Code of Ethics for Professional Accountants

University Degree Business and Administrative studies

Auditor independence is very important in establishing the credibility of the audit opinion. The purpose of an audit is to enhance the credibility of financial statements by providing reasonable assurance from an independent source that they present a true and fair view. (Wikipedia Foundation Inc., 2008) Independence requires both independence of mind and independence in appearance. Independence of mind refers to the state of mind an auditor is in and how the auditor acts in dealing with a specific situation. Independence in appearance refers to the avoidance of facts and circumstances so as to reduce the opportunity for an auditor to act otherwise than independently, which consequently adds credibility to the audit report. (Tze, P. and Millichamp A. H., 2004)

In order to remain strictly auditor independence, many have advocated that auditor should not be allowed to provide any other services out of audit to his audit clients. (Wikipedia Foundation Inc., 2008) However, it does not prohibit auditor in preparing the profit tax return for his clients and adopting an advocate role in resolving questions related to tax return that may raised by the Inland Revenue Department in Hong Kong under the current Code of Ethics for Professional Accountants. This issue questions whether the auditor is independent enough to handle the above practice. This assignment will go through the advantage and disadvantage of auditor providing tax services to his clients, and suggest how the auditor might resolve such problems when he seeks to evaluate the reasonableness of the tax liability accrual made by a Hong Kong listed company.

The great advantage possessed by company’s auditor is that as a consequence of his audit work in prior periods, he is familiar with the general factual background against which the provisions of the law must be applied. Accordingly the auditor generally does not have to seek for client’s instruction to those facts, as would be the case with another tax adviser who does not possess the same familiarity. Furthermore, familiarity with client’s affairs in general enables an auditor to raise issues of fact and context which the client himself may not consider relevant especially if the client is not a tax professional. As a result, it cans greater cost effectiveness as well as better quality of advice. (Kolia, F., 2006)

Moreover, it is obvious that if the auditor involved in assessing tax significant events of his audit client and process during the year, they will be far better place to perform the year end audit function using the insights gain over the period. As auditor is required in any event to identify and analyze the tax significant events, the same event will have to analyze twice if tax advisory opinion is prepared by an external adviser. Therefore, it would be an advantage if company’s auditor also provides tax services to his audit client in order to lower the cost of obtaining that advice and shorten the audit process. (Kolia, F., 2006)

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In addition, materiality from an audit perspective varies substantially as between different companies and the Rand value which is designated as material is not known to the audit client, it is impossible to pre-identify those events which will have material tax consequences. The audit client possibly will be obliged to change his financial statements or accept he will be qualified. For such fundamental a difference to become apparent during a very limited time available for the completion of the audit process is clearly undesirable. All tax significant matter which have potentially material audit consequences must be discussed with and advised upon by a company’s auditors at the time the particular event takes place in order to protect the interests of all stakeholders. Therefore, it would be another advantage of providing tax services by company’s auditor so as to avoid the above situation. (Kolia, F., 2006)

However, by relying on tax advice from the company’s auditor, company may have chance to participate in tax shelter to avoid tax on profits resulting from the exercise of company stock options. This can rapidly put the auditor and the client into violation. The auditors almost inevitably become an advocate for his client if the Inland Revenue Department questions the validity of the shelter. The client will quite naturally look to the source to help convincing the Inland Revenue Department that the tax benefits claimed are legitimate. (Goelzer, D. H., 2003) Independence would be impaired when the auditor acted as an advocate for the audit client according to the principle of independence. (Purcell, T. and Lifson, D., 2001) Additionally, the auditor may find itself in the position of auditing his own work. The tax accrual on the client’s financial statements may be materially influenced by the supposed benefits of the tax shelter. (Goelzer, D. H., 2003)

