FRAUD & ERROR (iSA 240) Notes

FRAUD & ERROR (iSA 240) Questions and Answers

KEY TERMS

Engagement Letter

before commencement of the audit, the auditor and the client should agree on the terms of the engagement. The agreed terms should be recorded in an audit engagement letter or other suitable form of contract.

Professional Ethics

These are rules of conduct that govern the behavior of an accountant

International Standards on Auditing

Within each country, local regulations govern to a greater or lesser degree, the practices followed by the auditors.  Such regulations may either be of a statutory nature of in the form of statements issued by the regulatory or professional bodies in the country concerned. The international auditing standards are intended for international acceptance.

INDUSTRY APPLICATION

Whatever is covered in this topic is very relevant in the auditing professional and is all applicable in all audit engagements. it guides the auditor as to his rights and the engagement letter. also, audit professionals are expected to adhere to the highest standards of ethics and this topic gives the student the rules that are set out by the profession.

INTRODUCTION

Before an auditor is appointed to an audit, there are numerous processes and procedures that must be completed first. The company needs to consider the qualifications of the auditor amongst other things. The auditor and the client also need to agree on the terms of engagement before hand and this is done through an engagement letter signed by both the client and the auditor. This is covered by iSa 210 on Terms Of Audit Engagements . The auditor is also expected to be aware of his rights and also the professional and ethical requirements that he needs to adhere to before he starts an audit engagement.

According to Section 159 of Companies act, every company shall at each annual general meeting appoint auditors to hold office till the next annual general meeting. Notwithstanding the above, a retiring auditor however appointed shall be deemed to be reappointed without any resolution being passed subject to certain provisions. Section 159 (7) provides that the remuneration of the auditor shall be fixed by:

• The directors or the registrar of Companies .
• The company in annual general meeting or in the manner determined in the annual general meeting.

However  appointed

The directors can appoint the first auditors of the company to hold office till the conclusion of the first annual general meeting. The directors can also appoint auditors to fill a casual vacancy in the office of the auditor. A casual vacancy arises when the auditor resigns before end of his or her term of office, dies or becomes disqualified as such by being deregistered. Should the directors and shareholders fail to exercise their right to appoint an auditor, the directors must notify the registrar of companies within seven days of that failure and the registrar will appoint an auditor to that company.

Subject to certain provisions

in an annual general meeting, one of the items of the agenda is the reappointment of auditors. if the matter is not discussed at that meeting, then the auditors are deemed to have been reappointed automatically. Similarly, if no intention to reappoint another auditor has been notified and the auditor has expressed desire to continue in office, an acclamation rather than resolution is sufficient for the auditor to be automatically reappointed.

Qualifications for appointment of an Auditor

A person shall not be qualified for appointment as an auditor of a company unless he or in the case of a firm, every partner in the firm is a holder of a practicing certificate issued pursuant to section 21 of the Accountants Act. In Kenya a person is issued with a practicing certificate if she or he fulfills the following:-

• A Certified Public Accountant (CPA)
• Member of Institute of Certified Public Accounts (ICPAK)
• Have post qualification experience in auditing environment for at least two years. none of the following persons shall be appointed an auditor of a company
• An officer of a servant of the company. This is because if appointed auditors, employees or officers of the company would be auditing their own work and thus they may not be objective.
• An employee of an officer or servant of the company. A person who is a partner of or is in the employment of an officer or servant of the company cannot be appointed auditor as he is too involved at personal and financial level to be seen to be as independent.
• a body corporate. These are excluded because auditor’s principle function is to express an opinion on truth and fairness of the financial statements and only natural persons can express an opinion as they have a mind and a heart. in addition, users rely on auditor’s opinion to make decisions and if the auditor’s opinion is materially wrong, the users should be able to recover from the auditor the loss incurred to an unlimited extent. most body corporates have limited liability, thus they cannot be appointed auditors.

Section 161 (3) states that a person shall not be qualified for appointment as auditor of a company if he is disqualified for appointment as an auditor of any other company which is that company’s subsidiary or holding company.

