Advocacy and Familiarity Threats
Threat: Advocacy Threat – Section 200-6
Reason: The client has put a condition for extending the audit contract which involves a promotional speech by the audit partner in order to woo investors. Threat seems to be material as perceived independence is threatened (APES, 2010).
Threat: Familiarity Threat – Section 200-7
Reason- With the intention of smooth relations in the near future, a 14 day all paid trip is offered to the audit partner(including family) and additional one member and the expense would be completely borne by client firm. Material gifts taking may impair objectivity and thereby not only pose material threat to perceived independence but this may extend to actual independence which could be disastrous (APES, 2010).
Threat: Familiarity Threat – Section 200-7
Reason: The new member Michael has his father occupied as financial controller in the client firm. Clearly, Michael may face compromised objectivity owing to situation involving conflict of interest whereby he has to balance both personal and professional interests which would be difficult. Apparently, the threat is significant to both perceived and actual independence (CPA, 2013).
Threat: Self –Review & Familiarity Threat – Section 200-5 & 200-7
Reason: Familiarity threat exists as only till one month back, Annette shared an employment relation with the client and thus knows the staff well. Self- review threat exists since her work at the client’s firm was related to book keeping and she seems highly confident that there are low chances of any misrepresentation . Considering that she might have to audit the very accounts she prepared, clearly there would be bias and objectivity will be adversely impacted (CPA, 2013).
Internal policy of the audit firm should restrict engagement of any employees in any promotional activity at the request of the audit client. Client firm also must adhere to the sound corporate governance framework in appointment of auditors and the respective conduct with them (Caanz, 2016).
Internal policy of the audit firm should restrict any employees from assuming ownership or acceptance of any material gift from the audit client. Declaration must be submitted to the firm in case of any immaterial value gift accepted extended by client. Client firm also must adhere to the sound corporate governance framework in respective conduct with external auditor and thus not extend any material gifts whatever may be the intention (Gay and Simnett, 2012).
Internal policy of the audit firm should demand at the time of joining the firm a disclosure with regards to the employment status of the family members along the relevant details of the profile and the employer. Further, at the time of being assigned to an audit team, undertaking to be taken that no close or distant relative employed in audit firm under any capacity (Arens et. al., 2013).
Internal policy of the audit firm should demand at the time of joining the firm a disclosure with regards to the past employment along with the relevant details of the profile and the employer. Further, at the time of being assigned to an audit team, undertaking to be taken that no previous employment relation has been shared with the audit firm under any capacity in the past (Leung, Coram and Cooper, 2012).
i. Risk of inappropriate estimation of demand of spare part tends to have adverse impact on the underlying profits generated. This is because if high levels of inventory are maintained, then incremental cost to store the inventory. Also, maintenance cost related to inventory could be there coupled with opportunity cost of the funds attributed to excess inventory. On the other hand, if inventory levels are low than desired, then the service level to the clients may suffer which could result in loss of business and financial obligations . This is because the spare parts are imported and would have a high lead time resulting in business operations of client getting adversely impacted (Arens et. al., 2012).
ii. Spare parts related fraud could happen which seems highly likely between the mechanics and the clients. This could typically take place when for servicing, mechanic goes to remote locations and sell the spare parts at lower cost while reporting to the supervisor that an equipment under warranty needed change of part which was not chargeable from the client (Gay and Simnett, 2012).
- There would be a rise in audit risk primarily due to inherent risk and also detection risk. It is essential that when recording the usage of spare parts, two accounts are particularly relevant i.e. expense and revenue. This is because there are some spare parts which are not charged due to equipment being covered under warranty while for the others, the cost is borne by the client. Hence, the former is an expense to the company while the later is revenue (Arens et. al., 2013). Even though there is no fraud, but accounting for this and understanding what is chargeable or not may be complex thus leading to high inherent risk. Further, the auditor also on his/her part may find difficult to find aberrations in this regard leading to high detection risk (Leung, Coram and Cooper, 2012). The accounts that may be misrepresented include the accounts related to expense and also revenue
- Relevant components of audit risk that would be materially impacted include control risk along with inherent risk. Inherent risk tends to rise on account of the existing business practices which allow immense scope for development of quid pro quo relation of service mechanic with the client. Further, since there is lack of effective control mechanisms in order to keep this under check, hence control risk would also be witnessed in this situation (Caanz, 2016). Two relevant accounts that would be prone to misstatement would be expense account and revenue account as fraudulent information is passed on by the mechanic resulting in potential revenue being booked as expense leading to inflation of expense at the cost of revenue (Gay & Simnett, 2012).
References
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( 2nd ed.), Sydney: Pearson Australia
Caanz, S. (2016), Auditing And Assurance Handbook 2016 Australia (3rd 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 (5th ed.), Sydney: McGraw-Hill Education
Leung, P., Coram, P. & Cooper, B.J. (2012), Modern Auditing and Assurance Services (4th ed.), New York: John Wiley and Sons
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