Baker & McKenzie prepared a study on auditor independence and concluded that auditors who advise their clients in tax matters and file a tax opinion for the same client are not independent as Baker & McKenzie believes that a tax opinion, by definition, certifies that the client complied with its tax obligations. As the opinion enjoys a legal presumption that the facts stated are true an correct, Baker & McKenzie argued that the auditors essentially audit their own work as the auditor participates in tax planning and execution for their client and later certifies that the client has complied with their tax obligat6ions. Clearly, this is a lack of independence under the principles of the independence. (Tax advisers slam proposal to change independence rules, 2006)

Another disadvantage that threats to independence basically is the self-interest threat. Substantially, auditor will threaten revenue he receives from other business with the same client. Auditor may shirk his responsibilities and perform the audit and tax services without independence so as to satisfy client and maintain the engagement. This could lead to the manipulation of figures and exploitation of accounting standards. (Asharf, S. and Allen, P. L., 2003) It is common for the auditor to provide extra services such as helping his clients to reduce tax charges so that the auditor can keep his clients or earn an addition fee for such extra services. The auditor would no longer be working with independence as they would be dependent on the directors. (Wikipedia Foundation Inc., 2008)

Auditor may occasionally quote low prices to directors to ensure repeat business or to get new clients. As a result, the audit firm may not be able to perform fully audit and tax services as they do not have enough income to pay for thorough investigation. This would bring into question the auditor independence. In addition, price competition between accounting professions putting pressure on audit firms to reduce audit fees. The bidding of contracts encourages the reduction of auditor engagement hours. Such pressure caused the audit firm to reduce costs may compromise the quality of an audit and accuracy of tax. These lower the standard of audit performance and mislead shareholders. (Wikipedia Foundation Inc., 2008)

So, how does the auditor provides tax services without impairing independence? Although the Public Company Accounting Oversight Board identifies that routine tax return preparation and tax compliance, general tax planning and advice, international assignment tax services, and employee personal tax services would not be prohibit (Wolosky, H. W., 2005), more companies are switching their tax work to another accounting firm as the audit committees eager to avoid any chance of conflicts. (Borrus, A., 2004) In order to avoid any chance of conflicts, audit firm could simply interchange clients so as to maintain his revenue receives from client and also not impair independence. (Tax advisers slam proposal to change independence rules, 2006)

Other than that, audit firm may split into audit team and tax team so each team will keep the work that they will already have. (Tax advisers slam proposal to change independence rules, 2006) Tax department only responsible for assisting clients with preparing and filing tax returns, providing advice on tax and estate planning, and providing representation on tax issue before the Inland Revenue Department or tax courts to prevent impairment in independence. (Messier, W. F. et al., 2006) Alternatively, audit firm can also start up another new business specific in providing tax services to his audit client or non-audit client if possible so as to avoid impairment of independence and earn external revenue from non-audit client.

However, it will be quite difficult for audit firm which is small and medium size to split into team or start up a specific business only provide tax services. In this case, small and medium audit firm can seek for job rotation or assign at least one specific person in charge of tax services to his audit client. The person who is in charge of auditing should not handle any work relating to tax and all work relating to tax should be passed to the person who is specific in charge of tax service or pass to another auditor within the firm. Moreover, files between audit and tax should not be exchanged in order to maintain auditor independence.

Last but not least, Audit Committee is responsible for appointing, compensating, retaining and oversee the work of the independent auditors. In fulfilling this responsibility, the Audit Committee pre-approves audit and non-audit services provided by the independent auditors in order to ensure the services do not impair the auditor’s independence. (ExxonMobil, 2004) It is important that the audit Committee of the company should take in a role to approve tax services in advance. This approval can increase importance, influence, and potential for liability that audit committee has received because of Sarbanes Oxley. (Parles, L. M. et. al., 2007)

In conclusion, the Public Company Accounting Oversight Board acknowledges the advantages of an auditor also offering tax services, but it also see obvious situations in which it believes independence is impaired. (Wolosky, H.W., 2005) With the goal of Sarbanes Oxley to ensure the accuracy and reliability of financial information of companies on public markets, the benefits of the government’s intercession are often overlooked. Leading to a more fair market to investors and increase confidence of the current and future investors, Sarbanes Oxley required accounting profession a full disclosure, accuracy and transparency from now on. The accounting profession must address and learn to implement the regulations while determining how to balance auditing and consulting for his client within the framework of Sarbanes Oxley. (Parles, L. M. et. al., 2007)

