## **Learning Outcomes**

After reading this article, you will be able to identify and explain the main types of threats to ethical behaviour in audit and assurance engagements. You will understand what safeguards are, how to apply them to practical scenarios, and how to recognise and manage conflicts of interest. You will also learn when to decline or withdraw from engagements if threats cannot be mitigated, and will be able to apply these principles to typical ACCA exam questions.

## **ACCA Audit and Assurance (AA) Syllabus**

For ACCA Audit and Assurance (AA), you are required to understand the ethical framework governing auditors and how to apply safeguards to reduce threats to an acceptable level. You must also be able to deal with conflicts of interest in practice. This article covers:

- The identification and application of the five fundamental ethical principles.
- Recognition and evaluation of ethical threats: self-interest, self-review, advocacy, familiarity, intimidation.
- Understanding the concept and examples of safeguards and how to apply them.
- Identifying, disclosing, and managing conflicts of interest.
- Decision making when threats cannot be reduced to an acceptable level, including withdrawal and declinature of engagements.
- The auditor’s responsibility for independence, objectivity, and confidentiality.

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. List the five fundamental principles of professional ethics.
2. Explain the difference between a self-interest threat and a familiarity threat, with examples.
3. What is a safeguard, and provide two examples of safeguards that could reduce threats to independence?
4. What action must an auditor take if a conflict of interest exists and cannot be managed, even with safeguards?
5. Can an audit firm act for two companies involved in a legal dispute with each other? If so, under what requirements?

## **Introduction**

Maintaining professional ethics and independence is central to audit and assurance. Auditors are required to follow a code of ethics consisting of five fundamental principles and must be alert to situations that threaten compliance. Such threats—self-interest, self-review, advocacy, familiarity, and intimidation—can arise in many forms and must be either eliminated or reduced to an acceptable level. If not, the auditor must refuse or resign from the engagement.

Safeguards are procedures or actions that reduce the risk of threats affecting ethical behaviour. They can be established by the profession, legislation, regulation, or within the firm. In some scenarios, especially where conflicts of interest occur—such as when acting for two competing or legally-opposed clients—even effective safeguards may not be possible. In those cases, further action, including declining or ending an engagement, may be needed to uphold professional conduct and comply with auditing standards.

> **Key Term: Fundamental principles**
> The five essential ethical standards auditors must uphold: integrity, objectivity, professional competence and due care, confidentiality, and professional behaviour.
>
> **Key Term: Threats**
> Circumstances that may compromise a practitioner’s compliance with ethical principles, such as self-interest, self-review, advocacy, familiarity, or intimidation.
>
> **Key Term: Safeguard**
> An action or measure that eliminates an ethical threat or reduces it to an acceptable level.
>
> **Key Term: Conflict of interest**
> A situation in which the professional’s duties to two or more clients, or to a client and personal interests, are in opposition so that objectivity or confidentiality is at risk.

## Types of Ethical Threats

The International Code of Ethics identifies five main types of threats:

- **Self-interest threat:** Where financial or other personal interests improperly influence judgement (e.g., excessive fees from one client, overdue fees, ownership of shares).
- **Self-review threat:** Where an auditor audits their own firm's work or recent work (e.g., preparing accounts that will be audited by the same firm).
- **Advocacy threat:** Where the auditor promotes a client’s position to the extent that objectivity may be compromised (e.g., representing a client in court).
- **Familiarity threat:** Where a close or longstanding relationship with a client or staff impairs objectivity (e.g., auditing a close relative's work or serving the same client for many years).
- **Intimidation threat:** Where actual or perceived pressures—such as threats of dismissal or lawsuits—coerce the auditor into acting contrary to the code.

> **Key Term: Self-interest threat**
> The risk that financial or personal interests will inappropriately influence professional judgement or behaviour.
>
> **Key Term: Self-review threat**
> The risk arising when an auditor is required to re-evaluate their own work or that of their firm.
>
> **Key Term: Advocacy threat**
> The risk that an auditor’s objectivity is threatened by acting as an advocate for a client.
>
> **Key Term: Familiarity threat**
> The risk of becoming too sympathetic to the interests of a client due to a close or longstanding relationship.
>
> **Key Term: Intimidation threat**
> The risk that an auditor is deterred from acting objectively by threats, whether actual or perceived.

## Safeguards: Purpose and Types

Safeguards are the ways that professional accountants prevent threats from leading to a breach of ethical principles. They may be established:

- **By the profession:** Such as mandatory continuing professional development or disciplinary oversight.
- **By law or regulation:** For instance, requirements for external quality reviews or partner rotation.
- **Within the firm:** Policies such as independent second partner review, staff rotation, client acceptance procedures, or confidentiality training.

Some threats can be managed fully with safeguards, while others may remain significant even after safeguards are applied.

