120: The conceptual framework

R120.3         The professional accountant shall apply the conceptual framework to identify, evaluate and address threats to compliance with the fundamental principles set out in Section 110.

120.3 A1      Additional requirements and application material that are relevant to the application of the conceptual framework are set out in:

(a)   Part 2 – Professional Accountants in Business (including CGMA designation holders)

(b)   Part 3 – Professional Accountants in Public Practice; and

(c)   International Independence Standards, as follows:

(i)    Part 4A – Independence for Audit and Review Engagements; and

(ii)   Part 4B – Independence for Assurance Engagements Other than Audit and Review Engagements.

R120.4         When dealing with an ethics issue, the professional accountant shall consider the context in which the issue has arisen or might arise. Where an individual who is a professional accountant in public practice is performing professional activities pursuant to the accountant’s relationship with the firm, whether as a contractor, employee or owner, the individual shall comply with the provisions in Part 2 that apply to these circumstances.

R120.5         When applying the conceptual framework, the professional accountant shall:

(a)   Exercise professional judgment;

(b)  Remain alert for new information and to changes in facts and circumstances; and

(c)   Use the reasonable and informed third party test described in paragraph 120.5 A4.

Exercise of professional judgment

120.5 A1      Professional judgment involves the application of relevant training, professional knowledge, skill and experience commensurate with the facts and circumstances, including the nature and scope of the particular professional activities, and the interests and relationships involved. In relation to undertaking professional activities, the exercise of professional judgment is required when the professional accountant applies the conceptual framework in order to make informed decisions about the courses of actions available, and to determine whether such decisions are appropriate in the circumstances.

120.5 A2      An understanding of known facts and circumstances is a prerequisite to the proper application of the conceptual framework. Determining the actions necessary to obtain this understanding and coming to a conclusion about whether the fundamental principles have been complied with also require the exercise of professional judgment.

120.5 A3      In exercising professional judgment to obtain this understanding, the professional accountant might consider, among other matters, whether:

• There is reason to be concerned that potentially relevant information might be missing from the facts and circumstances known to the accountant.
• There is an inconsistency between the known facts and circumstances and the accountant’s expectations.
• The accountant’s expertise and experience are sufficient to reach a conclusion.
• There is a need to consult with others with relevant expertise or experience.
• The information provides a reasonable basis on which to reach a conclusion.
• The accountant’s own preconception or bias might be affecting the accountant’s exercise of professional judgment.
• There might be other reasonable conclusions that could be reached from the available information.

Reasonable and informed third party

120.5 A4      The reasonable and informed third party test is a consideration by the professional accountant about whether the same conclusions would likely be reached by another party. Such consideration is made from the perspective of a reasonable and informed third party, who weighs all the relevant facts and circumstances that the accountant knows, or could reasonably be expected to know, at the time the conclusions are made. The reasonable and informed third party does not need to be an accountant, but would possess the relevant knowledge and experience to understand and evaluate the appropriateness of the accountant’s conclusions in an impartial manner.

R120.6         The professional accountant shall identify threats to compliance with the fundamental principles.

120.6 A1      An understanding of the facts and circumstances, including any professional activities, interests and relationships that might compromise compliance with the fundamental principles, is a prerequisite to the professional accountant’s identification of threats to such compliance. The existence of certain conditions, policies and procedures established by the profession, legislation, regulation, the firm, or the employing organisation that can enhance the accountant acting ethically might also help identify threats to compliance with the fundamental principles. Paragraph 120.8 A2 includes general examples of such conditions, policies and procedures which are also factors that are relevant in evaluating the level of threats.

120.6 A2      Threats to compliance with the fundamental principles might be created by a broad range of facts and circumstances. It is not possible to define every situation that creates threats. In addition, the nature of engagements and work assignments might differ and, consequently, different types of threats might be created.

120.6 A3      Threats to compliance with the fundamental principles fall into one or more of the following categories:

(a)   Self-interest threat – the threat that a financial or other interest will inappropriately influence a professional accountant’s judgment or behaviour;

(b)   Self-review threat – the threat that a professional accountant will not appropriately evaluate the results of a previous judgment made; or an activity performed by the accountant, or by another individual within the accountant’s firm or employing organisation, on which the accountant will rely when forming a judgment as part of the performing a current activity;

(c)   Advocacy threat – the threat that a professional accountant will promote a client’s or employing organisation’s position to the point that the accountant’s objectivity is compromised;

(d)   Familiarity threat – the threat that due to a long or close relationship with a client, or employing organisation, a professional accountant will be too sympathetic to their interests or too accepting of their work; and

(e)   Intimidation threat – the threat that a professional accountant will be deterred from acting objectively because of actual or perceived pressures, including attempts to exercise undue influence over the accountant.

120.6 A4      A circumstance might create more than one threat, and a threat might affect compliance with more than one fundamental principle.

R120.7         When the professional accountant identifies a threat to compliance with the fundamental principles, the accountant shall evaluate whether such a threat is at an acceptable level.

Acceptable level

120.7 A1      An acceptable level is a level at which a professional accountant using the reasonable and informed third party test would likely conclude that the accountant complies with the fundamental principles.

Factors relevant in evaluating the level of threats

120.8 A1      The consideration of qualitative as well as quantitative factors is relevant in the professional accountant’s evaluation of threats, as is the combined effect of multiple threats, if applicable.