In the case of a private company, a person who is an officer or an employee of the company can be appointed auditor of that company. This is because in a public company there is clear distinction between the shareholders and the management and therefore there is need to protect the shareholders from excesses of management. however, in private company, the shareholders and management tend to be the same people either of same family or close friends, thus the auditor cannot really protect somebody from himself.

Section 161 (1) deals with one characteristic with one characteristic an auditor must possess which is technical competence.

Section  161 (2) deals with the other characteristic an auditor must posses especially for public companies which is independence. The auditor must be free and be seen to be free from any influence from the directors in carrying out an audit.

Removal of Auditors from Office

according to section 160 of Companies act, the shareholders and only the shareholders can remove the auditor from the office before his term in office expires. Only an ordinary resolution (over 50% majority) of the company in the annual general meeting is required to remove the auditor from office but a special notice of twenty eight days of the intended removal should be given to the company and the auditor .

Since the directors may want to remove the auditor because of disagreements on accounting policies or if the auditor threatens to expose their frauds, section 160 of the Companies act seeks to give the auditor some protection from the directors. The defenses given to the auditor include:

• The right to receive a copy of the notice and the intended resolution at the meeting where his removal will be discussed.
• The auditor after receiving a copy of notice can prepare written representations explaining his position on the matter. The directors are under obligation to distribute these representations to all shareholders at the company’s expense. if the directors feel that the auditor wants to publish defamatory material, they can obtain a court order which allows them not to distribute the representations.
• The auditor is entitled to attend the meeting at which his dismissal will be discussed and be can address that meeting on any matters concerning him as an auditor. if his representations were not distributed for a reason other than a court order, he can read them to the members at the meeting.

Even though a special notice is required for a meeting to dismiss the auditor, a special resolution is not necessary if the meeting is properly constituted. a simple majority of members present and voting is enough to remove the auditor from office.

An auditor may resign from office as long as a notice in writing to that effect is deposited at the company’s registered office. To be effective, the resignation must contain either:

• a statement to the effect that there are no circumstances connected with the resignation that should be brought to the attention of the creditors.
• a statement giving details of any circumstances leading to his resignations he believes should be brought to the attention of the shareholders.
• The Companies act permits the auditor to request the directors to convene an extraordinary general meeting for considering the auditor’s explanations of the circumstances surrounding his resignation.

Rights of auditors (Section 162)

• right to access at all times the accounting records of the company. These records included shareholders register, memorandum of association, minutes of meetings and returns from branches of the company.
• right to receive notice of general meetings, attend and speak during the general meetings.
• Right to require from officers and employees of the company any information and explanations deemed necessary for the purpose of the audit. This includes all information from client’s books, vouchers and management representations.
• right to require that subsidiaries and their auditors provide such information and explanations as deemed necessary for the audit of the holding company.
• right to remuneration. The auditor should be paid audit fees when due and be reimbursed audit expenses incurred in connection with the audit.
• right to legal and technical advice. an auditor has right to use work of an expert to get technical knowledge on areas he may require such.
• right to send representations to shareholders in case there are attempts by the directors to dismiss him. The auditor also has the right to receive a twenty eight day notice of the meeting where his dismissal will be discussed and he can speak or read his representations at that meeting.

Duties of the Auditor

• To report the shareholders on the financial statements laid before the company at the annual general meeting, whether in his opinion, the balance sheet gives a true and fair view of the company’s financial position at the balance sheet date, the profit and loss account gives a true and fair view as to the financial performance of the company and whether the financial statements comply with the requirements of the relevant financial reporting framework.
• To state in his audit report whether he received all the information and explanations in his opinion were necessary for the audit, whether proper books of accounts have been kept, whether the accounts are in line with the underlying records and whether he received adequate returns from branches of the company not visited.
• To assist investigators into the company’s affairs by providing his working papers, which are summaries of significant matters the auditor identified during the audit.
• To certify the profit and loss account and balance sheet in a prospectus and other statutory reports regarding numbers and shares sold by the company and cash received in respect to allotment of shares.
• To include in his report any required information about the director’s remuneration which has been omitted from the financial statements.
• To consider if any information in director’s report is inconsistent with the financial statements and to report the facts if there are any such instances.

