ACCTING 7009 Auditing And Assurance Services

1. The objective is to identify the threats posed to auditor independence in each of the following situations in line with the relevant ethical code given by APES.

Situation 1: The relevant facts indicate that CEO (Chris) of the client Luxury Travel Holidays LTD (LTH) expressed that the board of client intends to continue the audit relationship with the company but insists that it would be contingent on whether Geoff (Audit Partner) goes out of the way to make a speech at a seminar promoting the business interests of LTH. Such an action on the part of Geoff would not be permissible as advocacy threat (Section 200-6) would be present which forbids such promotional speeches as the same may bring perceived independence under threat and hint to a quid pro quo relationship. Hence, the given threat is significant and cannot be ignored (APES, 2010).

Situation 2 –  In appreciation of the work done by Geoff and the team, the client wishes to extend a 14 ay holiday voucher which would provide a fully paid to Greek Isles  along with respective families. This has been extended in order to maintain a smooth relationship. It is apparent that such a gift of material monetary value must not be accepted as it would create familiarity threat (Section 200-7) which clearly lists down that no gifts having material monetary value should be accepted by the members as this presents significant risk not only to perceived but in addition actual independence also (APES, 2010).

Situation 3-  Michael on being informed that he would be a part of the audit team of LTH is elated expresses his utility as a valuable asset for the team considering the position of his father as the financial controller for LTH. In the given scenario if Michael continues to be part of the team, then would create familiarity threat (Section 200-7) as there must not be any relationship between the members of audit team and the client firm to be audited  (APES, 2010).  The nature of the threat seems to be highly significant as the underlying audit quality can be materially impacted due to impairment of auditor independence due to presence of Michael who most likely would not be critical of the firm even if desired (CPA, 2013).

Situation 4:  The facts indicate that Annette which expressing her joy on being part of the audit team for LTH expresses that the audit process would be quite efficient and not much time taking as only till a month ago she was involved with the company on a temporary basis while providing them requisite book keeping & taxation  services. Thus, inclusion of Annette in the LTH’s audit team would result in self–review threat (Section 200-5) as she was till recently employed with the client and hence may not be critical of the financial records prepared by her own self (APES, 2010).  Indications of this happening is apparent from her statement that audit should less time which reflects that she is being judgmental and hence poses a significant threat of the independence of the audit team (CPA, 2013).

Situation 1 –  The firm level safeguard would be quite effective in this case.  The firm must have a strict internal policy which must necessarily bar any employee (including Audit Partner) to deliver any speech which may be promotional in nature as the perceived independence of the auditing team will be hit.  Besides, the client level safeguard could be achieved by ensuring that selection of auditor is carried out in a transparent manner by the board of directors in line with the sound corporate governance practices (Arens et. al., 2012).

Situation 2–  The relevant safeguard to the threat posed would be in the form of both firm level and client level. At the level of the firm, a strict internal policy which must necessarily bar any employee (including Audit Partner) from accepting any gifts (beyond a particular value like $ 100) from the audit client under any circumstances with indifference to the underlying intention of the client. Also, any such gift received with seemingly insignificant value must also be disclosed to the firm and record must be maintained of the same.  Besides, at the client level  through internal policy such actions that extend any favors or gifts to auditors must not be permissible as it enhances the risk of fraud for the company  (Gay and Simnett, 2012).

Situation 3:  The appropriate safeguard to be applied would be firm specific only.  This can be implemented by ensuring that employees are required to furnish information about the employment status of immediate family members along with their past and present association with various employers including their duration of employment and position occupied.  Also, when a particular member is allotted to a given client, then a compulsory undertaking should also be asked highlighting the family members who have been associated in the past or the present with the client firm (Caanz, 2016).

Situation 4: The appropriate safeguard to be applied would be firm specific only.  This can be implemented by ensuring that employees are required to furnish information about their employment association in the past with various employers including their duration of employment and position occupied.  Also, when a particular member is allotted to a given client, then a compulsory undertaking should also be asked highlighting that the member concerned has not no association in the past or present with the client firm in any capacity  (Leung, Coram and Cooper, 2012).

2.

• Based on the information provided, it is apparent that MSL is a company which provides equipment to the various miners along with maintenance services and also spare parts of the various equipments are provided by the company for incremental charges. The two key business risks are outlined below which have relevance for MSL.
• Incorrect estimation of the spare parts – It is apparent that the company offers a two year warranty within which free service would be offered once a year. It is possible that during such service spare parts may be required which has to be there with the mechanic as they have to travel to remote locations to serve the client. Additionally, for the MSL to source the spare parts, it may take considerable time since the lead time in this regards is high. Excess inventory in this regard would be disadvantageous as incremental cost would be incurred in storing and maintaining inventory along with blockage of incremental funds which could otherwise have fetched some interest (Arens et. al., 2012).
• Potential fraud and theft of the spare parts – It is apparent that there is immense scope for potential of frauds on behalf of the mechanic especially when they go to remote locations to serve the clients. It is potentially possible that they enter into a quid pro quo relationship with the client which would be mutually beneficial for both the parties while hurting the business interests of the employer. Further, there is possibility of theft also which could have adverse impact on the financial results of the company. The company needs to estimate these based on previous estimates and also potentially take up an insurance policy to minimize the risk  (Gay and Simnett, 2012).
• The impact of the above business risks on the overall audit risk is as highlighted below.
• Owing to correct estimation of the spare parts, the audit risk that could potentially arise are detection risk and inherent risk. Inherent risk could potentially arise as the spare parts in the given case need to be bifurcated into two parts one which go into servicing of equipments under warranty which would be booked as expense and others which would be chargeable by the company which would be treated as revenues and this could result in incorrect recognition of the spare part (Gay & Simnett, 2012). Further, the detection risk is also present here since the auditor would also need to identify the allocation of spare parts by understanding the maintenance contracts as some spare parts which are valuable may be charged even during free service. Hence, based on the this risk, the revenue and expense accounts may be impacted as explained above (Caanz, 2016).
• The two audit risks that are quite relevant are the inherent risk and the control risk.  Inherent risk arises in this case as the nature of the business is such that there is high potential of frauds occurring particularly with regards to provide services under warranty to the client. Besides, there is control risk also as the company may not have requisite measures in place in order to ensure that this risk remains within control (Arens et. al., 2012).  The two accounts that would be impacted would be expenses and inventory.  It is quite possible that inventory account is misstated as the amount reflected in the books could be different from actual count. Also, the spare part inventory which must actually generate revenue may be recorded as expense  (Leung, Coram and Cooper, 2012).

APES (2010), APES 110 Code of Ethics for Professional Accountants, APESB Website, Retrieved on April 20, 2017 from https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf 

Arens, A., Best, P., Shailer, G. & Fiedler,I. (2013). Auditing, Assurance Services and Ethics in Australia( 2^nd ed.), Sydney: Pearson Australia

Caanz, S. (2016), Auditing And Assurance Handbook 2016 Australia (3^rd ed.), Sydney: John Wiley &Sons

CPA (2013), Independence Guide, CPA Website, Retrieved on April 20, 2017 from https://www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/auditing-assurance/independence-guide.pdf?la=en 

Gay, G. & Simnett, R. (2012), Auditing and Assurance Services in Australia (5^th ed.), Sydney: McGraw-Hill Education

Leung, P., Coram, P. & Cooper, B.J. (2012), Modern Auditing and Assurance Services (4^th ed.), New York: John Wiley and Sons