Situation 1 –
Advocacy threats, pertains when the auditor advances, or promote, a client's business to a point where stakeholders believe that purpose is getting lowering down- it shall be difficult for LTH Ltd. to continue any business relationship with CJ if Geoff refused to give speech in the travel agency seminar.
Threat of accepting the complimentary holiday package in anticipation of new audit assignment.
Familiarity threats are seen when auditors are related parties with the customers . This could happen in many ways: (i) Related with the auditing team working at a higher level in the firm, (ii) Prior high position employee or partner of the firm being a director or employee of the customer,(iii) old relation between auditors and some of their favourite customers and (iv) Receiving favours or special treatment from the customers , higher officials or employees. Here threat is keeping Michael in the audit team where his dad is the financial controller of LTH ltd is threat here.
Self-review threats happens while reviewing any finding in the prior audit or when a member of the audit team was previously a senior official of firm or high ranked employee of the customer. Illustration of self review threats are (i)The auditor is at high position or senior employee of the firm, (ii) The auditors perform services which sre itself consideration of audit and hence independent opinion clause is hampered. Keeping Annette in the audit team who was a part in preparation of financial statements of LTH ltd is an evident threat here.
Evaluation Of Threats
Situation 1 –
if Geoff doesn’t give speech in the travel agency seminar with a view to promote LTH’S business to attract more investors then his business engagement shall be terminated i.e he shall not be reappointed as the auditor of LTH Ltd.
Situation 2 –
If CJ and Geoff doesn’t accept the complementary holiday package to Greek isles then the relationship with the LTH shall be hampered leading to no reappointment as the auditor of LTH which shall lead to a huge business loss.
There is a threat of disclosure as related party(Michael-son) is involved in expressing the true fair opinion about the financial records of the company prepared by Michael’s dad.
Annette who was involved in preparing the financial statements will also be expressing opinion as an auditor of LTH. There is a threat of expression of independent opinion.
Safeguards To The Threat Identified
As per guidance notes on independence of auditors the auditor should check that he does not get into a circumstance where there is conflict of interest and professional duty. Fundamental principles – integrity, objectivity, and professional scepticism should be practiced. Before taking the task, an auditor must consider whether there is any threats to his independence or not. If there is any threat , the auditor should either distance itself from the assignment or put in the measures that mitigate them. All such protective measure needs to be recorded in a prescribed procedure with documents that depict as evidence of following with the statutory laws. Hence Geoff should not deliver any speech in the travel agency seminar.
Situation 2 –
As per CA Act, 1949, the CA is prohibited to accept gifts . A person who receives amount in proportion to the gain received by his customer, may get aggravated to manifold the gain of his service or may follow means which are unethical. It will have the effect of deteriorating his integrity and lessen his independence. Therefore, the members of firm are prohibited from charging or accepting any kind of gifts or emoluments .Thus accepting holiday packages denotes professional misconduct which should be avoided.
Situation 3 –
As per CA Act, 1949 which provides that a CA who is doing practice shall be charged of professional wrong doing if he communicate his opinion on financial records of any entity in which he, his audit firm or a practicing partner in his audit firm has a considerable interest, unless he reveals his interest also in his report. Where a relative of the auditor is at high position in the client company or holds an important position and who has a considerable interest, in such cases for the reason as not to settle with the independence criteria of auditors , the member may refrain from undertaking the audit of financial records and expressing their opinion on financial records thereon. But, if an auditor feels that his independence does not get affected and he undertakes the audit tasks of such company, he should decipher his interest in his audit report when expressing the opinion on the financial statements of such client company. Hence Michael should not be a part of the audit team and if he wants to he is required disclose the facts.
Situation 4 –
The auditors are not allowed to write the financial books of accounts of their audit clients. A CA in practice shall be guilty of professional wrongdoing, if he is an employee of the company; or is at high position in the company, or is in the employment of the company prepares the financial statements and conveys audit opinion thereon too. Hence Annette who has prepared the financial statements can’t express opinion as an auditor as the independence shall be affected.
Recognizing financial risk includes looking at the daily financial transactions such as procuring the equipments and spare parts especially cash flow management i.e the outflow of cash while purchasing. Being aware of the problems of overtrading where there is no balance between the work that a firm takes and its ability to deliver the work. However how we give credit to consumers, who are our debtors,creditors, how we can recover the money, insurance to cover bad and doubtful debts.