Client Acceptance Procedures

Accepting Appointments as company auditor

Upon receipt of a request to accept an appointment as the auditor of a company, the auditor should:

• Ensure that he is professionally, legally and ethically qualified to act as auditor of that client.

he should ensure that he is not contravened by any provisions of Companies act regarding independence.

• he must ensure that he is not a servant or in partnership with a servant of the company and neither must he have any personal, family or business relationship with the prospective client.
• Establish whether his firm has the technical proficiency to undertake the audit. This includes whether the firm has adequate resources such as staff and time to undertake the assignment.
• Seek references about the status of the company and its management so as to assess the potential risk in associating with the prospective client. The information sought would include reputation of the company and of its directors.
• Communicate with the present auditor. The auditor should ask for permission from the prospective client to communicate with the outgoing auditor. if permission is denied, he should decline the appointment but if granted he should write to the outgoing auditor requesting all information which ought to be made available to enable him decide whether or not to accept the appointment. The outgoing auditor should also ask the client permission to communicate with the prospective auditor. if permission is denied, the outgoing auditor should inform the prospective auditor who should then decline the appointment. This process is called ethical clearance and is just not a matter of professional courtesy but aimed at enabling the auditor decide whether to accept appointment as well as enquire reasons for change of auditors.

After accepting the appointment;

• The auditor should ensure that the removal or resignation of the existing auditor is properly carried out in accordance with the Companies act.
• The auditor should obtain a copy of the new resolution passed at the annual general meeting to appoint him as the auditor.
• The auditor should set up a letter of engagement for the new client company.

a member invited to undertake professional work additional to that already being carried out by another auditor who will still continue with his existing duties, should as a matter of professional courtesy notify the other auditor of the work he is undertaking. This notification need not be given if the client advances a valid reason against it.

The letter of Engagement (iSA 210)

it is in the interest of both the client and the auditor that the auditor sends an engagement letter preferably before commencement of the engagement. The letter of engagement has the following purposes: –

• helps avoid misunderstanding in respect to the engagement. Without written understanding, there may be an implied contract created by either auditors conduct or a provision in the articles of association which may not be in auditor’s liking.
• Documents the auditor’s acceptance of the appointment as well as the objective and the extent of the auditor’s responsibility to the client.
• Confirms in writing any verbal arrangements between the client and the auditor.
• provides the auditor with a medium through which he can clarify the client’s and his respective responsibilities.
• The letter informs the client of other services that the auditor’s firm can provide e.g. taxation or consultancy.
• minimizes auditor’s liability to third parties.

Principal Contents of an Engagement Letter

• The objective of the audit of the financial statements.
• Management’s responsibility regarding the financial statements.
• The scope of the audit including references to applicable legislation or pronouncements of professional bodies to which the auditor complies.
• The fact that because of the test nature of auditing and other inherent limitations of an audit together with inherent limitations of internal control system, there is an unavoidable risk that some material misstatements may remain undiscovered.
• The expectation of unrestricted access to whatever records and documentations. other matters included in engagement letter are:
• Expectation of receiving from management written confirmation concerning representations made by the auditor in connection with the audit.
• The basis on which audit fees are computed or any other billing arrangement.
• A request to the client to confirm the terms of the engagement by acknowledging receipt of the engagement letter.

Audit of Components

Where the auditor of a parent company is also the auditor of its subsidiaries, the factors that influence the decision whether to send a separate engagement letter include:

• Legal requirements of disclosure in the financial statements.
• Whether a separate audit reports are to be issued on the subsidiary and parent companies.
• Who appoints the auditors of the component?
• The extent of any work performed by other auditors
• Degree of ownership in the subsidiary by the parent company.
• Degree of independence of subsidiary’s management.

Recurring Audits

on recurring audits, the auditor should consider whether the circumstances require the terms of engagement to be revised and whether there is need to remind the client of existing terms of engagement. The auditors may decide not to send a new engagement letter each period. however, the following factors may make it necessary to send a new engagement letter:

• Any indication that the client misunderstands the objective and scope of the audit.
• Any revised or special terms of the engagement.
• A recent change in senior management, board of directors or ownership.
• A significant change in nature or size of client’s business.
• Where legal requirements dictate so.

