The independence of the auditor explains the independency of the all the auditors irrespective of external or internal from the interested persons who may have a significant influence on the financial report of any entity. The auditors to be independent must apply the integrity and objectivity approach while performing the audit process. The independency of the auditor requires them to perform the audit with true and fair manner and with the best available knowledge of the auditor (Abbott et al. 2016). The auditor while performing the audit must utilise the auditing standards guidance and various code of ethics during the process. The internal auditors independency is threatened from the influence of the interested users of the financial statement and the external auditor’s independency is threatened from the external users like the creditors, lenders and debtors. The aim of auditing the financial reports is to increase its transparency level and offer reasonable assurance to the users of these statements. The independency also depends on the state of mind of the auditor. An auditor must be strong enough to not be influenced by the interested parties and shall not compromise his judgement and act with integrity and objectivity (Ahlawat and Nouri 2015). In addition of the compliance of accounting standards, auditor’s independency is another key factor for making the financial statements reliable.
(a) Threats associated with independency of auditors
In addition of the regular service that is agreed by the auditors in the audit engagement to be provided, sometimes the auditors agree to provide other services in exchange of additional non-monetary or monetary benefits. These services are known as the non-audit services (NAS). NAS generally covers the services related to outsourcing of internal auditor, actuary services, management consultant services and promotion of the business of client by any means. Moreover, when the auditor in any way promotes or is perceived to promote the client’s business, it raises the advocacy threat that means the auditor is promoting the business of the client to attract more investors. If the auditor agrees to offer non-audit services to the client, it will definitely affect their independency and judgemental approach (Porter et al. 2014). Further, the independency issue is very crucial as it is often questioned by the government, stakeholders, creditors and other users of the finance reports. Therefore, the auditor must give his opinion based on the best knowledge available to him and with true and fair approach. In the stated circumstances, the audit firm CJ has been approached by the client LTH for giving a speech in the travel agency seminar for getting reappointed as auditor in LTH. To maintain their independency, the audit firm CJ must not accept the offer or it will threaten their independency as promoting the business of the client is highly unethical (Olson, David and Desheng 2015).
Apart from the contracted fees mentioned in the audit engagement, the auditor is not supposed to receive any additional amount in form of fees, commission or any other non-monetary or monetary benefits that may endanger his independency. The auditor must keep him free from any kind of controversies that may raise question on his performance and judgement. Therefore, while performing the audit, he must give his judgement that is free from misstatement and error and shall be presented as per the best knowledge of the auditor (Khlif and Samaha 2014). As per the given circumstance, in addition to the prescribed fees the client LTH communicated that they will like to present a complimentary package for holiday to the audit partner Geoff and his family in expectation of smooth audit during the year 2015. If the offer is accepted by the auditor, it will raise the self-interest threat as the auditor will get additional benefit in exchange of carrying out smooth audit. Moreover, the auditor shall keep himself away from any kind of controversies that may raise question regarding his integrity. Therefore, to protect his independency and maintain the integrity of the audit firm, Geoff shall not accept the offer given by LTH and carry his task with professional approach (Dogui, Boiral and Heras?Saizarbitoria 2014).
If the close family member of the auditor or any partner of the audit firm is in the control of financial matters or associated with direct ownership through holding the shares, he must hold back himself from giving any judgement on the financial report of the client. The close family members here mean the parents, spouse, dependent child, non-dependent child or siblings. The financial interest also covers giving suggestions for the investment portfolio of the client, giving guarantee for the client’s debt or any borrowing and making any finance related decisions on behalf of the client. In given circumstance, Michel, who is to be appointed as the Auditor of LTH on behalf of the audit firm CJ is in the view that his engagement will be valuable for the audit team as his dad is engaged as the financial controller of LTH and is under the obligation of preparing the financial report of the client. Accepting the offer of CJ for appointment of Michel as the auditor of LTH will not only threaten his independency, but also will endanger the independency of the audit firm as a whole. Therefore, Michel shall not be appointed as the auditor for carrying out the audit of LTH.
It raises the familiarity threat when the auditor is not able to behave professionally owing to his previous engagement with the client or the auditor has good knowledge about the financial reports of the client. Annette was engaged with LTH just one month back for preparation of their accounts and calculations of their tax. It seems that she has knowledge about the weaknesses and strength of the client and the members of the organization. It is more likely that Annette will feel that all the staffs of LTH are performing their duties pretty well and does not require any observation. Further, it will raise the threat of self-review as the auditor in no circumstances can audit his own work that is done previously. Auditing her own work will more likely to be involved with manipulation and thereby will impair the independency while auditing. Thus, the audit firm CJ shall not appoint Annette as the auditor for auditing the financial statements of LTH.
