Fundamental principles, threats and safeguards

Accounting Ahead | Original study resource | accountingahead.com.au

Fundamental principles, threats and

safeguards

MODULE 1 | 1.2.1 | STUDENT COMPANION

Every assurance engagement rests on the Code of Ethics. Its five fundamental principles apply to every

professional accountant. The conceptual framework asks you to identify threats to those principles,

evaluate them through the eyes of a reasonable and informed third party, and address any that aren't

acceptable. Threats come in five types, and independence must exist both in mind and in appearance. A

threat is not a breach.

The five fundamental principles

Integrity

Be straightforward and honest in every

professional and business relationship.

Refuse to be linked with information you

believe is false or misleading.

Objectivity

Don't let bias, a conflicting interest or

pressure from other people override your

professional judgement.

Professional competence and

due care

Gain and keep the knowledge and skill a

client is entitled to expect, and act

diligently, carefully and on time, in line

with the standards. Can't get the

competence a job needs? Decline it.

Confidentiality

Don't disclose what you learn through

your work without proper authority,

unless the law or a professional duty

requires or allows it. Never use it for your

own or anyone else's advantage.

Professional behaviour

Comply with the law and avoid any

conduct that would discredit the

profession.

Part 1 of the Code: these apply to every professional accountant, in business or in public practice

A quick map of the Code

In Australia the APESB issues the same Code, with a few local additions, as APES 110.

Part Who it applies to, and what it covers

Part 1 Every professional accountant: the fundamental principles and the conceptual framework

Part 2 Professional accountants in business

Part 3 Professional accountants in public practice, including auditors and assurance practitioners

Part 4A Independence standards for audit and review engagements

Part 4B Independence standards for other assurance engagements

Part 5 Ethics and independence standards for sustainability assurance, added in 2025: in APES 110 from 1

January 2026; internationally for periods beginning on or after 15 December 2026

ADVANCED AUDIT AND ASSURANCE | M1 | 1.2.1 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

When confidential information may be disclosed: when the law requires it (for example, producing

documents in court proceedings, or reporting a breach of the law to the proper authority); when the law permits it

and the client authorises it; or when a professional duty or right applies and the law doesn't forbid it (for example,

a professional body's quality review, a regulator's investigation, or defending yourself in legal proceedings). Even

then, think about how much to disclose, and to whom. The duty continues after the engagement ends.

Case note: PwC Australia and the confidential tax consultations

Between 2013 and 2018, a senior tax partner at PwC Australia took part in confidential Treasury consultations

about new laws targeting multinational tax avoidance: he sat on Treasury's advisory group on base erosion and

profit shifting (November 2013 to June 2017) and joined consultations on the multinational anti-avoidance law

and the diverted profits tax, under confidentiality agreements signed in 2013, 2016 and 2018. The Tax

Practitioners Board later found that he had shared confidential information from those consultations with

colleagues inside the firm, and that the information was used to win and advise clients on how to respond to the

very laws being designed. In November 2022 the Board terminated his registration as a tax agent and banned

him from registering again for two years; it published the decision in January 2023. When the scale of the matter

became public in 2023, a Senate inquiry followed, the firm's chief executive stepped down in May 2023, and in

July 2023 PwC Australia sold its government consulting business to Allegro Funds (it became Scyne Advisory).

Principles broken: confidentiality (information given in confidence was passed on and used), integrity (the

conduct wasn't straightforward or honest with the government that had trusted the partner) and professional

behaviour (few things discredit a profession faster). The damage reached the whole firm and public trust in the

profession, not just one person.

Source: Tax Practitioners Board media release (23 January 2023); Treasury freedom of information release FOI 3269; Senate inquiry

reports (2023).

The conceptual framework: three steps

1. Identify

Spot the facts and

circumstances that create a

threat to a fundamental

principle

2. Evaluate

Is the threat at an acceptable level? Would a

reasonable and informed third party,

weighing all the facts, conclude you still

comply?

No 3. Address

Deal with any threat that isn't at an

acceptable level

Five types of threat

self-interest, self-review, advocacy,

familiarity, intimidation

Yes

Acceptable

Carry on, and evaluate again if the facts

change

Eliminate the circumstances that create the

threat

or

Apply safeguards that bring it down to an

acceptable level

if neither is possible

Decline or end the engagement

What counts as a safeguard?