Clearly, there is a case that there exists a significant cost and audit-process advantage to company of its auditor being allowed offer tax services. To legislate, it would increase the cost of doing business and create a significant threat of qualified audit reports being issued in situation where tax service with the company’s auditor would have avoided the problem arising. (Kolia, F., 2006)

Although there are several ways suggested before that may protect the auditor’s independent, this cannot fully avoid the impairment of independence as independence basically is rely on the personally ethics that an accounting profession behaves. Everything that is in connection with human being involved is difficult to control by neither rules nor limitations. No matter what, the most efficient way to maintain the independence of an auditor should be the principle ethic that an accounting professional conduct when he carries out auditing and provides tax services to his client.

Bibliography

Ashraf, S. and Allen, P. L. (2003) The changing landscape for tax and other services: Part 2. Corporate Taxation, March/April, 30(2), pp.3-16. ABI/INFORM Global. University of Bolton Learning Support. [Online] Available from <http://www.proquest.com/> [Accessed 1 June 2008]

Borrus, A. (2004) AUDITORS: THE LEASH GETS SHORTER; Providing tax services to audit clients will no longer be allowed. Business Week 3914, 27th December, p.52. European Business ASAP. Gale. University of Bolton Learning Support [Online] Available from <http://find.galegroup.com/ips/start.do?prodId=IPS> [Accessed 8 June 2008]

ExxonMobil (2004) Audit Committee pre-approval policy and procedure memorandum. [Online] Available from <http://www.exxonmobil.com/corporate/investor_governance_policies_procedure.aspx> [Accessed 1 June 2008]

Goelzer, D. L. (2003) The PCAOB and tax services. Tax Executive, March/April, 55(2), pp.146-149. ABI/INFORM Global. University of Bolton Learning Support. [Online] Available from <http://www.proquest.com/> [Accessed 1 June 2008]

Kolia, F. (2006) Tax Services and auditor’s independence – the case of the defence. [Online] Available from <http://www.ey.com/global/content.nsf/South_Africa/15_Aug_06_Tax_services_and_auditors_independence> [Accessed 8 June 2008]

Messier, W. F. et al. (2006) Auditing & Assurance Services : A Systematic Approach, 4th ed. Boston: McGraw-Hill/Irwin.

Parles, L. M. et. al. (2007) Sarbanes-Oxley: An Overview of Current Issues and Concerns. Review of Business, Spring, 27(3), pp.38-44ABI/INFORM Global. University of Bolton Learning Support. [Online] Available from <http://www.proquest.com/> [Accessed 1 June 2008]

Purcell, T. and Lifson, D. (2001) Auditor independence and tax practitioners. Journal of Accountancy, June, 191(6), pp.71-74. ABI/INFORM Global. University of Bolton Learning Support. [Online] Available from <http://www.proquest.com/> [Accessed 1 June 2008]

Tze, P. and Millichamp A. H. (2004) Hong Kong Auditing, 5th ed. Hong Kong: Pilot Publishing Company Limited.

Tax advisers slam proposal to change independence rules. (2006) International Tax Review, March, p.1. ABI/INFORM Global. University of Bolton Learning Support. [Online] Available from <http://www.proquest.com/> [Accessed 1 June 2008]

Wikipedia Foundation Inc. (2008) Auditor Independence. [Online] Available from <http://en.wikipedia.org/wiki/Auditor_independence> [Accessed 8 June 2008]

Wolosky, H. W. (2005) PCAOB on Tax Services and Independence. The Practical Accountant, February, 38(2), pp.22-23. ABI/INFORM Global. University of Bolton Learning Support. [Online] Available from <http://www.proquest.com/> [Accessed 1 June 2008]

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