and nature of fees charged with the audit
committee, or others charged with governance;
(ii) Taking steps to reduce dependency on the client;
(iii) External quality control reviews; and
(iii) Consulting a third party, such as a professional regulatory body
or another professional accountant.
A self-interest threat may also be created when the fees generated by the
assurance client represent a large proportion of the revenue of an individual
partner. The significance of the threat should be evaluated and, if the threat is
other than clearly insignificant, safeguards should be considered and applied
as necessary to reduce the threat to an acceptable level.
Such safeguards might include:
(a) Policies and procedures to monitor and implement quality control of
assurance engagements; and
(b) Involving an additional professional accountant who was not a member
of the assurance team to review the work done or otherwise advise as
necessary.

Fees - Overdue

“A self-interest threat may be created if fees due from an assurance client for
professional services remain unpaid for a long time, especially if a significant
part is not paid before the issue of the assurance report for the following year.
Generally the payment of such fees should be required before the report is
issued”. The following safeguards may be applicable:
(a) Discussing the level of outstanding fees with the audit committee, or
others charged with governance;
(b) Involving an additional professional accountant who did not take part
in the assurance engagement to provide advice or review the work
performed; and
(c) The firm should also consider whether the overdue fees might be
regarded as being equivalent to a loan to the client and whether, because
of the significance of the overdue fees, it is appropriate for the firm to be
re-appointed.

Pricing

When a firm obtains an assurance engagement at a significantly lower fee
level than that charged by the predecessor firm, or quoted by other firms, the
self-interest threat created will not be reduced to an acceptable level unless:
(a) The firm is able to demonstrate that appropriate time and qualified
staff are assigned to the task; and
(b) All applicable assurance standards, guidelines and quality control
procedures are being complied with.

Contingent Fees

“Contingent fees are fees calculated on a predetermined basis relating to the
outcome or result of a transaction or the result of the work performed. For the
purposes of this section, fees are not regarded as being contingent if a court or
other public authority has established them.
A contingent fee charged by a firm in respect of an assurance engagement
creates self-interest and advocacy threats that cannot be reduced to an
acceptable level by the application of any safeguard.
Accordingly, a firm should not enter into any fee arrangement for an assurance
engagement under which the amount of the fee is contingent on the result of
the assurance work or on items that are the subject matter of the assurance
engagement.
A contingent fee charged by a firm in respect of a non-assurance service
provided to an assurance client, may also create self-interest and advocacy
threats.
If the amount of the fee for a non-assurance engagement was agreed to, or
contemplated, during an assurance engagement and was contingent on the
result of that assurance engagement, the threats could not be reduced to an
acceptable level by the application of any safeguard.
Accordingly, the only acceptable action is not to accept such arrangements”.
For other types of contingent fee arrangements, the significance of the threats
created will depend on factors such as:
(a) The range of possible fee amounts;
(b) The degree of variability;
(c) The basis on which the fee is to be determined;
(d) Whether the outcome or result of the transaction is to be reviewed by an
independent third party; and
(e) The effect of the event or transaction on the assurance engagement.
The significance of the threats should be evaluated and, if the threats are other
than clearly insignificant, safeguards should be considered and applied as
necessary to reduce the threats to an acceptable level. Such safeguards might
include:
(a) Disclosing to the audit committee, or others charged with governance,
the nature and extent of fees charged;
(b) Review or determination of the final fee by an unrelated third party; or
(c) Quality and control policies and procedures.

Gifts and Hospitality

“Accepting gifts or hospitality from an assurance client my create self-interest
and familiarity threats. When a firm or a member of the assurance team accepts
gifts or hospitality, unless the value is clearly insignificant, the threats to
independence cannot be reduced to an acceptable level by the application of
any safeguard. Consequently, a firm or a member of the assurance team should
not accept such gifts or hospitality”.