An action that actually reduces a threat: for example, a reviewer from outside the team

checks the work, or the people on the engagement are changed

Acceptable level: a level at which, in the judgement of a reasonable and informed third party, you still comply

with the fundamental principles. Picture an objective outsider who weighs every relevant fact you knew, or could

reasonably be expected to know; they don't have to be an accountant. The three ways of addressing a threat

come in order: remove the cause if you can, reduce the threat with safeguards if you can't, and walk away if

neither works.

ADVANCED AUDIT AND ASSURANCE | M1 | 1.2.1 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Five types of threat, at Linden Ridge Partners

Threat Arises when... At Linden Ridge Partners (imagined)

Self-interest A financial or other interest could improperly

influence your judgement

One listed client's fees have grown to a fifth of the whole firm's

income

Self-review You will be evaluating your own work, or work

done by your firm

The advisory team designed a manufacturer's inventory costing

system; the audit team must now test the inventory figures it

produces

Advocacy You promote a client's position so far that your

objectivity is compromised

The firm is asked to promote a client's shares to investors, or to

represent a client in a dispute with the tax office

Familiarity A long or close relationship makes you too

sympathetic or too accepting

One client's engagement partner has led its audit for many years

and holidays with its finance director

Intimidation Actual or perceived pressure deters you from

acting objectively

A chief executive hints that the firm will be replaced if it insists on

an adjustment to profit

Where protection comes from

The current Code treats these as conditions, policies and procedures that help you identify and evaluate

threats. It keeps the word safeguard for an action that actually reduces a threat on a particular engagement,

such as rotating a partner or adding a reviewer.

Source Examples

The profession, legislation and

regulation

The Code itself; the auditing standards; the Corporations Act; ASIC's inspections;

education and professional development requirements

The client's environment An audit committee that oversees the auditor's appointment and approves any

non-audit work; competent client staff who make the management decisions

The firm Independence policies; partner rotation; reviews by partners outside the team;

monitoring of whether staff hold shares in clients

Applying it at Linden Ridge: rotating the engagement partner and adding an independent reviewer could

reduce the familiarity threat. For the fee dependence, a professional accountant from outside the firm might

review the audit work before the report is issued. Because the client is listed (a public interest entity), the Code's

fee rules also apply (periods beginning on or after 15 December 2022):

fees are, or are likely to be, more than 15% of the firm's total fees: the firm must tell those charged with

governance (here, the audit committee);

above 15% for two years in a row: the firm must consider a pre-issuance review by a professional accountant

from outside the firm, and the fee dependence must be publicly disclosed;

above 15% for five years in a row: the firm must stop being the auditor, except in rare cases with a compelling

public interest reason to continue.

ADVANCED AUDIT AND ASSURANCE | M1 | 1.2.1 | STUDENT COMPANION

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Independence: in mind and in appearance

Both are needed: an honest auditor who looks compromised still damages the value of the opinion. In Australia,

ASIC is responsible for surveillance and enforcement of auditor independence under the Corporations Act;

Module 2 covers the legal rules, including partner rotation.

Independence of mind Independence in appearance

What it is The state of mind that lets you reach a

conclusion without being affected by

influences that compromise your judgement

Avoiding facts and circumstances so significant

that your integrity, objectivity or scepticism

would seem compromised in the eyes of a

reasonable and informed third party

What it allows Integrity, objectivity and professional

scepticism in the decisions you actually

make

Users' trust in the opinion, which rests partly on

their belief that the auditor is independent

Who can see it Only you Investors, regulators and the public

Threat or breach? Threats are a normal part of professional life. A breach happens when a threat isn't identified

and dealt with, or when you do something the Code prohibits, such as an audit team member holding shares in

the audit client.

Practice questions

MODULE 1 | 1.2.1 | TRY THESE BEFORE THE WORKED ANSWERS

Question 1 - Name the threat and the principle under pressure

Situation (all firms are imagined) Threat type Principle

(a) An audit manager at Quill & Merrow inherits units in a property trust that the

firm audits, and plans to keep them for the income.

