Situation 1: Firm is being appointed to prepare accounts and audit of same company
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Situation |
Threat |
Justification |
Safeguard |
Assessment of audit independence |
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1. Firm is being appointed to prepare accounts and audit of same company |
In the first situation, threat is associated with appointment of similar firm for presenting and preparing business statements as well as audit of the alike financial statement which are organized by auditing firm. The threat identified in this situation is related with independence of auditor`s the conflict of interest (Arya, & Glover, 2014). |
Client has approved some adjustments in trial balance as client`s company has expertise; but it is required that audit firm should be well aware of some adjustments as well. |
Two different or poles apart contract shall be made with auditing and accounting firm. |
Audit independence can only be achieved by making two different set of agreement or contract. |
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2. Job is offered by the company to the audit team member. |
This situation can create threat for the auditors in regards to the duties discharge by them independently as well as the financial statements could be stated in false way. |
Job is offered by the company in between the procedure of audit and the auditors cannot discharge their duties of job for the similar audit client therefore, threat to the independence is present in the situation. |
1. Auditor shall be removed or replaced with some other auditor. 2. The auditor shall deny or not join job at Jupiter ltd. |
Independence can only be achieved when the auditor who has got the proposal of the job denies the offer; and in case if he accepts the offer then that auditor should be replaced with other auditor. |
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3. Fruity Juices Ltd has advised for consulting engagement in order to save time of staff during auditing. |
This situation will create threat as the auditor`s self-interest after being indulging in the consulting engagement will reduce. |
Consulting engagement is carried out in order to save the time of staff, in which limited questions will be asked to them. Through this, scope of audit will become limited and the independence of the auditor would also be affected (Barnes, & Renart, 2013). |
1. Auditor shall deny for the consulting engagement. 2. Auditor shall ask such questions to the staff which are important to get information for audit. |
The auditor shall set back or remove unimportant questions during audit. |
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4. Finance director of Apex Ltd, gets retire and the new director is friend of the audit manager. |
Threat is from the relation of friendship between the finance director and audit manager. |
Threat of familiarity will be there as the audit manager and the finance director are friends which can affect auditor`s independence. |
Only safeguard is to resign from the auditor`s position. |
Question on the independence of the auditor will not arise as after resigning from the post. |
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5. STL, is superannuation fund and requested the audit company to Represent them at the Superannuation Complaints Tribunal. |
There is not any threat to the auditor`s independence. |
Representation service is delivered to the client which do not create any threat for auditor`s independence (Blay, & Geiger, 2012). |
Not required |
Not applicable |
Activities which are part as well as which are not the part of responsibilities which are carried out by the auditors associated with the fraud under ISA 240 are discussed below-
- Ascertain the material fraud instance in order to detect the threat as well as the management`s inconsistent response shall also be investigated by the auditor.
- During audit process, professional skepticism shall be maintained by the auditor.
- Discuss with the audit team shall be done at regular intervals by the auditor during the audit process (DENG, LU, SIMUNIC, & YE, 2014).
- Process of managing risk by the WMD employees or Eastpac bank should also be assessed by the auditor.
- Unusual or unexpected transactions in the financial statement shall also be evaluated in proper manner by the auditor.
- To evaluate the presence of risk factors related with the fraud should also be evaluated by the auditor.
- Journal entries should be reviewed or tested by the auditor.
- Appropriate evidence of auditing should be noted in order to identify the fraud in financial statement (ELDaly, 2012).
- It is not the responsibility of auditor to determine the management`s skills.
- It is not the responsibility of the auditor to check whether the client is following code of conduct.
Inventories account- Undesirable variances in price of the material can lead to misstatement of material. As credit notes issued by the bank are used to pay for the inventories of raw material which can arise risk of shipment failure and then raw materials payment could be affected.
Debtors-In, Amistad Furniture Manufacturers, sales are based on return basis which are subject to thirty days as a due date for payment. Period for higher credit allowed to the debtors is another risk for debtors (Hossain, 2013).
Amistad has not maintained the level of sales as per convent of bank. Annual sales of 400,000 are required by bank and these sales shall be 100,000 quarterly. But previous year`s sales of Amistad was $ 350,000 which drops by $ 50,000.
- Price of timber has increased in UD dollars in comparison to the Australian dollar`s value.
- In, Amistad there is fund of 30% from the total assets ratio for shareholders which are debt to 70% to total asset ratio and this can cause threat to the assumption for going concern.
- Amistad possess adverse side of business operation because of the gross loss in operations of business. This leads to arise question to the statement for going concern for Amistad (Ianniello, 2012).
- Current ratios can be analyzed in proper way by the availability of facts.
- Material variances can be checked to evaluate profitability.
- Sales timing based on returns can be properly analyzed.
- Detailed checking as well as vouching if level of inventory can also be carried out during audit procedure.
Issue associated with internal control is related with the authorizing of marketing manager to make sale offer and to approve the customer`s invoice and to make approval of issuing credit note.
- There is risk of fraud by the marketing manager as to increase the sales level; offers are made on the sales. And for the increment in sales or achieving the target sales, marketing manager will get bonus of 20%; this can lead to the fraud factor.
- At the end of year there was increment in sales but there was also decline in gross margin and return of sales which is also a fraud factor (Marinovic, 2013).
