Luxury Travel Holidays (LTH) expressed its interest to reappoint Clarke & Johnson (CJ) as its auditor for their next financial year audit. However, the client company placed a condition that Geoff, the audit partner, should give a speech about LTH at the upcoming travel agency seminar to assist promoting LTH’s business. This causes a threat to auditor’s independence. This falls in the category of Advocacy threat wherein the auditor is requested/asked to endorse the client’s business/position and represent the client in some way (Bragg, 2010). However, this is the normal practice of CJ to give such unsolicited opinion. There is also the threat of intimidation because LTH claims that it would be difficult to continue working with CJ should Geoff declines this assistance. This is in no way justified on the part of LTH to expect Geoff to give his unqualified opinion on the former’s business.
Implication: If CJ accepts this condition then they will have to be prejudiced in favour of LTH and hence cannot remain objective in their reviews. An auditor’s work is to exercise specialised verdict when auditing the financial data, compliance, procedures, policies and standard operating procedures of a client. If the auditor starts promoting the interest of his client, whether unintentionally or intentionally, there is an impact of the objectivity of his judgement. Such requests by LTH entailing client advocacy seems to extend the boundaries of performance standards, and this might go beyond reasonable and sound professional practice, compromising the credibility, and hence posing an undesirable risk of harming the reputation of CJ and Geoff in the context of objectivity, independence and integrity (Oringel, 2012). If Geoff does promote the business at the travel agency seminar, the company’s shareholder will not have confidence in the audit reports issued by CJ.
Safeguard: As promoting the client will put the objectivity and reputation of CJ at stake, following safeguards can be applied:
Whether for appreciating a job well done, or celebrating a customary holiday or improving relations, there are plentiful opportunities for auditors to obtain gifts from clients. In the present scenario also, LTH offers to present a complimentary 14-day holiday package for Geoff and his family. This includes all expenses of travelling and accommodation. In return for this, LTH expects to express its gratitude toward Geoff and CJ and cultivate healthy relationships expecting another smooth audit for the next financial year. It is completely unacceptable on the part of LTH to arrange for such service hospitality for Geoff and I., By all means, this could be construed as bribery because the gift is not reasonable in the given circumstances. The auditors must not accept such hospitality service unless the value of these gifts is modest (Zerni, 2012).
Implication: Excessive/undue hospitality e.g. free extravagant holiday package, dinner in a costly restaurant, costly gifts impair the principle of objectivity. Independence of the auditors will get impaired because a familiarity will be created by acceptance of the gift and this will result in the creation of self-interest threats (Zerni, 2012).
Exceptions: If the value of the gift is immaterial and it is extended in the normal course of business without the intention of influencing auditor or for obtaining favours.
Safeguards:
This threat occurs when the auditor is too trusting or sympathetic of the client due to close personal ties with them. Familiarity is likely to blunt scepticism which an auditor is expected to practice. In this scenario, Geoff insists on involving Michael into the audit team of LTH. Michael exclaims that he is very interested in this assignment as his father is the Financial Controller of LTH. To maintain the objectivity of the work, an audit company, its partner, or any individual involved in the audit assignment (or even an immediate member of the family) must not have direct financial interest in the client company (Hay, Knehcel and Willekens, 2014).
Implication: Michael cannot be a part of the audit team because his father is the financial controller of LTH. As his father is employed by LTH, he can benefit directly from the rise in LTH’s profits and is likely to be reluctant in raising any concerns which could adversely reflect on the performance of the company and in turn his father. As Michael’s father is the financial controller, he is expected to comply with all the regulatory requirements for financial reporting. If his father has committed some fraud or even a mistake, Michael would not be willing to disclose it as this will hamper the reputation of his father and may put his job at risk. If Michael is included in the audit team, then he will not qualify the audit report, when qualification is needed because this will impact his father’s position. Moreover, if he is made an auditor on LTH, then he will lose his independence because he will face conflicts between maintaining personal relations and professional standards. Family relationships with the client or its management might lead to familiarity, self-interest and at times even intimidation threats (Hay, Knehcel and Willekens, 2014).
