1. a) Based on the various conversations provided, the objective is to highlight the key threat keeping in frame the APES 110 ethics guide.
The audit firm’s CEO using the name of board of directors wants to strike a bargain whereby Geoff would promote the company in the seminar by giving a speech while the company(i.e. LTH) would provide the contract to the audit company.
Section 200-6 i.e. advocacy threat would be present and would be material in nature.
One of the situations when the above threat arises is when a member of the audit team indulges in a particular activity which the external stakeholders may consider as promotional thus causing a significant damage to the perceived independence. Thus, such a situation needs to be avoided considering that the utility of services essentially is driven by the trust of the users (APES, 2010).
Geoff and another member have been extended free travel packages for duration of 14 days to one of the Greek Isles and also include respective families. All the above costs to be spent by the client company for the maintenance of a smooth relationship.
Section 200-7 i.e. familiarity threat would be present and would be material in nature (APES, 2010).
Taking any material gifts from the client is a serious threat to auditor independence for it may lower objectivity and give rise to potential bias or conflict of interest. Also, the acceptance of material value gifts like the one extended in the situation may be extremely damaging for the perceived independence as the outsiders may view this as existence of mutually beneficial relationship between the auditors and the client firm management (CPA, 2013).
At the time of being informed that Michael has been included as part of LTH’s audit team for the coming year, he expressed that his inclusion would be valuable for the team since his father currently was the financial controller of LTH.
Section 200-7 i.e. familiarity threat would be present and would be material in nature (APES, 2010).
It is expected that no member of the audit team should have a relative working for the client firm especially in a significant position. This is imperative since it gives rise to conflict of interest and bias which compromise the overall objectivity which needs to be avoided. Here also, Michael may skip some material misstatements observed either on purpose of otherwise since he would not like to hurt the professional interests of his father (CPA, 2013).
At the time of being informed that Annette has been included as part of LTH’s audit team for the coming year, she expressed that the audit of LTH would not consume much time and also this will provide her opportunity to catch up with her former co-workers as only during the last one month
Section 200-5 and 200-7 i.e. self-review and familiarity threats would be present and would be material in nature (APES, 2010).
Annette’s objectivity may be compromised as there may be bias towards the former employee along with potential conflict of interest especially in case of a request from a senior employee at LTH. Besides, since the work profile of Annette involved accounting and book keeping, hence it is probably that during the audit process, she might be required to critically analyze the records prepared by herself and thus she might assume that it is error free or may not report the same as she prepared it (CPA, 2013).
b. The relevant safeguards to potentially mitigate the above identified threats are given below.
Firm Level Safeguard – Strict internal policy making it prohibitory for any employee to entertain any request to indulge in any promotional activity organized by the client (Leung, Coram and Cooper, 2012).
Client Level Safeguard – Transparency in the selection of the external auditor in line with the established corporate governance principles (Arens et. al., 2013).
Firm Level Safeguard – Strict internal policy making it prohibitory for any employee to accept any gift which exceeds $100 in monetary value and acceptance of token gifts also must be reported through a specified declaration form for future records (Caanz, 2016).
Client Level Safeguard – The conduct with the auditor should be governed by principles that do not violate the independence and ensure that their relevant professional and ethical code is not breached. Hence, such requests should not be made (Gay & Simnett, 2012).
Firm Level Safeguard – Strict internal policy making it mandatory for new employees to furnish the relevant details of all family members in terms of their employment status along with the employer and position. Additionally, any changes in the same must be promptly made to the firm through a disclosure firm. Besides, every member belonging to a particular audit team would need to make an undertaking that no relative is or was employed with the client in any capacity at any point of time (Caanz, 2016).
Firm Level Safeguard – Strict internal policy making it mandatory for new employees to furnish the relevant details of of their past employment engagements along with the employer and position. Besides, every member belonging to a particular audit team would need to make an undertaking that they were not employed with the client in any capacity at any point of time (Leung, Coram and Cooper, 2012).
2. a) The brief information about the company is available especially with regards to the ordering of equipment and usage of spare parts coupled with the services that are extended. Keeping this in mind, the two major risks to business for MSL are outlined below.
One of the key concerns is with regards to incidents related to fraud on account of spare parts. This is quite possible considering the nature of the business where the clients may be situated in remote parts considering the location of the mining project. It is known that when companies purchase equipments, they are given free service once a year for two years. Also, it is known that for servicing some clients the mechanics have to go to remote corners which takes number of days at a stretch. It is quite possible that one such mechanic may do a fraud with regards to spare part considering the high value of the same. This can be enacted by the mechanic forwarding a spare part to the client for discounted price while indicated that the same had to be replaced in the equipment under warranty. This would tend to enhance the overall cost and then to subside the revenue (Arens et. al., 2013).
Another key business risk which is relevant here tends to deal with potential implications of inaccurate spare part demand estimation. If there is an overestimation in this regard which is material, then a sizable portion of the capital would be caught up in the form of spare part inventory. Consequently, additional storage and carrying cost would be associated with these excess spare parts. Clearly this amounts to economic loss to the company and adversely impacts the bottomline. On the other hand, un underestimation is more problematic as it would cause a delay in providing repair and maintenance services to the client especially because these spare parts are imported and thus even after placing an order, there would be a time delay. In such time there may be loss of business and more impotently reputation loss which would have adverse impact on both topline and bottomline (Caanz, 2016).
b. The implications of the business risks identified above for the various individual components of audit risk are outlined below.
It is apparent from the description of the fraud in spare part that there is inherent risk involved since the business practice increases the chance of fraud. Also, there seems to be lack of enough cost effective control mechanisms to reduce the risk of fraud which results in higher control risk in the given case. The relevant accounts that may be materially misstated on account of this are the revenue account along with the expense account. The misstatement in these could be caused primarily because the spare parts that are non-chargeable owing to warranty coverage would be expense while the chargeable spare part would bring in revenue for the company. However, owing to the fraud, expense may be overstated while revenue understated (Leung, Coram and Cooper, 2012).
Clearly, inherent risk is present considering the difficulty in correct estimation of demand as a host of parameters are involved. Besides, detection risk would also be there as it may be difficult to the auditor to understand whether the estimation was correct or not as this would require an understanding of the underlying service contracts coupled with the factors that impact the spare rate demand. One of the accounts affected would be inventory as it is highly possible that the company would stock higher inventory but might report a lower number. Further, the expense account may also be impacted as the underlying adjustment of inventory levels would be done in the expense account only and the interaction between these two accounts can be used by the firm to manage profits especially due to cyclical nature of the mining business (Gay & Simnett, 2012).
References
APES (2010), APES 110 Code of Ethics for Professional Accountants, APESB Website, [Online] Available at https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf [Accessed April 27, 2017]
Arens, A., Best, P., Shailer, G. & Fiedler,I. (2013). Auditing, Assurance Services and Ethics in Australia, 2nd edn., Sydney: Pearson Australia
Caanz, S. (2016), Auditing And Assurance Handbook 2016 Australia, 3rd edn., Sydney: John Wiley &Sons
CPA (2013), Independence Guide, CPA Website, [Online] Available at https://www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/auditing-assurance/independence-guide.pdf?la=en [Accessed April 27, 2017]
Gay, G. & Simnett, R. (2012), Auditing andAssurance Services in Australia, 5th edn., Sydney: McGraw-Hill Education
Leung, P., Coram, P. & Cooper, B.J. (2012), Modern Auditing and Assurance Services, 4th edn., New York: John Wiley and Sons
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