• 10 Marks

AAA – L3 – Q14 – Rules of Professional Conduct

Identify and evaluate threats to the Code of Ethics for accountants in BKG Financial Ltd case.

Dabidaba & Co., an audit and assurance firm, has been engaged as auditors for the BKG Financial Ltd, a public limited liability company for some time now. BKG Financial has sixty branches throughout the country and branches in Benin, Mali, and Senegal. The Bank is one of the banks in the country which can boast of large landed properties. Dabidaba & Co. receives about 20% of its income from this particular client. Before last year’s audit, the bank engaged the audit firm to value its land and buildings in all its branches and headquarters. This work was executed by the audit firm and a report has been issued to management. The report has been incorporated in this year’s financial statements to be audited soon. Dabidaba & Co. sees BKG Financial Ltd. as a very important client whose works are always executed with dispatch.

Required:
(i) Identify and evaluate the significance of any threats to the Code of Ethics for Professional Accountants raised in the case.            (ii) Recommend safeguards to eliminate the threats (mentioned in (i) above) or reduce them to an acceptable level, if these are possible.

The scenario raises the following threats to the IESBA’s International Code of Ethics for Professional Accountants:

  1. Self-Review Threat:
    Dabidaba & Co. performed a valuation of BKG Financial Ltd.’s land and buildings, which was incorporated into the financial statements they will audit. Auditing their own valuation work creates a self-review threat, as the firm may not objectively evaluate the valuation’s appropriateness, especially if errors or biases exist. This threat is significant because the valuation could materially impact the financial statements, and the firm’s prior involvement compromises independence.
  2. Self-Interest Threat:
    BKG Financial Ltd. accounts for 20% of Dabidaba & Co.’s income, indicating significant fee dependency. This creates a self-interest threat, as the firm may be reluctant to challenge management or issue an adverse opinion due to the risk of losing a major client. The significance is high, as such dependency can impair objectivity and professional skepticism, particularly for a public interest entity like a bank.

Both threats are serious, as they undermine the firm’s independence and objectivity, which are critical for a credible audit, especially for a listed company with public interest implications.

     To address the identified threats to the Code of Ethics, the following safeguards are recommended:

  1. Self-Review Threat (Valuation Services):
    • External Review: Engage an independent external auditor or valuation expert to review the valuation work performed by Dabidaba & Co. before it is included in the financial statements. This reduces the risk of bias in auditing the firm’s own work.
    • Separate Teams: Use different teams within the firm for the valuation and audit engagements, ensuring no overlap in personnel. This segregates responsibilities and enhances objectivity.
    • Decline Non-Audit Services: If the self-review threat cannot be adequately mitigated (e.g., due to the valuation’s materiality), Dabidaba & Co. should decline to provide valuation services for assets included in the financial statements, as per IESBA guidelines for public interest entities.
  2. Self-Interest Threat (Fee Dependency):
    • Diversify Client Portfolio: Actively seek new clients to reduce the proportion of income from BKG Financial Ltd. below 20%, thereby lowering dependency.
    • Engagement Quality Review: Implement a mandatory engagement quality review by a partner not involved in the audit to ensure objectivity and professional skepticism are maintained.
    • Transparent Disclosure: Disclose the fee dependency to BKG Financial Ltd.’s audit committee and discuss safeguards to maintain independence, ensuring governance oversight.

If the self-review threat cannot be reduced to an acceptable level (e.g., if the valuation is highly material and no external review is feasible), Dabidaba & Co. may need to resign as auditors to comply with ethical standards. Similarly, if fee dependency remains significant despite safeguards, the firm should consider resigning to avoid compromising independence. These safeguards, if properly implemented, can reduce threats to an acceptable level, but their effectiveness depends on the firm’s commitment to ethical principles and regulatory compliance.

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