(b) Safeguards against the threat of independency of auditor
The services provided by the auditors to the client must contain a list of services that shall not be provided as providing those services may impair their independency. Different measures that can be taken to protect the auditor’s independency are:
- Consistent with the auditor’s requirement – while carrying out the audit, the auditors must use the code of ethics and the auditing standards. The internationally accepted standards for maintaining the ethics will assist in reducing the difficulty of audit process.
- Overlooking the other issues – an independent auditor can assist in providing the error free report and maintaining the transparency of report. They must be able to ignore the political influence and shall provide the judgement with true and fair approach, enhance the transparency of report and share the data of the client with due care.
- Rotation of the audit team member – rotation of the key partners among the audit team will reduce the chances of self-interest and familiarity threat and will enhance the integrity and objectivity aspect among the team members and it will not involve high amount of cost. Moreover, the past data of the entity whose audit is to be performed will be available with all the partners, which in turn, will help for quality maintenance.
- Transparency level and efficient audit team – the efficient team of audit plays important role for achieving the auditor’s independence. The team members must be well versed with the guidelines of audit and with regard to the quality they must carry out their job with integrity and objectivity (Sarwoko and Agoes 2014).
2(a) Business risks associated with purchase of spare-parts and equipment
The auditing standard guidelines state the auditor’s responsibility regarding identifying and analysing the associated risk associated with the financial statement’s material misstatement through identifying the client’s internal control, business environment and organizational system. The auditor’s main aim is to evaluate the risk level of the financial statement that taken place due to fraud, error or any kind of material misstatement. The auditing of the financial statements enables the auditor to present those statements in transparent and true and fair manner (Krishnan and Wang 2014). To attain these objectives, the auditors must:
- Evaluate the likelihood of material misstatement and the impact of those misstatement that could lead to error or fraud
- Analyse the all over risks of the client’s business and getting clear idea of the client’s business environment, transaction classes, method of accounting, disclosures of accounting policies.
- Analyse the identified risk and the effect of those risk on the financial reports (Yoon et al. 2015).
Various business risk related to the purchase of spare-parts and equipment that shall be considered by Hassad and Crampton while planning for the audit are:
Strategic risk – The strategic risk states about the risk of managing inventories and is associated with the system of stock management. There are mainly two options, the 1st option is to exchange the available inventory with the purchase of another product and in this case they will not have to follow any regulated policy (Tepalagul, Nopmanee and Ling Lin 2015). The business can simply ask the opinions experienced managerial personnel to comment on this matter. The 2nd option is to manage the inventories as per the regulated approach of managing inventories. The selection of option is based upon the investment associated with the inventories and the probable loss that may take place with the inventory management. If the client’s business can take-up the consequences of loss comfortably, then they can go for the 1st option and if they cannot take-up the risk of downtime then they have to find for any other appropriate strategy to minimise the impact of probable loss (Causholli, Chambers and Payne 2015).
Operational risk – the operational risk involves the performance of various strategies. It is associated with the implementation of any strategy that is set-up for implementation. For instance, the entity prepare some policies for inventory management, however, at the time of implementation it is found that it cannot be implemented at the projected level. The reason for this may be the management is not taking due care for following the strategies or there is some inherent weaknesses in the strategies itself. If the organization does not follow the policies properly, it is regarded as they are not taking due care for following the strategies. For the inventory management of spare-parts, risk assessment ensures the analysis of appropriate measures for managing the inventory properly (Benjamin 2014).
(b) Types of audit risk and their impact on account balance
The above mentioned risk that is the strategic risk is the application risk. It takes place when the auditor fails to take any control or the entity fails to implement any strategy. The financial reports and the financial transactions are susceptible to application risk. The involvement of risk is directly related with the amount of risk. The accounts that are affected by this risk are the closing as well as opening balance of inventory, net profit and gross profit (Cohen et al. 2017).
On the other hand, the operational risks are associated with the detection risk. This risk states that chances are there that the auditor will not be able to detect any inherent risk that could lead to material misstatement of the financial reports. It seemed that the auditor has not taken proper care while performing the audit. It has great effect on the accounting transactions of sales account, purchase account, inventories, revenue account and opening as well as closing stock (Bae et al. 2016).
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