### **Worked Example 1.1**

**An audit partner owns shares in an audit client. What is the threat and how should it be addressed?**

> **Answer:**  
> This creates a self-interest threat. The appropriate safeguard is for the partner to dispose of the shares immediately or to remove themselves from the audit engagement. If either is not possible, the firm must decline or resign from the engagement.

### **Applying Safeguards in Practice**

The firm must:

1. **Identify potential threats** as part of client acceptance or continuance procedures.
2. **Evaluate their significance.**
3. **Apply safeguards** if threats are not insignificant.
4. **Document** decisions and actions taken.

Common safeguards include:

- Using staff not involved in the provision of non-assurance services to perform the audit.
- Implementing quality control reviews by individuals unconnected to the engagement.
- Consulting with ethics partners or external advisers.
- Rotating senior staff off the engagement after a set number of years.
- Maintaining separate teams (with confidentiality agreements) for clients in potential conflict.

However, not all threats can be managed with safeguards. If a threat remains at an unacceptable level, the firm must refuse or withdraw from the engagement.

> **Key Term: Acceptable level**
> A level at which a reasonable and informed third party would conclude that the auditor’s compliance with ethical principles is not compromised.

### **Worked Example 1.2**

**A small audit firm receives unpaid fees from a client for several years, and the outstanding balance is material to the firm's revenue. What risks arise, and what action is required?**

> **Answer:**  
> This is a self-interest threat since the firm may prioritise payment over objectivity. The firm should obtain payment before continuing work. If this is not possible and the outstanding fees are significant, safeguards may be inadequate—so refusing reappointment may be required.

## Conflicts of Interest

A conflict of interest arises when an auditor’s duty to one client conflicts with duties to another—or when personal interests might compromise independence or confidentiality. Common situations include:

- Acting for clients in competition or in a legal dispute.
- Providing services to transacting parties on opposite sides of the same transaction.
- Serving as auditor and having close personal relationships with management.

Where conflicts are identified:

1. **Disclosure and consent:** The firm must explain the situation and seek written consent from all parties before proceeding.
2. **Use of safeguards:** Such as separate engagement partners/teams, restricted information access, and confidentiality agreements within teams.
3. **Independent review:** Key judgements may be reviewed by an unconnected senior member of staff.
4. **Physical and electronic barriers:** Measures to prevent confidential information from being shared.
5. **Withdrawal:** If consent is refused or effective separation cannot be maintained, the firm must decline or withdraw from any engagement creating the conflict.

> **Key Term: Chinese walls**
> Internal arrangements which restrict communication and information flow between separate teams to prevent conflicts of interest or breaches of confidentiality.

### **Worked Example 1.3**

**Your firm audits both Alpha Ltd and Beta Ltd, who are in direct legal dispute with each other. What steps are necessary?**

> **Answer:**  
> The firm must notify both companies about the conflict. If both agree in writing and effective safeguards (e.g., separate teams, information barriers) are in place, the engagement may proceed. If either client refuses consent, or effective separation is impossible, the firm must cease to act for one or both clients.

## When Safeguards Are Not Sufficient

If, after applying all available safeguards, the threat remains at an unacceptable level, the firm must take further action. This includes:

- Refusing to accept the new client or engagement.
- Withdrawing from the engagement.
- Informing appropriate authorities if required by law or regulation.

These actions must be fully documented, together with the reasons for the decisions taken.

### **Exam Warning**

> In exam questions, always be specific about the type of threat, the required safeguard, and whether the engagement should continue or be declined. Saying “apply safeguards” without details will not score marks.

### **Revision Tip**

> When reviewing scenario-based ethics questions, use a checklist: Identify the threat, describe one or more concrete safeguards, and conclude on whether to proceed or withdraw.

## **Summary**

Ethical threats can take many forms and may arise repeatedly in practice. Auditors must first identify all possible threats, assess their significance, and apply safeguards to lower them to an acceptable level. Whenever a conflict of interest exists, both disclosure and client consent are mandatory, and appropriate separation of teams and data is required. If these measures are inadequate, withdrawal is the only option.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- The five fundamental ethical principles required by the Code of Ethics.
- Identification and assessment of self-interest, self-review, advocacy, familiarity, and intimidation threats.
- The concept, purpose, and application of safeguards.
- Steps required to disclose, manage, or avoid conflicts of interest.
- Procedures when safeguards are not sufficient, including withdrawal or refusal.
- Importance of documentation and ethical decision making in audit practice.

## **Key Terms and Concepts**

- Fundamental principles
- Threats
- Safeguard
- Conflict of interest
- Self-interest threat
- Self-review threat
- Advocacy threat
- Familiarity threat
- Intimidation threat
- Acceptable level
- Chinese walls

Professional ethics and conduct - Safeguards and conflicts of interest