(a) Identification and evaluation of Threats in relation to an Auditors Independence
Situation 1 – Chris
In this situation the threat of advocacy has been identified (Edwin, 2015). The threat of advocacy arises when the auditor or any other personnel working in the audit firm gets engaged in promoting the auditee firm or advocating for and on behalf of the firm. In the given situation, the CEO of the LTH company suggested to the board that the Audit partner Geoff of Clarke and Johnson should give speech about LTH so as to attract customers otherwise they would not be able to engage in any business segments with the audit firm.
The effect of this threat will be that the auditor may not be able to unbiased authenticating the financial information.
Situation 2 - Chris
In this situation the threat of Self Interest has been identified (Barizah, 2006). These threats arise when the auditor acts in their own interest and that may be financial or non financial including personal. For example auditee pays audit fees or any other extra perquisites which are at free of cost or at concessional rate. In the given situation, the auditee has given 14 day free package for the family member of audit partner.
The effect of this threat will be that the auditor has to agree on the adoption of various accounting policies adopted by the auditee.
Situation 3 – Michael
In this situation the threat of familiarity or trust has been identified (Allen, 2002 and UK, 2003). These types of threats arises when the auditor have close and long term relationship either personally or professionally with the auditee. In the given situation, the audit team member, Michael, has close and long relationship with the Finance Controller of the Auditee Company as he is his father.
The effect of this threat is that the auditor may not it find fit to respond to any assertions made by the auditee and rather have to agree on it.
Situation 4 – Annette
In this situation the threat of Self review has been identified (Parker, 2015). These types of threats arise when the audit firm performs the two functions for the company. The member performing the functions may be same or different. One will be audit and the other one will be non audit services like accounting, etc. In this situation, Annette has done tax calculations and other accounting work prior to audit.
The effect of this threat is that the auditor will not consider or take into account while authenticating the financial information if any audit objection is noticed due to the fact that the accounting work is also done by the same firm and that cannot be deviated.
(b) Safeguards to the Identified Threats
The conceptual framework of financial reporting provides the number of safeguards for the identified and evaluated threats. Along with this, the safeguards have been listed through three ways:
- Statute, Rules, Regulation and the code of conduct of profession
- Processes and procedures of internal controls employed by Auditee
- Procedures and processes of doing work within the audit firm for the audit team members (Mc Grath, 2001).
The safeguards for the identified threats have been listed below:
- Assuring that the accounting work or any other non audit service is not performed by any person who is the part of the team member of an audit.
- Engaging an qualified Certified Public Accountant or Chartered Accountant who can perform the reviewing work of the team member in the best manner
- Involvement of Non audit services including accounting, consultation and management services shall be limited to the extent possible so as to determine that it will not hurt the independence of the auditors
- Distance shall be maintained while performing the audit work so as to ensure that the close relationship shall not come in between the work.
- Auditee firm shall have good corporate governance so as to avoid the chances of having any material misstatement in the financial statements and that too shall not be enough to have qualified opinion.
- There shall be mandatory and compulsorily provision in the law to have rotation of auditors and that too shall be made in proper periods.
- Restriction shall be put on the extent of the relationship of an auditor and auditee
- Imposing on the importance of disclosure of the material misstatements to the audit committee, board and other top officers of the company.
- Auditor shall immediately resign from the engagement by utilizing the professional care and due diligence in case the auditee firm puts provision stating that if the audit firm will not do particular function on behalf of the company then they will disengage the auditors.
- Members of the audit team shall not be engaged in particular audit where they have the close and long run relationship rather the new team member shall be engaged for audit work so that free verification can be done (Livine, 2005).
Business Risks that the Crampton and Hassad will consider for Audit 2015
Following business risks should be considered by the auditor:
- No Warranty or Guarantee for Main Equipment – Mining Supplies Limited places the purchase order to the suppliers located in Europe, United States of America and China. The purchase order list of the details or specifications as required by the customer. They manufacture and supply the equipment as per the provided specification and send the equipment and spare parts at their location centre. The spare parts have two year warranty along with one free maintenance service. But no guarantee and warranty has been granted in case the equipment gets damaged within three or six months and stop working (Imrie, 2011). The company shall have provided the replacement period also. This is the main risk as if the customer comes with defects in the equipment then company will have to bear the unnecessary expenditure. This is the main business risk which the auditor shall consider while planning the audit program for the year ending 2015.
- Sudden Change in Technology or Methods – In the today’s business world this change or phenomena is very common and has led to closure of many businesses. In the case under study, if after giving the purchase orders to the suppliers and getting it manufactured from them, the request is received from the customer as we will not be able to take up the order due to change in technology or way of doing the mining process. In this situation, the financial health of the organization will automatically get deteriorated and finally the company will be in debt trap. Secondly, the company has not considered any difference between the short term and long term purchase orders. Both of them are treated as part rather than doing the both in a separate and different manner. As damages caused due to change in technology or methods can be easily accommodated in short term purchase although it might affect the liquidity of the company but the same will not be bearable for any company if it’s been a long term purchase order as the same will directly affects the solvency position of the company (EY, 2016).
There are other businesses risks also increase in cost, interference of the Government in the sector, access to engage in new projects and etc.
(b) Audit Risk for Each Business Risk
- Detection Risk- For the first business risk of having no warranty and guarantee for the main equipment, the nature of audit risk that has been identified and detailed is the Detection Risk. Detection risk is defined as the risk which entails that the auditor procedures are not able to identify the material misstatement contained in the financial statements. Hence he has to apply additional procedures to get the same. He needs to look after the agreement and contracts already entered with the supplier as to know whether the contract any provision for guarantee or replacement of the main equipment specifying the period. If the contract contains the provision then there will not be other procedures to be adopted and rather the cases are to be identified which are sold during the year and provision for warranty or guarantee shall be maintained in the books of accounts on ascertainable basis. In case the contract does not contains the provision then the same fact shall be disclosed in the notes to accounts and it will be mentioned that the cost will be paid as and when becomes due. Thus, the account balances of Provision for Warranty will be affected by this kind of risk (Long, 2015).
- Inherent Risk and Risk of affecting Going Concern- For the second type of business risk, the audit risk that prevails is inherent risk. Inherent risk is defined as the risk of having occurrence of material misstatement due to the nature and culture of the organization and also due to the influence of an external or an internal environment. In the given case, the company does not have bifurcation in short term and long term plans due to which it is treated as inexperienced or an ineffective management. This type of management will further lead to the mistakes in adoption of accounting policies and accounting for the transactions in the books of accounts. The account balances that will be affected directly due to this type of risk are debtors and creditors including the secured or unsecured loans if any availed from the market or any financial institutions (Becker, 2015).
This further poses a risk of having the assumption of going concern which is the major requirement for the preparation of books of accounts and financial statements. Due to this risk whole financial statements will be affected.
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EY, (2016), “Top 10 Business Risks”, available at http://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 14/04/2017.
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Becker E, (2015), “Audit Risk vs. Business Risk”, available at http://www.osyb.com/blog/small-business/audit-risk-vs-business-risk/ accessed on 14/04/2017.