Auditor’s Liability and Negligence

Auditors are known to be competent and honest and therefore when they say that financial statements show a true and fair view, users of the financial statements will have faith in them and make decisions based on the information contained in the financial statements. Since auditors work is relied upon by other parties to make economic decisions, the auditor has a responsibility to do his work with reasonable care, skill and diligence. he must not certify what he does not believe to be true and he must take reasonable care and skill before he believes that what he certifies is true. What is reasonable care and skill is very difficult to assess in any given case. however, it is clear that:

• An auditor may fail to exercise sufficient care and skill.
• as a consequence, some fraud or error may remain undetected. The fraud or error may be material and thus he will fail to detect that financial statements do not show a true and fair view.
• A user who relies on that work of the auditor may incur a financial loss.
• The financial loss incurred flows from failure to do his job properly and therefore the auditor may have to make good from his own resources, the loss suffered by the user of the financial statements.

Criminal Law and the Auditor

a member of iCpaK is guilty of professional misconduct if:

• he allows any person to practice in his name as an accountant unless such a person is a holder of a practicing certificate and he is in partnership with him or employed by him.
• he enters, for the purpose of or in the course of practicing as an accountant into partnership with a person who does not hold a practicing certificate or secures any professional business through the services of such a person.
• he discloses information acquired in the course of professional engagement to any person other than the client without the consent of the client or otherwise as required by law.
• He certifies or submits in his name or in the name of his firm, a report of an examination of financial statements and the examination of such statements and related records have not been made by him, a partner or any employee of his firm.
• he fails to observe and apply professional, technical, ethical or any other standards prescribed by iCpaK as guidelines for practice by members of the institute.
• He permits his name or that of his firm to be used in connection with an estimate of earnings contingent upon future transaction in a manner which may lead to the belief that vouches or guarantees for the accuracy of the forecast.
• He expresses his opinion as financial statements of any business in which he, his immediate family, his firm or any partner in his firm has an interest unless he discloses that interest when expressing his opinion.
• He fails to disclose in financial statements or otherwise, a material fact known to him the disclosure of which is necessary to ensure that the financial statements are not misleading.
• he fails to report a material misstatement known to him and therefore causes it to appear in financial statements with which he is concerned in a professional capacity.
• he is found to engage in fraudulent acts or acts which result into loss.
• he expresses an opinion on any matter with which he is concerned in professional capacity without obtaining sufficient information on which to base his opinion.
• he includes in any statement, return or form to be submitted to iCpaK knowing it to be false in any particular matter.

Negligence

negligence is some act or omission which occurs because the person concerned failed to exercise that degree of a reasonable care and skill which is reasonably expected in the circumstances of the case. a liability refers to the fact that an auditor who is appointed to repost to the shareholders whether the financial statements show a true and fair view could be held liable for negligence if it is determined that he did not carry out his work with due professional care. There are no decided cases in Kenya against auditors,

This  makes it difficult to precisely determine what circumstances the auditor could be held liable in and which parties could successfully bring an action against the auditor. auditor’s liability falls under three categories:

• Civil and criminal liabilities.
• liability to the client company under law of contract.
• liability to third parties under tort o negligence.
•  

1          Civil and criminal liabilities.

An auditor could be sued in a civil court if he breaches his position of trust and confidentiality. E.g. if he uses information acquired in course of an engagement for his financial gain or for benefit of another party. regarding criminal liability, section 136 of the companies act provides that an auditor shall be criminally liable if he willfully makes false statement in any report, certificate or financial statements with an intention to deceive or mislead.

2          Liability to the client company under law of contract.

The audit client company represents all shareholders acting as a body (in this respect, a company cannot be represented by a single shareholder). The auditor has a duty to report to the shareholders whether the financial statements show a true and fair view. The auditor therefore has a contract with the company. Under this contractual relationship, it is implied that the auditor will carry out his work with a reasonable degree of care and skill. The degree of care and skill required mainly depends on nature of work undertaken. Generally if the auditor has complied with the GAAPs and guidance from the ISAs, it would be difficult to prove that the auditor was negligent.

in the case of Kingston cotton mill, the judge considered the degree of care and skill required of an auditor and declared that it is the duty of an auditor to bring to bear on the work he has to perform, that skill, care and caution which a reasonably competent, cautious and careful auditor would use.