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Risk factor for fraud |
Account balance |
Assertion of risk |
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Bonus of 20 % |
Sales bonus expenses or account for Sales bonus |
Sorting: In the financial statement the bonus get by the marketing manager should be classified as bonus and salary and presented in the statement so that risk could be mitigated. Accurateness: the bonus paid to the marketing manager for achieving the targeted sales should be calculated in accurate way. |
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Higher level of sales as well as gross margin |
Sales account |
Broadness: Transactions related with the sales should be recorded in the statement for income. Cut-off: In accurate interval of period all the sales carried out on return basis should be cut – off in adequate way (Michelon, Bozzolan, & Beretta, 2015). |
Recalculation and conformation- In the scenario, it is stated that the marketing manager will be entitled to get bonus for the increment in sales or when the targeted sales would be achieved by the marketing manager (Zhou, & Zhu, 2012). Therefore, in order to analyze the adequacy for level of sales or bonus on sales, a confirmation from the debtors shall be made. A written form should be filled from the debtors in order to get confirm about the sales made and confirmation of the trial balance of the debtors shall also be done in order to check the total sales made. After then, gross margin shall be recalculated on basis of bonus on sales percentage as well as the deductions of direct expense should also be done.
Systematic procedure- Amistad`s budget and financial data of previous period should be used in the procedure of audit so that actual figures can be matched as well as the calculation of variances could also be done (Arya, & Glover, 2014).
A statement of identified deficiencies, explanation of the business risk arise from deficiency, control which could be implemented by DPL in order to address those deficiencies identified and test of control which could be performed to evaluate that the controls are effectively operating are discussed below-
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Deficiency |
Explanation |
Control |
Test of control |
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1. Company`s website is not integrated with the inventory system which is a deficiency as the level of inventory and the stock`s availability cannot be checked. |
Business risk which can be arise through this deficiency is of adverse inventory management which leads to make incomplete sales order as DPL`s management would not be able to check the stock`s availability due to deficiency of integration of website. |
Enterprise Resource Planning system shall be implemented to integrate the website with inventory system (Barnes, & Renart, 2013). |
CAAT can be used as test of control. |
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2. In, DPL delivery of goods is made by local courier and deficiency identified in this scenario is absence of the proof of receipt of goods. This is one of the deficiencies as there will be no proof with the company that the goods are delivered to the right customer or not in absence of the delivery receipt. |
In absence of delivery receipt there is risk of decline in customers as customers can say that they have not get the delivery which can be loss for the business (Blay, & Geiger, 2012). |
An authorized courier operator shall be appointed by DPL. As well as the delivery receipt should also be get signed through the customer who is going to get the product. |
DPL can use re-performance test of control in order to mitigate the risk of business loss. |
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3. Absence of automation system and delays are made in forwarding the order of sales to the dispatch department. Another deficiency identified is related with absence of control over delivery receipts. |
This deficiency can arise possible risk of incurring loss in business due to delay in dispatching order of sales. As, the customers would not be happy due to delay in receiving the products. And this can incur business loss (DENG, LU, SIMUNIC, & YE, 2014). |
Enterprise Resource Planning system should be implemented by DPL. As, through this system sales order can be tracked in proper way which would be helpful in mitigating business risk. |
Preparation of memorandum to check dispatch of sales order should be done in proper time period. |
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4. Higher authorities have not set a level of discount. It is one of the deficiencies of management related with internal control system. |
This deficiency can expose DPL to huge risk as the sales assistant can manipulate the discount rates according to his interest and the business can incur loss due to heavy discount made on sales. |
Discount level or rate of discount should be set by high authorities and the discount made on sales should be mentioned in the sakes order. |
Re-performance test of control should be undertaken by the auditor (ELDaly, 2012). |
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5. Reconciliation statement of supplier is not made at DPL. |
This deficiency can create business risk as the work load will increase and confusions among the team of sales department and employees can also arise. In such scenario, inappropriate activities of mismanagement in the organization associated with the information of suppliers or account balance would be affected (Hossain, 2013). |
Duties of supervisor and ledger clerk should be segregated. |
To test the control, auditor should do proper inspection of entries related with suppliers (Ianniello, 2012). |
References
Arya, A., & Glover, J. (2014). Auditor Independence Revisited. Journal Of Accounting, Auditing & Finance, 29(2), 188-198.
Barnes, P., & Renart, M. (2013). Auditor Independence and Auditor Bargaining Power: Some Spanish Evidence Concerning Audit Error in the Going Concern Decision. International Journal Of Auditing, 17(3), 265-287.
Blay, A., & Geiger, M. (2012). Auditor Fees and Auditor Independence: Evidence from Going Concern Reporting Decisions*. Contemporary Accounting Research, 30(2), 579-606.
DENG, M., LU, T., SIMUNIC, D., & YE, M. (2014). Do Joint Audits Improve or Impair Audit Quality?. Journal Of Accounting Research, 52(5), 1029-1060.
ELDaly, M. (2012). Responsibility of Egyptian banks’ auditors for going concern assumption in light of Egyptian Central Bank Law No. 88/2003. International Journal Of Economics And Accounting, 3(3/4), 344.
Hossain, S. (2013). Effect of Regulatory Changes on Auditor Independence and Audit Quality. International Journal Of Auditing, 17(3), 246-264.
Ianniello, G. (2012). Non-Audit Services and Auditor Independence in the 2007 Italian Regulatory Environment. International Journal Of Auditing, 16(2), 147-164.
Marinovic, I. (2013). Internal control system, earnings quality, and the dynamics of financial reporting. The RAND Journal Of Economics, 44(1), 145-167.
Michelon, G., Bozzolan, S., & Beretta, S. (2015). Board monitoring and internal control system disclosure in different regulatory environments. Journal Of Applied Accounting Research, 16(1), 138-164.
Zhou, G., & Zhu, X. (2012). Client Importance and Auditor Independence: The Effect of the Asian Financial Crisis. Australian Accounting Review, 22(4), 371-383.
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