1. a) In the first situation, the board of directors being impressed with the last year’s audit performed by Clarke and Johnson intends to reappoint them as the auditor for the 30 June financial year audit. Chris being the CEO of the company also intends to invite Geoff (CJ’s audit partner) to deliver a speech about the company’s effectiveness in the upcoming seminar so that more investors are attracted. However, if Geoff refuses to offer such assistance, the company has no intention to re-engage them. This is a threat tothe auditor’s independence in relation to appointment and termination procedure because the firm will not get its engagement if they do not progress as per the company’s wishes. Besides, Chris is already aware that this demand from the auditor is their normal practice, but still, he states that the Board will not continue with business engagements with CJ if they fail to provide such assistance. In the second situation, Chris has provided a fourteen-day holiday package voucher for Geoff and his family in order to attain another smooth audit like that of the last year. Moreover, the company has also offered benefits of taking care of every expense incurred by Geoff during his travel. This clearly implies a self-interest threat to the auditor’s independence because even though an auditor is bound to provide an unbiased judgment, yet such benefits can easily tamper their reporting (Tepalagul & Lin, 2015). In other words, the auditors may provide an inappropriate judgment in order to the please the Board for such extended benefits. In the third situation, it can be seen that Geoff has suggested the company appoint Michael in their tax advisory segment and accommodate him in the audit team as well (Lapsley, 2012). However, Michael’s father already works for the company as a financial controller and hence, it is clear that Michael will have a mutual interest in the company’s financial matters. Besides, if he is accommodated in the audit team of LTH, he may show his unethical nature by offering biased opinions. Furthermore, his father may also persuade him to shed light only on the effective sides of the company. Nonetheless, this is a case of familiarity threat. In the last situation, Annette is an accountant who operates in the accounts and tax department of the company and now it is recommended by Geoff to accommodate her in the audit team as well (Church et. al, 2008). This is a case of self-review threat on the part of Annette because she already is well accustomed with the accounting computations and workings of the company and being an auditor will not make her find any shortcomings in her own doings (Blay et. al, 2011). This is because a person cannot audit his or her own accounting works and therefore, the judgement of Annette may become biased in nature.
b) The safeguards for the previously mentioned threats are as follows:
In the first situation, it is the responsibility of CJ to prevent acceptance of such appointment because they have to perform non-audit tasks for such engagement. Furthermore, CJ must communicate with independent audit committees regarding such intimidation by the CEO. Besides, showing a good side of the company to attract more investors can diminish their ethical values and therefore, in order to present a fair and unbiased judgment, it is very relevant for CJ not to perform non-audit tasks. In the second situation, the auditor must design strict rules and regulations that restrict receipt of gifts in cash or kind apart from normal audit fees (Fazal, 2013). The auditor must not accept any type of favors or help that may influence his judgment. In addition, the auditors must also make way for proper communications with the management of the audit firm in order to disclose the nature of services offered and fees chargeable in respect of the same. Besides, rotation or reassignment of auditors can also be considered to safeguard from such self-interest threats. In the third situation, the safeguard most appropriate are that the audit team must not comprise of members who are related to the owners or other employees of the company. Moreover, the SOX Act also establishes the same guidelines in respect of an auditor’s appointment and therefore, the audit team must not be interconnected to any management person. Besides, selection of any other qualified personnel as an auditor who does not have any kind of interest in the company can prove immensely advantageous. In the last situation, the audit team must not comprise of members who were employees of the company prior to being appointed as an auditor. This is because an ex-employee can be incapable in auditing and examine his or her own doings. Further, he or she may not find any error in the work performed by them. Therefore, in order to avoid self-review threat, the most appropriate safeguard is the appointment of another qualified person in place of an ex-employee so that an independent and unbiased judgment can be obtained.
Therefore, it can be termed as the best protection in tune to the past mentioned threats upon the auditor’s independence. However, it is completely in the auditors aim to check whether the independence is influenced by the company’s proceedings. Further, the protections play a vital role in the development of the genuine view of the financial statement of the company, hence leading to a notion that is independent and free from any undue influences.
