1. You are an audit manager with Clarke & Johnson (CJI). For the past years CJ has been the auditor of luxury Travel Holidays LTD (LTH), a travel company. Geoff, the audit partner, has asked you the to contact Chris, LTH's CEO, with a view to CJ being re-engaged as the auditor for the upcoming audit of the 30 June 2015 financial report.
Geoff has also indicated that intends to allocate Michael, a first-year accountant, and Annette, an accountant in CJ's tax advisory department, to the LTH audit for the first time. Geoff suggested that you discuss the audit with each of these staff, with a view to identifying any independence issues. You held talks with Chris, Michael and Annette of these conversations were as follows:
Conversation with Chris, situation 1
Chris stated: The board of directors were impressed with last year's audit and would like to propose reappointing CJ as the auditor of the 30 June 2015 financial report audit. The board would also like to invite Geoff to give a speech about LTH at the next travel agency seminar, to assist in promoting LTH's business to attract more investors. I understand that this is outside CJ's normal practice; however, the board expressed the view that it will be very difficult for LTH to continue any business engagements
with CJ should Geoff refuse to provide such assistance.
Conversation with Chris, situation 2
Chris stated: To express our sincerity towards CJ and Geoff, and to maintain the good relationship in anticipation of another smooth audit for 2015, LTH would like to present a complimentary 14-day holiday package voucher for four people to the Greek isles for both Geoff's and your family. All expenses, including accommodation and travelling cost, will be paid by LTH.
Conversation with Michael 3
Michael stated: I am very excited to be part of the audit team. I believe that I will be a valuable asset to the team, as my dad is LTH's financial controller. He is responsible for the preparation of LTH's financial report.
Conversation with Annette 4
Annette stated: I am glad that I have been allocated to this year's LTH's audit team. It' s going to be a very efficient audit this year! I was on a temporary assignment at LTH's just a month ago, helping LTH with its tax calculations and preparing accounting entries that will be reflected in the 30 June 2015 financial report, so I don't think there will be much audit work required around the tax accounts. It will be great to catch up with everybody at LTH again, as they are so easy to work with.
(a) For each situation, identify and evaluate any threats in relation to auditor independence.
(b) Identify any safeguards to those threats identified above.
2. You are an audit senior with Crampton and Hasaad and you are planning the audit of Mining supplies LTD (MSL) for the year ended 30 June 2015. MSL sells mining equipment and spare parts to mining companies across Australia. MSL has operational centres in Perth, Newcastle, and Mt. Isa. Each operational centre warehouses the equipment and spare parts and provides sales and maintenance services. MSL's head office is located in Melbourne where finance, IT and other corporate services are provided.
MSL has equipment purchase order contracts with a number of manufacturing suppliers based in Europe, Us and China. These manufactures build the specialised, made- to-order equipment and spare parts and ship them to MSL's operational centres.
Each item of equipment purchased by a customer comes with a two-year spare parts and labour warranty from MSL. The warranty entitles the customer to a maximum of one free maintenance service per year during the warranty period.
Depending on the type of equipment and customer's location, a maintenance service can take between one day and one week. MSL uses contracted mobile mechanics who travel to the customer's location to carry out all maintenance services. Some services require the mechanic to travel long distances, due to the remote locations. Any maintenance services that are inside that are outside the warranty conditions are billed to the customer. The billing covers a daily labour rate for the mechanic's time, any parts replaced and reimbursement for travel, accommodation and living expenses incurred by the mechanic.
(a) In relation to the purchasing of equipment and spare parts, describe two business risksto MSL that Crampton and Hasaad will consider in planning the 2015 audit.
(b) For each business risk identified in (a) describe a specific audit risk that could arise. Each responses should include the identification of account balances that are impacted directly by the audit risk.
