APES 110 And Auditing Principles: Risks, Safeguards, And Mitigation Strategies Essay.

Overview of Conversations Highlighting Breaches of APES 110 and Auditing Principles

 Question (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:
1. 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’.
2. 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’.
3. Conversation with Michael
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.’
4. Conversation with Annette
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.’
Required: 
(a) For each situation, identify and evaluate any threats in relation to auditor independence .
(b) Identify any safeguards to those threats identified above.
Assignment Question (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. 
Required:
(a) In relation to the purchasing of equipment and spare parts, describe two business risks to 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. The applicable threat associated with each of the conversations presented below is as identified below.

Conversation 1: Chris, LTH’s CEO communicates to the audit manager of CJI that the board would like to extend the association by awarding the audit contract but it would be dependent on the extension of a favor by Geoff whereby he would have to deliver a promotional speech in the interests of the client thereby helping it to attract higher investors.  Indulging in such promotion activities is prohibited by APES 110 due to presence of advocacy threat (Section 200-6). The users coupled with the investors may look at the promotional speech with suspicion thus raising doubts regarding the auditor independence and the company needs to take the relevant safeguards in order to minimize the current threat (APES, 2010).

Conversation 2: A holiday package of 14 day duration is offered by CEO of the client to the audit partner and manager where all expenses would be taken care by the client and also carrying family along was possible.  In case of accepting of high value gifts, the familiarity thereat is present as highlighted in s. 200-7. The acceptance of gifts that too of significant financial value must not be undertaken as the underlying objectivity may undergo significant impairment as the auditor may be tempted to promote the interests of companies at the cost of the trust bestowed by users thus drawing on the  necessity to take appropriate measures (APES, 2010).

Conversation 3: When Michael learns about him being part of LTH’s audit team, he assures that his addition would be quite valuable as his father occupied the office of financial controller for LTH. Michael should be dropped from the team or else the familiarity threat (Section 200(7)) would be significant.  Michael may experience this situation where on one hand his professional ethics would be tested when he might have to upheld the interests of his father thus leading to conflicting interest and hence through adequate safeguards, threat must be minimized (CPA, 2013).

Conversation 4: When Annette learns about her being part of LTH’s audit tea, she assures that the audit of LTH is not expected to be time consuming and this inclusion opportunity would also provide her interaction with former colleagues as it has been only a month since she joined CJI and LTH happens to be her previous employer.  The applicable threats are s. 200(5) (self review threat) and s. 200(7)) (Familiarity threat).  Here there is presence of self review threat as some of the statements that would be analyzed by Annette may have been prepared by her own self and thus it is likely that fails to see errors or chooses to ignore the same. Further, the inclusion of Annette would lead to threats of familiarity because of the reputation with the senior employees.  Clearly the risks are quite material and need appropriate mitigation techniques. (CPA, 2013).

1. The appropriate safeguards to enabling of minimization of identified threat above are indicated below.

Risks Arising Due to Breaches of APES 110 and Auditing Principles

Conversation1: At the firm level the appropriate strategy would be to enact a policy if one does not exist so as to broadly commit to the APES 110 principles and thereby ensure zero tolerance towards engagement in any promotional activity. Further, there would be strict enforceability of this policy. The client also on its part must ensure that no favoritism and unethical requests should be expected in the selection of the auditor as in the long run wrongdoing would harm the company (Arens et. al., 2013).

Conversation 2: At the firm level the appropriate strategy would be to enact a policy if one does not exist so as to broadly commit to the APES 110 principles and thereby ensure that the employees accept no gifts from clients irrespective of their value and in case a particular gift is retained , then the same should be revealed to the company. Also, there must be strict enforceability of this policy measures and no deviation would be acceptable (Gay & Simnett, 2012).

Conversation 3

The appropriate safeguard existing at the firm level is  ensuring that the audit firm has complete data about the employment of near relatives’ which would ensure that the audit firm can take additional measures to safeguard the independence. Through a online database, the employees would be expected to update this as and when required. Further, a declaration on the candidates’ part is required before a member can be selected to any audit team in order to ensure that no immediate or distant family member has been employed in any position by the client (Caanz, 2016).