Financial risk assessment should consider factors such as rates of interest and overseas currency and foreign exchange risks. Exchange price fluctuations will impact the debt obligation and the prices of the products and services of our firm compared with those manufactured or produced overseas.
If one trades in overseas market, one will come across more financial risks. It is hard to calculate the worth and worthiness of an overseas customer and to recover the debt obligation which is not paid.
(2) Operational Risk
Operational risk is an unforseen disaster in the company’s daily business activities. It includes machinery failure or technical disaster, like a server crack down or it could be caused by manpower or manual processes. Operational risks relates to the trading and administrative procedures and also supply chain management. Such risk involve: transportation, accounting and auditing controls and procedures, IT procedures, statutory and other regulations, company’s board composition. One should evaluate these operations and prioritize the risks and make necessary provisions and solutions to mitigate the same. If someone’s firm makes and receives regular deliveries of assets, consider making up a business continuity plan to maintain operations especially in the event of a petrol/diesel/coal strike or paucity or any other issue. Information technology risk is a predominant risk.
Specific Audit Risk Of Financial Risk And Operational Risk
Audit risk is that risk where the financial records are materially incorrect, even though the audit opinion stated states that the financial statements are free from any material misstatements. The elements of audit risk are the risk of material misstatement and detection risk.
Detection risk happens when we don’t use the correct audit procedures . Assessing the control risk and inherent risk and then mitigating or resolving the audit risk mathematics by assigning detection risk to reduce the audit risk to an acceptable and considerable level.
Elements Of Detection Risk:
Not properly applying an audit procedure: When one is using ratios and trends to find out if a financial account balance is at reasonable value or not, and we use the incorrect ratio.
Wrong interpretation of audit results: one using the correct audit procedure but make the wrong decision when calculating the auditing results.
Selecting the incorrect audit testing method: Distict financial balances are best depicting using specific auditing testing tools
Controlling Risk From Equipment And Spare Parts
Risks due to use of the equipment to be eliminated or mitigated wherever feasible, .A mix of control measures is important depending on the scenarios, our assessments of the risks involved, and how feasible the control measures are.
This includes appropriate protection guards, devices, warning systems, control devices, personnel protection equipment.
Protection guards to be of good construction . Guards also need to be kept in nice condition. Guards must be kept at a decent distance from the dangerous parts of the equipment and to see whether the equipment is operating safely. Stop, start and emergency controls is required , safety devices or other controls cannot mitigate the risks such as noise, hazardous substances and vibrations. Strong systems should be used along with using feasible procedures and providing full information, instructions and guidance and trainings to personnel.
Inherent Risks In Equipment And Spare Parts Are-
Some inherent risk are-
Recording the correct cost basis: make sure the client has capitalized all costs relating to the procurement of equipment’s and spare parts.
Examining the maintenance account so that any major maintenance expensed are added to the cost of the asset rather than expensed in revenue account. Any repair that condireably increases the useful life of the asset should be taken into consideration.
Recognizing the book value calculations: Lease accounting and computing fixed assets that aren’t purchased are inherently risky, because there may arise complex accounting issues and can be difficult-to-audit transactions and risky as well.
Account Balances That Are Impacted Directly By The Audit Risk
- Assertions about classes of transactions and happening of an event for the period under audit – occurrence of a transaction ,completeness of a transaction , accuracy of transaction , cut off procedures and classification of transactions
- Assertions about account balances of audit – asset’s existence or liability, rights and obligations of asset or completeness, and valuation of assets or liability and allocation of expenses.
- Assertions about presentation and disclosure in the financial statements– occurrence and rights and obligations, completeness in the financial statemnents, classification and understandability, and accuracy and valuation at the balance sheet date.
Illustrations of audit risks include:
- Auditing and accounting treatment of revenue and capital expenses – the audit risk here could give exposure to plant and equipment, spare parts and if revenue expenses has been capitalized rather than charging in the cost of asset charge as an expense in the income records of the entity.
- Inventory Valuation – If there are huge levels of aging inventory, slow moving inventories.
- Completeness of liabilty – when provisions have been wrongly treated as contingent liabilities
- Completeness of revenue – When the firm which is being audited has majorly sales value in cash.
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