It is identified that Annette was employed with LTH on a temporary assignment and was with the client company till a month ago. She helped them prepare accounting entries and with their tax calculations. She also has healthy social bonds with his ex-colleagues in LTH. It gives rise to two types of threats to Annette’s independence. Firstly, she has had a great experience working with LTH and has developed friendships with LTH’s employees. Annette may practice self-serving prejudice which is based on psychology and emerges when due to close relations, one cannot detach one’s interest from that of his/her friends or family. Although, the degree of power of this threat is not entirely clear. Auditors ought to pursue some ethical and professional norms while they are also bound by social norms (Chiang, 2016). There is another more powerful threat than social bonding. It is the threat of complacency. Annette admitted that she does not think that much audit work will be needed around tax accounts of LTH as only a month back he helped the company with the tax calculations. When an auditor builds some level of overconfidence in his/her familiarity with the client, then this results in complacency threat (Romero, 2010).
Implications: Social bonds with LTH may impair the independence of Annette’s work because she may feel reluctant in pointing out the mistakes due to the fear of damaging the relationships. Familiarity and complacency can have both positive and negative impacts. Due to such overconfidence, it is possible that Annette may underweight some warning signs. However, familiarity might also have a positive impact as it implies an improved understanding of the client and will assist Annette and the rest of the team to perform better (Romero, 2010).
(a) Two business risks that Crampton and Hasaad might want to consider in relation to purchasing of equipment and spare parts are namely: inherent risk and control risk. Fixed assets like equipment and spare parts are huge investments for the company. The company needs to evaluate if the utility of this equipment will be lifelong for the company or not. In addition to this, the firm should also analyse if the Return on Investment of these fixed assets is justifiable to make the investment or not. Moreover, if the market value or fair value of the asset was $1500, but it was purchased for $2000 then this also poses asset usage and amount risk (Bode, 2007).
Control risks, on the other hand, refer to the likelihood of loss emerging from the predisposition of internal control systems to lose their efficacy over time, and hence expose or fail to stop the exposure of assets that needed protection. During an asset life cycle’s operation stage, there might be issues of over or under maintenance. They main issue pertaining to over maintenance entails two issues which make the asset management framework ineffective. Firstly, a substantial cost is generally associated with the implementation of non-value adding maintenance. Hence cost could loosely be used as a guideline as there are industry benchmarks for maintenance expenditure that can be espoused. Secondly, the company that could be reproached of over-maintenance of its assets is likely to perform intrusive maintenance tasks more often (Wahab, Zain and Rahman, 2015). This implies extra exposure risk for the company to infant mortality failure and hence extra costs incurred.
b) The audit risk pertaining to the inherent risk emerges when the accounting for equipment and spare parts has not been done properly. As such fixed assets involve huge sums of money, it is not only important to show them in the books of accounts, but it is also crucial to do proper accounting for it. The auditor needs to check, whether the asset has been accounted for properly or not and at market value or fair value.
The audit risk related to control risk arises when the management of the asset is not assigned to an authorised person. In addition to this, the auditor has to verify if there is adequate infrastructure to support the use of the asset or not.
References
Adelopo, I., 2016. Auditor Independence: Auditing, Corporate Governance and Market Confidence. Routledge.
Bode, S., 2007. Auditor independence and regulation. SAGE.
Bragg, M. S., 2010. Wiley Practitioner’s Guide to GAAS 2011: Covering all SASs, SSAEs, SSARSs, and Interpretations. John Wiley & Sons.
Chiang, C., 2016. Conceptualising the linkage between professional scepticism and auditor independence. Pacific Accounting Review, 28(2), pp.180-200.
Hay, D., Knehcel, R. and Willekens, M., 2014. The Routledge Companion to Auditing. Routledge.
Mohamed, D. and Habib, M., 2013. Auditor independence, audit quality and the mandatory auditor rotation in Egypt. Education, Business and Society: Contemporary Middle Eastern Issues, 6(2), pp.116-144.
Oringel, J., 2012. Effective Auditing For Corporates: Key Developments in Practice and Procedures. A& C Black.
Romero, S., 2010. Auditor independence: third party hiring and paying auditors. EuroMed Journal of Business, 5(3), pp.298-314.
Wahab, E., Zain, M. and Rahman, R., 2015. Political connections: a threat to auditor independence? Journal of Accounting in Emerging Economies, 5(2), pp.222-246.
Zerni, M., 2012. Do client firms manage the perception of auditor independence?: Evidence from the Swedish non?audit service market. Managerial Auditing Journal, 27(9), pp.821-845.
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