1. (a) Risk for Independence of Auditor
Condition 1 with Chris
While analyzing the situation given in the case, it has found the threat of economic bond will hamper the independence of the auditor. This type of threat appears in the situation because the auditor is forced for presenting the financial statements of company in a seminar. This shows the undue influence on the auditor has been put for promoting the company so that the business of the organization can be increased by getting the more reliability of investors in company. Also, the auditor has been clued-up that if the auditor denies doing so then next year engagement will not be in his favor. (Edwin, 2015). The risk will be evaluated with the quantum of damage it will create to Auditor Independence in maintaining the true and fair reporting.
Condition 2 with Chris
After considering the condition given, the threat of loss of engagement and threat of self interest are identified. These threats comes in the situation because the company has offered extra free benefits i.e. free holidays packages for audit team member and his family for two weeks. The free benefit has been offered for the coming year audit working so that audit can be done in even way. In this manner, the independence of auditor is in danger situation (Barizah, 2016). The risk in the situation will be evaluated by the level of self interest generated in the mind of audit team member. The auditor will issue the unqualified report if the company is able to create such type of interest and the extent of not reporting the error will increase automatically.
Condition 3 with Michael
In this condition, after analysis the level of risk the threat of relationship has been identified by the Auditor. In this condition, one of the audit team members has close and cordial relationship with the Finance head of the company. Finance Controller of the company has dominance over Michael, member of audit team, as he is the father of Michael. Because of this dominant relationship, the Finance head influenced the audit team not to report certain matter or to report certain matter in manipulative manner. And this can create the situation of hiding of certain material facts. The risk in this type condition can be assess on the basis of degree of influence in the relationship and for how much time it will present during the audit tenure (UK, 2013).
Condition 4 with Annette
After listening Annette, the risk involved in the condition under consideration is the threat of Self Review. This happens because the Annette has worked for organization for one month for areas not covered as audit services. The audit member provided the services on accounting entries and taxation matter. The member has build up very good relationship with the employees of the company with whom he has done accounting work finalization. If the audit team member has done mistake in making accounting entries, then he will not report the same in while doing the audit so that partner of audit firm will not scold him. The risk can be assess by ascertaining the quantum of work done by the Audit team member in relation to accounting and taxation matter and the facts suppressed by the her while doing such services (Parker, 2015).
(b) Protection against the risks involved in the given conditions
Protective measures the methods which help to reduce the level of risks involved in any particular situation. In case of Audit, the auditor has to use these measures while conducting the audit to protect the independence or integrity so that the reporting done by him is true and fair in letter spirit. The protective measures which are available for auditor are laid down in different and applicable laws, regulations, rules, statutes of the country in the auditor is working. Also, the protective methods can be developed by the audit firm from its past experiences. Sometimes even the client policies lay the safeguards which the auditor will follow to save his integrity. The below are certain protective measures that are generally followed by the auditor in the situations given:
- Differentiating the Audit and non Audit service team member. This means the if the auditor gives audit and non audit services to client, the non services team member shall not be the part of Audit Team for the same client during the same year for which both the services are given to client.
- The member of audit team should work very professionally by applying the different professional ethics made of them. And they should not develop the dominant relationship with any of the officers of the company.
- If there is undue influence on auditor, then the auditor shall vacate the office of audit after informing to appropriate authorities.
- The auditor shall not accept any undue benefit given by client so that he can report about the matters of the company without any mental pressure.
- The audit partner should ensure that audit staff is not related to any officer of the company on the personal front (Livine, 2015).
2. (a) Risk in Business of Client taken into account at the time of Audit
Every business is full risks or threats. And while conducting the audit, the auditor has to take into account in his audit program the risk involved in the business of the client. The risks involved in the business increases as size and complexity of the business increase. The auditor has to see these risks before the start of the audit. The below are the two risks which are involved the business given in the situation:
- The major business risk involved in the given situation is deteriorating the Customer base. Revenues in the business are earned from the Customers of the products or services in which the company deals. The growth of the company depends on the happiness of their customers. In the given case of company of MSL Mining Supply Limited, the company is acquiring the raw materials from different locations of the world i.e. United States, United Kingdom, China etc. The raw materials are being purchase without having a proper warranty and substitution if case of damage. Similarly, the company is not giving the warranty and replacement to customers and has led to decrease the satisfaction level of customers. If the company wants to make their customers satisfied then the company has to incur the huge cost so that they can give warranty and replacement free of cost to their customers. These costs increase the overall expenses of the company and reducing the margin of the company (Imrie, 2011).