The auditor has no duty to an individual shareholder. a shareholder who makes an investment decision by relying on the auditor’s report and suffers financial loss cannot claim for damages under the law of contract. only if the company i.e. the entire body of shareholders has suffered a loss can such a case be brought under law of contract .

3 Liability to third parties under tort or  negligence.

in this case third parties refer to anyone other than the client company who has used the auditor’s report and wishes to make a claim for negligence. it therefore includes any individual shareholders in the company, any potential invertors and other providers of capital such as lenders and creditors. The difference between these parties and the client company is that such third parties have no contract with the auditor and therefore no implied duty of care.

For third parties to succeed in claiming for damages under negligence, they must prove that;

• a duty of care existed i.e. the auditor owed the third parties a duty of care.
• The duty of care was breached through auditor’s negligence.
• They suffered a financial loss as a direct consequence of an auditor’s negligence.

in hedley byrne and Company limited versus heller and partners (1963), it was held that ‘a duty of care exists where there is a special relationship between the parties. i.e. where the auditor knew or ought to have known that the financial statements would be made available and would be relied upon by a particular person.’  The implication of this statement is that, for there to exist a duty of care, the third part must have been identified in some way to the auditor. E.g. where the directors inform the auditor that the financial statements would be used to obtain a loan, the auditor will have to owe duty of care to the bank in the same way he owes a duty of care to the client.

Ways of minimizing potential liability for professional negligence include:

• By not being negligent.
• Adhering to the requirements in iSas, codes of professional conduct and utilizing sound professional judgment.
• Agreeing with the client duties and responsibilities of the auditor and the client in the engagement letter to avoid future misunderstandings.
• Defining in the audit report the precise work the auditor has undertaken.
• Stating in the engagement letter the purpose for which the report has been prepared and that the client may not use it for any other purpose.
• Identifying the authorized recipients of reports in the engagement letter in the report.
• Limiting or excluding liability by a term in the engagement letter or in the case of third parties a disclaimer in the report.
• advising the client on the engagement letter on the need to ask for permission before using the auditor’s name and withholding such permission when appropriate.

Professional Ethics

a member of a profession owes duty to the public including the employer, the profession itself and to other members of the profession. professional ethics are rules of conduct that govern the behavior of an accountant. In Kenya, they are issued by institute of Certified Public Accountants of Kenya (iCpaK) in form of statements and explanatory notes. a professional accountant should act in a manner consisted with the good reputation of the occupation and refrain from any conduct which might bring discredit to the profession. The following are fundamental principles stated by ICPAK to ensure auditors are credible people before they give credibility to financial statements.

1. integrity: a member should be straight forward, honest and sincere in his approach to professional work. a member must be aware of his role in the society and maintain high standards of conduct should not satisfy what he knows as untrue as true and should take caution not to mislead intentionally or unintentionally.
2. professional independence: This is a fundamental concept to the accounting profession as a whole. it is essentially an attitude of mind characterized by objectivity and integrity. a member in public practice should be and should appear to be free in every professional assignment he undertakes, of any interest which might distract him from being objective. he must be impartial and must not allow prejudice or bias to affect his judgment. a member not in practice may be unable to be or seen to be free of any interest which might conflict to the proper approach of his professional work. However, this does not diminish his duty of objectivity in relation to that work.
3. Confidentiality: The guide to professional ethics states that information acquired in the course of professional work should not be disclosed except where consent has been acquired from the client, where there’s public duty to disclose or where there is legal or professional duty to disclose such information. a member acquiring information in the course of professional work should neither use nor appear to use that information in his personal or third party advantages e.g. if a member is auditing a limited company and he realizes that the company has made a substantial increase in profits, it would be unethical to advise a friend to buy the shares of this company in anticipation of the expected increase in the share prices as a result of increase in profitability.
4. Technical competence: a member has duty to carry out his professional work with care and skill and in conformity with the professional ethical standards issued by iCpaK and by the laws of Kenya. a member should not undertake or continue professional work which he himself is not competent to perform unless he obtains such advice and assistance as will enable him to perform such work. To be competent a member should be fully conversant with accounting, book keeping, auditing, financial management, information technology, receivership, liquidation and bankruptcy law, taxation both personal and corporate and must be aware of the economic environment within which his clients operate. To be competent, he must also possess sound judgment. This is in professional as well as economic issues. he should be a good communicator.