(b) Bramblecote Accountants valued a client's investment properties for its

financial statements. Its audit team will now audit those values.

(c) A partner at Ferrier Lowe tells a radio interviewer that an audit client's new

bond issue is 'the safest investment in the state'.

(d) At Ostler Grey, a tax manager's brother-in-law, who runs a rival business,

keeps asking him about a client's profit margins.

(e) A client's finance director tells Ashdown Pell's audit manager that the firm

will lose the tax work unless a large loan to the managing director is shown as

an ordinary trade receivable.

(f) To win its first listed audit, Merriden & Co quotes a fee covering only about

60% of the hours its own budget says the work needs.

ADVANCED AUDIT AND ASSURANCE | M1 | 1.2.1 | STUDENT COMPANION

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Question 2 - Apply the conceptual framework

Theo Tolland is the audit senior on the audit of Corrowa Freight (imagined), a road transport company. His

domestic partner, Jarrah, has just started work in Corrowa's payroll team, processing the weekly wages of its

300 drivers. Wages are Corrowa's largest expense, and the audit plan gives Theo the payroll testing. Apply the

three steps of the conceptual framework: identify the threats, evaluate them, and explain how they should be

addressed.

Question 3 - When confidentiality and integrity fail together

Using the PwC Australia case, explain how a breach of confidentiality can also be a breach of integrity. Refer to

what each principle requires.

ADVANCED AUDIT AND ASSURANCE | M1 | 1.2.1 | STUDENT COMPANION

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Worked answers

MODULE 1 | 1.2.1 | WORKED ANSWERS - ATTEMPT THE QUESTIONS FIRST

Question 1 - Threats and principles

Situation Type of threat Principle under pressure

(a) Inherited units in an audit

client

Self-interest: the income gives her a

reason to favour the trust

Objectivity (independence): sell the

units promptly or leave the team

(b) Auditing its own valuations Self-review: the firm would be checking

its own work

Objectivity (independence)

(c) Praising a client's bonds on

radio

Advocacy: promoting the client's

securities

Objectivity, and professional

behaviour

(d) Questions from a

brother-in-law

Familiarity: a close family tie (intimidation

if he applies pressure)

Confidentiality

(e) Threat to the tax work Intimidation: pressure to accept a

misleading disclosure

Integrity (being linked to misleading

information) and objectivity

(f) Fee far below the budget Self-interest: a temptation to cut corners

to protect the margin

Professional competence and due

care

Question 2 - Theo Tolland and Corrowa Freight (sample answer)

Identify: Jarrah is Theo's immediate family member (a domestic partner counts as a spouse). Testing the

payroll she helps process creates a self-interest threat (he may want to protect her job), a familiarity threat

(he may be too ready to accept her work) and possibly an intimidation threat to his objectivity, scepticism

and independence; confidentiality is also at risk.

Evaluate: it depends on both roles. If Jarrah could exert significant influence over the accounting records or

the financial statements (say, as payroll manager posting the wages journals), the Code bars Theo from the

audit team. As a new wages officer she probably can't, but wages are the largest expense and Theo would

test her work directly, which a reasonable and informed third party is unlikely to accept.

Address: Theo tells the engagement partner at once. Eliminate the threat by taking him off the team

(required if Jarrah has significant influence), or apply safeguards: give the payroll testing and anything

touching Jarrah's area to another team member, with review by an appropriate reviewer. If neither works,

Theo comes off the engagement. Document the decision and evaluate again if Jarrah's duties change.

Question 3 - Confidentiality and integrity in the PwC case

Confidentiality forbids disclosing information gained through professional work without proper authority, or

using it for anyone's advantage. The partner received Treasury information under confidentiality agreements and

passed it to colleagues, who used it to win and advise clients. Integrity requires you to be straightforward and

honest in every professional relationship. The government let him into the consultations because it trusted him;

taking part while passing the content on was not straightforward or honest with that party. So one course of

conduct breaches both principles, and professional behaviour too.

ADVANCED AUDIT AND ASSURANCE | M1 | 1.2.1 | WORKED ANSWERS

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