In these videos, we walk through 5 AUD practice questions in each to teach about the ethical and independence rules for auditing government entities. These questions are from AUD content area 1 on the AICPA CPA exam blueprints: Ethics, Professional Responsibilities, and General Principles.
The best way to use each video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
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Ethical and Independence Rules for Auditing Government Entities
The Generally Accepted Government Auditing Standards (GAGAS), often referred to as the Yellow Book, set forth the ethical principles and independence rules that auditors must follow when conducting audits of government entities or entities receiving federal awards. These standards ensure that auditors act with integrity, serve the public interest, and maintain objectivity in their work.
Ethical Principles Under GAGAS
GAGAS outlines six fundamental ethical principles to guide auditors:
- Serving the Public Interest
Auditors have a duty to act in the public’s best interest by promoting accountability and transparency.- Example: An auditor uncovers significant misuse of grant funds and reports it, despite pressure from the audited entity to downplay the issue.
- Integrity
Auditors must conduct their work honestly, without bias or deceit.- Example: An auditor declines a bribe from an official seeking to conceal financial misstatements.
- Objectivity
Auditors must be impartial and free from conflicts of interest, ensuring that personal or external factors do not influence their judgment.- Example: An auditor who previously worked for the entity being audited recuses themselves to avoid a potential conflict.
- Proper Use of Government Information, Resources, and Positions
Auditors must not use their access to government information or positions for personal gain.- Example: An auditor does not share confidential audit findings with unauthorized individuals or use the findings for personal benefit.
- Professional Behavior
Auditors must comply with laws, regulations, and professional standards.- Example: An auditor ensures their audit procedures align with GAGAS requirements and applicable federal regulations.
- Avoiding Conflicts of Interest
Auditors must avoid situations where their objectivity or independence might be questioned.- Example: An auditor declines an engagement where their close relative works as a financial officer for the audited entity.
Independence Threats Under GAGAS
In addition to the ethical principles, GAGAS emphasizes the importance of independence in appearance and fact. Independence threats can arise in various forms:
Self-Interest Threat
Definition:
A self-interest threat occurs when auditors have a financial or personal interest that could impair their objectivity.
Example:
- Scenario: An auditor’s firm receives 15% of its revenue from consulting services provided to a vendor closely linked to the audited entity.
- Analysis: The financial reliance on the vendor creates a self-interest threat, as the auditor may hesitate to report findings that could harm the vendor relationship.
Self-Review Threat
Definition:
A self-review threat arises when auditors audit their own work or judgments from previous engagements.
Example:
- Scenario: Six months before auditing a government agency, a CPA firm helped the agency prepare its financial statements and develop internal controls.
- Analysis: Auditing the agency’s financial statements and controls now requires the auditor to evaluate their prior work, creating a self-review threat.
Familiarity Threat
Definition:
A familiarity threat arises from close personal or professional relationships with individuals at the audited entity, potentially impairing objectivity.
Example:
- Scenario: The executive director of a nonprofit being audited is a close personal friend of the auditor, and they frequently vacation together.
- Analysis: The personal relationship creates a familiarity threat, as the auditor may unconsciously avoid issuing critical findings.
Management Participation Threat
Definition:
A management participation threat occurs when auditors take on management roles or responsibilities within the audited entity.
Example:
- Scenario: An auditor agrees to temporarily approve vendor invoices and post journal entries after the finance director of a school district resigns.
- Analysis: By performing management functions, the auditor undermines their independence and cannot objectively evaluate these decisions.
Mitigating Independence Threats
To address independence threats, auditors must assess the facts and circumstances and implement safeguards, including:
- Assigning another auditor to review areas of concern.
- Declining engagements where independence cannot be reasonably assured.
- Disclosing relationships and ensuring transparency with stakeholders.
Conclusion
GAGAS provides a comprehensive framework for ethical behavior and independence, ensuring that auditors serve the public interest while delivering high-quality audits. By understanding and applying the six ethical principles and recognizing common independence threats, auditors can maintain trust, objectivity, and compliance with professional standards.
