What are the threats to compliance with the fundamental principles identify and explain each provide examples as well?

To bound auditors around the world to achieve objectives of engagement effectively and also providing users of financial statements with reasonable assurance and making them responsible for other aspects of the profession auditors have to abide by the requirements of code of ethics. Principles laid out in code of ethics are also know as fundamental ethical principles and auditor is required to assure all such principles are fulfilled. Fundamental principles include honesty or integrity, objectivity, professional competence and due care, confidentiality and professional behaviour.

However, during the practice while carrying requirements of engagement auditors may face or they expect to face such situations when the will not be able to fulfill ethical requirements. Such obstructions are called threats to fundamental principles. Although threats can make many different shape but broadly they can be classified in FIVE categories:

Self-interest threat arises when stake of auditor or stake of any immediate or close family member of auditor is involved in the entity and thus he might cause the auditor to violate multiple ethical requirements.

For example if auditor has investment in the same company he is auditing and issuing adverse report will also affect his investment and this might provoke auditor not report objectively.

Self-review threat arises when auditor is asked to examine or report on his own assessment, opinion, judgement or work and thus he is basically self reviewing his work. Its like asking student to assess his own exam script. Such situations may push auditor to give biased evaluation just to save reputation even if previous judgement was wrong.

For example, under a separate arrangement auditor gave the evaluation of internal control system as effective. Now during the audit it is found internal control system is not that effective as was expected. As new evaluation is suggesting otherwise basically nullifying previous evaluation of the same person. Auditor may find it discrediting and might not report objectively.

In other usual case is where auditor has previously provided some accounting services to the entity and later same person is auditing the accounting records. In such situations he might be biased in finding errors as this will discredit his independent services.

Advocacy threat arises when auditor (most of the time unintentionally) supports the opinion or position (of the client most of the time) to the extent that it is not supported with relevant evidence or simply auditor supported the opinion beyond the degree of objectivity.

For example bank asked client to file an auditor’s report on specific matters for loan contract and in that report auditor mentioned sound financial position of the entity without sufficient appropriate evidence. Or worse, auditor stated in the report that entity is financial sound when its not the case in actual.

Familiarity threat arises when auditor due to the nature of relation with the other party become too sympathetic that it compromised the objective requirement of code.

For example such situations arise when client is close friend, relative or family member of the auditor.

However, point must be noted that familiarity threat is different from self-interest threat because in familiarity threat auditor feels sympathetic for others’ interests whereas in self-interest threat auditor weighs his own interest above ethical requirements of the code.

Intimidation threat arises when auditor, directly or indirectly, threatened physically or mentally to keep him from working objectively.

For example auditor is given a threat that if he reports objectively then audit fee will not be paid or subsequent audits with the auditor will be cancelled. It might take the shape of physical threats like harming family members or use of coercion on auditor. To learn more in detail about intimidation threat read: What is intimidation threat in auditing?

Issues that can affect the integrity and reliability of auditor reports

What are Threats to Auditor Independence?

In the auditing profession, there are five major threats that may compromise an auditor’s independence. Before an audit engagement, it is crucial that each member of the audit team review the five threats to independence. If an auditor is exposed to a certain threat, he or she should either develop safeguards to reduce the threat to an acceptable level or resign from the audit engagement.

What is Auditor Independence?

Auditors are expected to provide an unbiased and professional opinion on the work that they audit. An auditor who lacks independence virtually renders their accompanying auditor report useless to those who rely on them.

For example, consider yourself a potential investor in ABC Company. If you know that the auditor for ABC Company keeps a close, personal relationship with the CEO of the company, how much would you trust that the audited work is a fair representation of the company’s financial standing? How can you be certain that the auditor and CEO did not collude to issue a favorable audit report?

The fact is that auditors who lack independence compromise the integrity of financial markets and the reliability of information. Investors would not be willing to extend capital to companies, knowing that the audited information was performed by an auditor who is not independent. Furthermore, banks would not be willing to issue a loan for fear that the auditor might’ve provided a biased audit report.

Five Threats to Auditor Independence

The following are the five things that can potentially compromise the independence of auditors:

1. Self-Interest Threat

A self-interest threat exists if the auditor holds a direct or indirect financial interest in the company or depends on the client for a major fee that is outstanding.

Example

The audit team is preparing to conduct its 2020 audit for ABC Company. However, the audit team has not received its audit fees from ABC Company for its 2019 audit.

Issue

The audit team might be tempted to issue a favorable report so that the company is able to secure a loan to settle the fees outstanding for their 2019 audit.

2. Self-Review Threat

A self-review threat exists if the auditor is auditing his own work or work that is done by others in the same firm.

Example

The auditor prepares the financial statements for ABC Company while also serving as the auditor for ABC Company.

Issue

By having the auditor review his or her own work, the auditor cannot be expected to form an unbiased opinion on the financial statements.

3. Advocacy Threat

An advocacy threat exists if the auditor is involved in promoting the client, to the point where their objectivity is potentially compromised.

Example

The auditor is assisting in selling ABC Company while also serving as the auditor for the company.

Issue

The auditor may issue a favorable report to increase the sale price of ABC Company.

4. Familiarity Threat

A familiarity threat exists if the auditor is too personally close to or familiar with employees, officers, or directors of the client company.

Example

ABC Company has been audited by the same auditor for over 10 years and the auditor regularly plays golf with the CEO and CFO of ABC Company.

Issue

The auditor may have become too familiar with the client and, thus, lack objectivity in their work.

5. Intimidation Threat

An intimidation threat exists if the auditor is intimidated by management or its directors to the point that they are deterred from acting objectively.

Example

ABC Company is unhappy with the conclusion of the audit report and threatens to switch auditors next year. ABC Company is the biggest client of the auditor.

Issue

The auditor’s independence may be compromised, as ABC Company is their biggest client and they, quite naturally, do not want to lose such a client. Therefore, the auditor may issue a report that appeases ABC Company.

More Resources

We hope you’ve enjoyed reading CFI’s guide to threats to auditor independence. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources listed below:

• Accounting Ethics 
• Audit Fraud
• Legal Liability of Auditors
• Top Accounting Scandals

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Which of the following are categories of threats to compliance with one or more of the fundamental principles in ACCA's code of ethics and conduct?