- The other business risk involved in the case is Loss of Goods in Transit. The company is purchasing the materials without having proper agreement with its creditors about the loss of stock in transit. So if there is any loss while transporting the material from supplier to company place, then the loss has to be borne by the company which in itself increases the cost of the company. Non clearance in agreement with supplier led the company in hay way situation which affect the profitability of the company (EY, 2016).
(b) Risks in Audit
While conducting any audit, there are chances of risk involved in audit. The risk so involved should be taken into account by auditor while planning and doing the audit. The audit should consider these risk to given an uninfluenced opinion on the affairs of the company. The report presented by auditor is prepared after considering the risks of audit otherwise the audit report will not give an actual picture of the company. More importantly, the audit risk shall be defined in accordance with the business risks identified while planning the audit. Following are the audit risks that may be encountered by the auditor:
- Inherent Risk – It is the risk which occurs due to the inherent limitations present in the company. These limitations are due to the fact of having the same procedures and policies that have been prevailing from the inception of the company. The business risk of deterioration of the customer base has been due to the lack of internal control procedures in relation to management of the customer relationship is very weak and due to which there might be chances where the company may incur the losses and can go to liquidation of the company (Long, 2015 and Becker, 2015).
- Detection Risk- The detection risk is the risk that has been encountered in the second type of risk. The presence of this type of risk has been identified because of the fact that the auditor is not able substantiate with the documents and the earlier practices being followed by the company whether the cost of loss of stock will be borne by the company or by the supplier. He has to include in his plan of audit whether the substantive or additional procedures are required for the same or not. The account balances that have been identified in this and will be affected are the stock and account payables in comparison to the last year.
Becker E, (2015), “Audit Risk vs. Business Risk”, available at https://www.osyb.com/blog/small-business/audit-risk-vs-business-risk/ accessed on 27/04/2017.
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Edwin M, (2015), “Analysis of Threats to Auditor Independence and Available Safeguards against those threats”, available at https://www.academia.edu/9406967/ threats_to_auditors_independence accessed on 26/04/2017
EY, (2016), “Top 10 Business Risks”, available at https://www.ey.com/Publication/vwLUAssets/EY-business-risks-in-mining-and-metals-2016-2017/%24FILE/EY-business-risks-in-mining-and-metals-2016-2017.pdf accessed on 27/04/2017.
Imrie B, (2011), “Business Risks facing the Mining Industry”, available at https://www.in.kpmg.com/SecureData/ACI/Files/Top_20_Risks_the_Mining_Industry.pdf accessed at 26/04/2017.
Livine G, (2015), “Threats to Auditor Independence and Possible Remedies”, available on https://www.financepractitioner.com/auditing-best-practice/threats-to-auditor-independence-and-possible-remedies?full accessed on 27/04/2017.
Long G, (2015), “Audit Risk and Business Risk”, available at https://www.cpaireland.ie/docs/default-source/Students/Study-Support/P2-Audit-Practice-Assurance-Services/audit-risk-and-business-risk.pdf?sfvrsn=0 accessed on 27/04/2017.
Parker A, (2015), “6 Key Threat to Auditor Independence”, available on https://www.intheblack.com/articles/2015/01/06/6-key-threats-to-auditor-independence accessed on 27/04/2017.
UK Essays, (2013), “Threat To Auditor Independence Accounting Essay.” Available at https://www.uniassignment.com/essay-samples/accounting/threat-to-auditor-independence-accounting-essay.php?cref=1 Accessed on 26/04/2017