2. a) Crampton and Hassadas an auditor of Mining and Supplies Ltd must take into account the following business risks associated with the outsourcing of manufacturing of spare parts and equipment. First, the company has not implemented any type of approach to make sure whether the quality of equipment obtained from the suppliers is effective or not. Moreover, such products are directly transported to the warehouses of the company and are sold to the customers thereafter (Gilbert et. al, 2005). This sheds light on the fact that since the goods are directly sent from the warehouses, there is no mechanism that can ensure the quality of received items. Therefore, this can result in several rejections and returns by customers if the quality of equipment is not up to the mark (Carcello, 2012). As the company itself is responsible in this case, it is bound to pay the carriage expenses that will be incurred for replacing the equipment with the fresh ones. In addition, since each item of equipment brought by a customer comes with a two-year labor warranty and spare parts, the company has no right to ask the same from the original manufacturers and hence, this increases its warranty costs. Besides, every supplier is situated at far off locations from the company’s head office, and there is a high business risk that the ordered equipment might be damaged on the way. In addition, proper insurance policies cannot cover the loss of destruction or theft of the transported goods, thereby generating another business risk (Holland & Lane 2012). Secondly, the maintenance services offered by MSL to its customers demand mobile mechanics to travel to distant locations and offer the same. However, these mechanics may charge undue charges from the customers because there is no measure to trace the exact area travelled by them and the efficacy of other expenses incurred mid-way.
When it comes to the expenses of the company, the maintenance expenses play a prominent role and it can stretch to an unstoppable level if there is an absence of a tracking method. Therefore, this tends to bring inflation in the expenses of the company that relates to transportation, as well as administration and to keeps the destruction at bay, the company is unable to judge the service quality (Heeler, 2009). Moreover, there appears no proper mechanism to grab the tools from the suppliers, the company is under an obligation to purchase the items from suppliers hence bringing the point of incapability to reduce the cost of manufacture.
b) In relation to the business risks mentioned above, there are audit risks as well. The first audit risk associated with Mining and Supplies Ltd is that the auditor is not able to take into account whether the costs incurred on warranty by the company is true to the best of its knowledge or not (Cappelleto, 2010). Therefore, in the absence of a proper measure, it may happen that either the mobile mechanics create fake inflated bills or the company itself may charge excessive warranty costs. Furthermore, the mobile mechanics are already aware of the fact that the company is bound to offer one free service to all its customers and as a result, they may do so in order to make the company responsible for all the charges incurred while providing free service. Besides, since the auditors cannot evaluate the correctness of the warranty costs, overstatement of such expenses can surely minimize the revenue figures of the company (Cameran et. al, 2016). In addition, both maintenance and finance divisions of the company are situated at distinct places and therefore, both these divisions are unknown to each other’s operations. Therefore, the warehouse department of the company cannot appropriately verify the reimbursement bills that are submitted to the finance divisions in the head office at Melbourne. Hence, in the prevalence of a huge administrative gap between these departments, even the auditors cannot doubt the bills paid by the company head office, as its warehouses have nil authority on warranty costs. Nonetheless, the account balances that can be influenced in this case are costs of spare parts, maintenance costs, and warranty costs of the company.
The second audit risk associated with Mining and Supplies Ltd is that the auditors cannot determine the exact value of the closing stock because the management has failed to introduce a mechanism that can ascertain the correct pricing of the equipment produced by the manufacturers and instead, has relied on the parts that are utilized in the manufactured items (Cameran et. al, 2016). Furthermore, since the warehouses even have not adopted a proper process to check the pricing of equipment, it may create a severe risk for the auditors. This is because the judgment of auditors based on the closing stock can influence the company’s revenue amounts as a whole. In other words, understatement of amounts of closing stock can diminish the profits of the company and overstatement of the same may increase the profits. All these complications can further result in stakeholders’ loss of confidence in the company (Wright & Charles, 2012). Nonetheless, the account balances that can be directly influenced in this case are figures of closing stock, revenue figures, and suppliers’ balances.
Hence, these are the audit risks identified in relation to the previously mentioned business risks and thus, the offering of a judgment comprising of errors can be very destructive for the company.
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