Actual or Threatened Litigation

“When litigation takes place, or appears likely, between the firm or a member
of the assurance team and the assurance client, a self-interest or intimidation
threat may be created.
The relationship between client management and the members of the assurance
team must be characterised by complete candor and full disclosure regarding
all aspects of a client’s business operations. The firm and the client’s
management may be placed in adversarial positions by litigation, affecting
management’s willingness to make complete disclosures and the firm may
face a self-interest threat”. The significance of the threat created will depend
upon such factors as:
(a) The materiality of the litigation;
(b) The nature of the assurance engagement; and
(c) Whether the litigation relates to a prior assurance engagement.
Once the significance of the threat has been evaluated, the following safeguards
should be applied, if necessary, to reduce the threats to an acceptable level:
(a) Disclosing to the audit committee, or others charged with governance,
the extent and nature of the litigation;
(b) If the litigation involves a member of the assurance team, removing
that individual from the assurance team; or
(c) Involving an additional professional accountant in the firm who was
not a member of the assurance team to review the work done or otherwise
advise as necessary.
If such safeguards do not reduce the threat to an appropriate level, the only
appropriate action is to withdraw from, or refuse to accept,the assurance
engagement.

Resolution of Ethical Conflicts

From time to time professional accountants encounter situations which give
rise to conflicts of interest. Such conflicts may arise in a wide variety of ways,
arranging from the relatively trivial dilemma to the extreme case of fraud and
similar illegal activities. The professional accountant should be constantly
conscious of and be alert to factors which give rise to conflicts of interest. It
should be noted that an honest difference of opinion between professional
accountant and another party is not in itself an ethical issue. However, the
facts and circumstances of each case need investigation by the parties
concerned.
It is recognised, however, that there can be particular factors which occur when
the responsibilities of a professional accountant may conflict with internal or
external demands of one type or another. Hence:
(a) There may be the danger of pressure from an overbearing supervisor,
manager, director or partner; or when there are family or personal
relationships which can give rise to the possibility or pressures being
exerted upon them. Indeed, relationship or interests which could
adversely influence, impair or threaten a professional accountant’s
integrity should be discouraged;
(b) A professional accountant may be asked to act contrary to technical and/
or professional standards;
(c) A question of divided loyalty as between the professional accountant’s
superior and the required professional standards of conduct could occur;
and
(d) Conflict could arise when misleading information is published which
may be to the advantage of the employer or client and which may not
benefit the professional accountant as a result of such publication.
“In applying standards of ethical conduct professional accountants may
encounter problems in identifying unethical behaviour or in resolving an ethical
conflict. When faced with significant ethical, professional accountants should
follow the established policies of the employing organisation to seek a resolution
of such conflict”.
If those policies do not resolve the ethical conflict, the following should be
considered:
(a) Review the conflict problem with the immediate superior. If the problem
is not resolved with the immediate superior and the professional
accountant determines to go to the next managerial level, the immediate
superior should be notified of the decision. If it appears that the superior
is involved in the conflict problem, the professional accountant should
raise the issue with the next higher level of management. When the
immediate is the Chief Executive Officer (or equivalent) the next higher
reviewing level may be the Executive Committee, Board of Directors,
Non-Executive Directors, Trustee, Partners’ Management Committee or
Shareholders;
(b) Seek counselling and advice on a confidential basis with an independent
advisor or the applicable professional accountancy body to obtain an
understanding of possible courses of action; and
(c) If the ethical conflict still exists fully exhausting all levels of internal
review, the professional accountant as a last resort may have no other
recourse on significant matters (e.g. fraud) resign and submit an
information memorandum to an appropriate representative of that
organisation.
In Nigeria, the banking laws and regulations require cases of fraud to be
reported to the regulatory authorities.
Any professional accountant in a senior position should endeavour to ensure
that policies are established within his or her employing organisation to seek
resolution of conflicts.
The professional bodies should provide confidential counselling and advice to
members who experience ethical conflicts. The Institute of Chartered
Accountants of Nigeria requires a member who is in doubt as to his or her
ethical position in any matter to seek advice of the Institute through the
Registrar/Chief Executive.

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