120.8 A2      The existence of conditions, policies and procedures described in paragraph 120.6 A1 might also be factors that are relevant in evaluating the level of threats to compliance with fundamental principles. Examples of such conditions, policies and procedures include:

• Corporate governance requirements.
• Educational, training and experience requirements for the profession.
• Effective complaint systems which enable the professional accountant and the general public to draw attention to unethical behaviour.
• An explicitly stated duty to report breaches of ethics requirements.
• Professional or regulatory monitoring and disciplinary procedures.

Consideration of new information or changes in facts and circumstances

R120.9         If the professional accountant becomes aware of new information or changes in facts and circumstances that might impact whether a threat has been eliminated or reduced to an acceptable level, the accountant shall re-evaluate and address that threat accordingly.

120.9 A1      Remaining alert throughout the professional activity assists the professional accountant in determining whether new information has emerged or changes in facts and circumstances have occurred that:

(a)   Impact the level of a threat; or

(b)   Affect the accountant’s conclusions about whether safeguards applied continue to be appropriate to address identified threats.

120.9 A2      If new information results in the identification of a new threat, the professional accountant is required to evaluate and, as appropriate, address this threat. (Ref: Paras. R120.7 and R120.10).

R120.10       If the professional accountant determines that the identified threats to compliance with the fundamental principles are not at an acceptable level, the accountant shall address the threats by eliminating them or reducing them to an acceptable level. The accountant shall do so by:

(a)   Eliminating the circumstances, including interests or relationships, that are creating the threats;

(b)   Applying safeguards, where available and capable of being applied, to reduce the threats to an acceptable level; or

(c)   Declining or ending the specific professional activity.

120.10 A1    Depending on the facts and circumstances, a threat might be addressed by eliminating the circumstance creating the threat. However, there are some situations in which threats can only be addressed by declining or ending the specific professional activity. This is because the circumstances that created the threats cannot be eliminated and safeguards are not capable of being applied to reduce the threat to an acceptable level.

Safeguards

120.10 A2    Safeguards are actions, individually or in combination that the professional accountant takes that effectively reduce threats to compliance with the fundamental principles to an acceptable level.

Consideration of significant judgment made and overall conclusions reached

R120.11       The professional accountant shall form an overall conclusion about whether the actions that the accountant takes, or intends to take, to address the threats created will eliminate those threats or reduce them to an acceptable level. In forming the overall conclusion, the accountant shall:

(a)   Review any significant judgments made or conclusions reached; and

(b)  Use the reasonable and informed third party test.

Independence

120.12 A1    Professional accountants in public practice are required by International Independence Standards to be independent when performing audits, reviews, or other assurance engagements. Independence is linked to the fundamental principles of objectivity and integrity. It comprises:

(a)   Independence of mind – the state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity, and exercise objectivity and professional skepticism.

(b)   Independence in appearance – the avoidance of facts and circumstances that are so significant that a reasonable and informed third party would be likely to conclude that a firm’s or an audit or assurance team member’s integrity, objectivity or professional skepticism has been compromised.

120.12 A2    International Independence Standards set out requirements  and application material on how to apply the conceptual framework to maintain independence when performing audits, reviews or other assurance engagements. Professional accountants and firms are required to comply with these standards in order to be independent when conducting such engagements. The conceptual framework to identify, evaluate and address threats to compliance with the fundamental principles applies in the same way to compliance with independence requirements. The categories of threats to compliance with the fundamental principles described in paragraph 120.6 A3 are also the categories of threats to compliance with independence requirements.

Professional skepticism

120.13 A1    Under auditing, review and other assurance standards, including those by the IAASB, professional accountants in public practice are required to exercise professional skepticism when planning and performing audits, reviews and other assurance engagements. Professional skepticism and the fundamental principles that are described in Section 110 are inter-related concepts.

120.13 A2    In an audit of financial statements, compliance with the fundamental principles, individually and collectively, supports the exercise of professional skepticism, as shown in the following examples:

• Integrity requires the professional accountant to be straightforward and honest. For example, the accountant complies with the principle of integrity by:

(a)   Being straightforward and honest when raising concerns about a position taken by a client; and

(b)   Pursuing inquiries about inconsistent information and seeking further audit evidence to address concerns about statements that might be materially false or misleading in order to make informed decisions about the appropriate could of action in the circumstances.

In doing so, the accountant demonstrates the critical assessment of audit evidence that contributes to the exercise of professional skepticism.

• Objectivity requires the professional accountant not to compromise professional or business judgment because of bias, conflict of interest or the undue influence of others. For example, the accountant complies with the principle of objectivity by:

(a)   Recognising circumstances or relationships such as familiarity with the client, that might compromise the accountant’s professional or business judgment; and

(b)   Considering the impact of such circumstances and relationships on the accountant’s judgment when evaluating the sufficiency and appropriateness of audit evidence related to a matter material to the client’s financial statements.

In doing so, the accountant behaves in a manner that contributes to the exercise of professional skepticism.

• Professional competence and due care requires the professional accountant to have professional knowledge and skill at the level required to ensure the provision of competent professional service, and to act diligently in accordance with applicable standards, laws and regulations. For example, the accountant complies with the principle of professional competence and due care by:

(a)   Applying knowledge that is relevant to a particular client’s industry and business activities in order to properly identify risks of material misstatement;

(b)   Designing and performing appropriate audit procedures; and

(c)   Applying relevant knowledge when critically assessing whether audit evidence is sufficient and appropriate in the circumstances.

In doing so, the accountant behaves in a manner that contributes to the exercise of professional skepticism.