Conversation 4

The appropriate safeguard existing at the firm level is ensuring that the audit firm has complete data about the employment of member which would ensure that the audit firm can take additional measures to safeguard the privacy.. Further, a declaration on the candidates’ part is required before a member can be selected to any audit team in order to ensure that member has not been employed in any position by the client ( (Leung, Coram & Cooper, 2012). 

• The various details about purchasing of spare parts along with equipments has been offered so as to enable understanding key business aspects. The two business risks worth highlighting are indicated below.

Risk of demand estimation not been correct

The company has contacts with global suppliers with whom it has enacted long term purchasing contracts.  Thus, majority of the spare parts and equipments are sourced through ship from these overseas partners which results in a time lag between order placing and receiving the same. Hence, it is imperative that the company should make sincere attempt to avoid any shortage in this regard as this would hamper the servicing to be offered by the company. However, excess inventory also has its issues namely the high carrying cost, potential obsolescence, maintenance and repair expense, higher security and insurance charges besides opportunity cost of idle cash. Thus, a equilibrium needs to be maintained between the above two endeavor  or else company would suffer potential losses (Arens et. al., 2013).

Safeguards to Mitigate Risks and Ensure Compliance with APES 110 and Auditing Principles

Risk of cash crunch 

Based on the details provided, it seems apparent that MSL has worked out long term purchase agreements with the foreign suppliers which makes it mandatory to buy a particular amount of spare parts and equipment. However, considering that mining is a cyclical business, hence for the company credit crunch is observed as it has to make payments to the suppliers while the customers would not offtake new machines and this would lead to higher inventory whose perils have been written rather recently. Meanwhile, the revenues would be lower and also there is lack of incremental new sales resulting in weak operational cash flows.  In such a scenario,  the company may witness shot term liquidity crisis especially if the prevailing gloom in mining extends  (Caanz, 2016).

1. b)  Risk of demand estimation not been correct

Inherent Risk: One of the components of audit risk that is enhanced is inherent risk since demand estimation of spare parts is particularly very difficult to do wit high precision which results in a business risk that is inherent.

Detection Risk –  It is likely that for a given demand which has been estimated for a given period may be difficult for the auditor to comment as right or wrong due to a host of factors involved in the estimation of the same.

The impacted accounts which can be misinterpreted are indicated below  (Leung, Coram and Cooper, 2012).

• Inventory account is likely to be understated as the various incremental costs borne during the keeping of excess inventory may not be reflected .
• Expense account understatement is quite plausible as for the items that are used in keeping up the inventory are not adequately represented.

Risk of cash crunch

Inherent Risk – The customer of the company have a cyclic business and considering the specialized nature of the products and services offered, there is an inherent risk of business not doing too well.

.Control Risk- The company is left with little measures to improve on the potential slowdown and deteriorating  financial position  of  the customers and hence needs to embrace the same.

The account those primarily affected  in a material manner are given below (Gay & Simnett, 2012).

• Inventory account is likely to be underestimated as the company to offtake some of the lost sales can potentially create incremental sales which would not being any cash flow.
• Overstating of the revenue account in order to present a robust picture to the creditors and other shareholders who can then invest in the business.

References

APES (2010), APES 110 Code of Ethics for Professional Accountants, APESB Website, Retrieved on May 02, 2017 from https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf 

Arens, A., Best, P., Shailer, G. & Fiedler,I. (2013). Auditing, Assurance Services and Ethics in Australia (2^nd ed.), Sydney: Pearson Australia

Caanz, S. (2016), Auditing And Assurance Handbook 2016 Australia (3^rd ed.), Sydney: John Wiley &Sons

CPA (2013), Independence Guide, CPA Website, Retrieved on May 02, 2017 from https://www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/auditing-assurance/independence-guide.pdf?la=en 

Gay, G. & Simnett, R. (2012), Auditing and Assurance Services in Australia (5^th ed.), Sydney: McGraw-Hill Education

Leung, P., Coram, P. & Cooper, B.J. (2012), Modern Auditing and Assurance Services (4^th ed.), New York: John Wiley and Sons