auditor’s independence is an important factor in establishing the credibility of an audit opinion. Therefore, iCpaK has given guidance in the best conduct code in situations where the auditor’s independence may be impaired. These are:

1. Fees

It is undesirable for a practice to receive a significant proportion of recurring fee income from one client or group of connected clients. a new or old practice is exempted from his provision because in the case of a new practice, he has not yet built a sufficient client base and an old practice may be in decline. Therefore, when a member finds himself with such a client, he does not resign immediately but first look for opportunities to reduce the significance of that client by looking for more work.

Where practice is deriving a significant portion of its professional fees from one client, the practice will be hesitant to do anything that could result in losing the client i.e. an auditor may be hesitant to qualify his report for fear of losing such a client.

• Personal and family relationship

a family of personal relationship can affect objectivity therefore an accountant should take step to ensure that this does not interfere with his objectivity in approach to auditing e.g. a problem may arise when a person in practice has a mutual business with an officer of the client company or has close friendship with one of the officers.

c)         Beneficial shareholding

a practice should ensure that he does not have as an audit client, a company in which a partner in practice, the spouse or minor child of such partner is the beneficial holder of shares nor should it employ on the audit, any member of staff who is a beneficial holder of such shares. Shares in an audit client may be involuntarily acquired e.g. where a partner inherits such shares or marries a shareholder. in such cases, the shares should be disposed off at the earliest practicable date. if the company’s articles of association require that the auditors should have a minimum number shares, then the member should take minimum number allowed. The shares cannot be used by the member in an annual general meeting to vote on the appointment of the auditor and his remuneration.

d)         Trustee shareholding

a practice should not have as an audit client a company, if a partner in the practice or the spouse of a partner is a trustee of trust holding shares in that company and the holding is in excess of 10 % of the issued share capital of the company or of the total assets comprised in the trust.

e) Practice loan

a practice should not make a loan to a client or guarantee a client’s borrowings or accept a loan from a client or have a borrowing guaranteed by a client. This does not apply to a practice having a current account with a client commercial bank or a similar financial institution. A firm may however accept a loan from a client if it is in that client’s ordinary course of business to give loans. loan therefore should not be accepted on terms more favorable than those available to others.

• Goods and services

acceptance of goods or services from a client may be a threat to independence. This should not be accepted by a partner, his spouse or minor child or by the staff of practice except on terms no more favorable than those available to the generality of the client’s employees. acceptance of undue hospitality poses a similar threat.

• Commission

Where advice is given to client in such that if acted upon it would result in a commission being earned by the practice or anyone on it, special care should be taken to ensure that the service is in fact in the best interest of the client. The client should be informed in writing both on the fact that commission would be received and as soon as practicable the amount and terms of such commission.

• Conflict of interest
• provision of other services to clients. a member should be alert to the danger posed to his independence by providing accounting and other services which place him in an executive position to his client. a member should use different staff for those services and also ensure that the client takes full responsibility for that work.
• Competing clients: a member should frankly disclose to both clients and advice them to choose another auditor and then disengage one of the appointments. however, he can also advise to resolve the conflict. An example of competing clients would be where a practice advises one client upon the figures on which to base a tender for a contract and if knowingly became involved in advising another rival company tendering for the same contract.
• receiverships and liquidation: if a company a member is auditing goes into receivership, the member should not accept an appointment as a receiver manager unless at least two years have elapsed. Where a practice, his partner or his employee has during the previous two years has had a continuing professional relationship with the company which goes into liquidation, he should not accept an appointment as liquidator of that company.
• previous employment: a member who has been an employee of a company having left that employment should not accept appointment as an auditor of that company until at least two years have elapsed.

Additional steps to enhance auditor’s independence

• rotation of partners. There should be mandatory rotation of audit partners responsible for audit of a company after a set maximum number of years. a primary objective of the rotation would be to guard against the possibility of the auditor and his staff becoming too close to senior management and thus consequent impairment of auditor’s independence.
• Having another appropriately qualified and experienced person the firm to review the work performed by the engagement partner and his team.
• Prohibiting undertaking of consulting work for existing audit clients. An accounting firm may establish departments each with its own staff in respect to audit engagement, consultancy services, tax services, human resource services and risk management. The staff responsible for consultancy have no contact with the staff responsible for the audit.
• peer review. This refers to the process through which institute of certified public accountants (iCpaK) establishes a committee to review audit procedures and quality control policies for members while conducting an audit. Such reviews would be aimed at evaluating whether the audit work performed meets the minimum quality  standards set by the profession and whether the audit opinion expressed is supported by the work done and evidence gathered.
• Enacting stringent laws, that seek to protect the auditor from being removed from office e.g. because of issuing a qualified audit opinion. Under the current provisions of the Companies Act, only a simple majority of shareholder is required to remove the auditor from office. Clearly there is need for more protection for the auditor.
• Enhancing the role of the audit committee. an audit committee is a committee set up with clearly defined role in setting policies for the awarding of non-audit work to the  auditor and not only recommending the appointment of the auditor each financial year but also fixing their remuneration. The capital markets authority (Cma) requires that all companies listed in the nairobi Stock Exchange (nSE) must have an audit committee. The purpose of such a committee is to guard and promote the independence of the auditors. The committee consists of mainly non-executive directors to enhance their effectiveness and independence.

Advertising and Publicity

a member should not advertise professional services or skills in such a way as to show himself to be more qualified than other practicing accountants. a member may place an advertisement under the following circumstances:

• When acting on behalf of the client.
• When acting in fiduciary or similar capacity.
• When seeking staff or salary employment.

A member may have paid announcements in the press for opening a new office, changing the name, address or membership of his firm or for member’s appointment. Publicity given to member’s activity both professional and otherwise is acceptable as it is publicity for the professional activity of a firm.

From the ethical guidance, it is unethical for an accountant to seek professional work by advertising his services. one cannot therefore place an advertisement in the media claiming he is a superior service provider than other accountants.

Advertisements should not contain comparisons with other members or firms, contain testimonies or endorsements or bring the firm, members or the accountancy profession discredit or dispute.

although advertisements may refer to the basis on which fees are calculated and where they contain any statements concerning the hourly rate charged by the firm, care should be taken to avoid giving the impression that lower quality performance is provided than that expected from professional persons.

Obtaining professional work

a member should not in any circumstances obtain or seek professional work for himself or for another party in unprofessional manner e.g. bargaining.

a practicing member should not give any commission, fee or reward to a third party in return for introduction to a client. however, a partner who brings in business can be paid commission by his own practice.

No member in practice shall comply with any request from a firm or company who is not a client of that firm to submit a quotation for audit fees unless the existing auditors are aware that such a request has been made by their client.

Charging Professional Work

Fees should not be charged on a percentage or similar basis except where it is authorized by the law or is generally accepted practice for certain specialist work e.g. construction work. also, no instructions should be accepted on a contingency basis e.g. bonus of 3% on profits. This is because auditor’s judgment should not be impaired by hope of a financial gain. If fees were computed as a percentage of the net profit, the auditor would be hesitant to propose to the management audit adjustment that would result to reduction of the audit fees derived from the assignment.

• in practice the most common mode of determination of audit fees is to compute them on the following considerations:
• The skill and knowledge required for the type of work involved. if the work required an expert, the fees would be higher
• The seniority of the person engaged in the work i.e. audit partners, managers, seniors and assistants.
• The time necessarily engaged on each person on the work.
• The nature of responsibility which the work entails.

Corporate Governance

The Capital markets authority  (CMA) developed guidelines for good practices by public limited companies in Kenya in response to the grave importance of governance issues in both emerging and developing economies and for developing growth in domestic and regional capital markets.

Corporate governance concerns the way a company is operated and directed. it has the following key aspects:

• The role of the board of directors and the audit committee.
• The overall control and risk management framework.

AUDIT SAMPLING (iSA 530) Notes

Audit Evidence Revision Questions and Answers