1. i) The luxury Travel Holidays LTD (LTH) will re-engage Clarke & Johnson (CJ) as the auditor for the upcoming audit for the 30th June 2015 financial report on one condition i.e. the audit partner Geoff would have to give a speech about LTH for their business promotion and attracting investors. Here independence of appearance has been affected where the auditor, having knowledge of all facts of the company, has been forced to address the third party for the interest of the business. Here conflict of interest arises in the case of providing non-audit services. It should be kept in mind that quality and integrity of financial information is very vital.
ii) The lucrative offerings from the party being audited are a threat to auditor independence. In an audit, the auditor should have an approach of objectivity towards the process of audit and that should be with integrity. There should be the independence of mind. The state of mind should not be influenced in such a way that auditors compromise professional judgement (Elder et. al, 2010).
iii) In this case, the auditor must be aware of the relationship of members of the audit team with the audited party. In this case, the accountant and one of the members of the audit team have the direct (father-son) relationship with the financial controller and preparer of the financial report of the company, being audited. The conflict of interest may arise for the specific relationship. There may be the case of compromising professional judgement in favour of relationship.
iv) The employment relationships of team members of audit team with the party being audited may affect the independence. The audit team should have all the necessary information related to the audit and proper explanation to cases and assistance should be available from the auditor whenever it is required. But, it should be checked that there is no conflict of interests (Guan et. al, 2008).
When there are threats to auditor independence, the auditor should identify and evaluate the same to apply proper safeguards. The safeguards are used to reduce the independence risks from the threats identified (Livne, 2015).
i. For any non-audit services depending on the case, the permission must be granted by the chairman of the board or committee or all the board or committee members. The approval of non-audit services by the external auditor should be reviewed thoroughly related to the independence factor and the objectivity. In this case, ethics and legislation should be followed (Hoffelder, 2012). But, at the time of applying guidance, auditors sometimes face challenges. Still, the auditors should not perform the functions in the purview of management, advocacy etc.
ii. In the audit, there should not be any compromise of professional judgement due to economic, commercial or relational interests. But in a society, it is not fully possible. In that case, the factors that may influence judgement are evaluated to a reasonable level and the third party should be informed where it is unacceptable (Elder et. al, 2010).
iii. Where the conflict of interest persists in more than seven days due to a specific relationship, the auditors should inform about the existing conflict of interest in writing to the respective authority or audit committee (Gilbert et. al, 2005).
iv. The hiring of personnel should be considered keeping in mind that it might affect the auditor independence. The audit committee must discuss in detail and investigate properly the independence issues. If required expert guidance should be solicited from legal counsel for appropriate action.
In relation to the purchasing of equipment and spare parts, the following business risks to MSL will be considered in planning the audit.
i) Here MSL has to depend on the manufacturing suppliers based in Europe, US and China for the specialised, made- to-order equipment and spare parts and delivery of them to MSL’s operational centres. In this case, suppliers reliability should be assessed depending on the business risk factors such as:
a) Additional costs in case suppliers fail to meet the obligations related to quality, delivery, servicing etc.
b) The complexity of order in case of execution of the contract.
c) The greater dependence on the dominant supplier compared to the contract value and suppliers turnover.
ii) MSL has equipment purchase order contracts with suppliers in case of purchasing equipment and spare parts. This is an agreement between the parties and it is legally enforceable. Business risk arises in case contracts do not incorporate specification in detail. The terms and conditions evaluating the entire possible situation related to the purchase and delivery of equipment and spare parts should be mentioned in the contract (Hoffelder, 2012). The terms related to payment should be clearly understood and agreed by the parties, which may generate risks related to block of money or the conditions going in favour of suppliers. The contract is required to be drafted and signed after willingly agreed upon by the parties.
i. Auditor mainly focuses on the transactions rather than the account balances. Due to the purchase of capital equipment and spare parts, money gets blocked for a long time. The risk becomes high if this period is extended for long (Lapsley, 2012). This process should be audited correctly. The mistakes are not rectified easily. The audit risk of not gathering proper supplier information is also associated with the business risk related to suppliers. Information of suppliers related to their organisational structure, financial position, production capacity, manufacturing process ensuring quality, experience, no. of employee, training record, and litigation if any etc. is gathered (Fazal, 2013). The financial status is also judged by some key accounting ratios, reducing profits, increasing debts, fall in liquidity position, reducing employees, changing name frequently etc. The financial strength should be sufficient to handle the order.
ii. Audit risk is also found in the case of contractual matters. The auditor should check the contract minutely to reduce risk and thereby helping both the company and signatory. Few things should be noticed. The payment should be done only after receiving delivery and satisfactorily testing the equipment as per the standard laid in the contract (Fazal, 2013). The additional conditions should also be mentioned in the contract regarding packing, date of completion, transport, delivery, acceptance testing, access to audit, maintenance of books, site/work access, post contract support etc. The risk is to be reduced by making conditions of purchase more favourable than the conditions of sale (Hoffelder, 2012). The contract must be signed by the authorised person for the institution, who has delegated the purchase authority
Reference
Elder, J. R, Beasley S. M.& Arens A. A 2010, Auditing and Assurance Services, Person Education, New Jersey: USA
Fazal, H 2013, What is Intimidation threat in auditing?, viewed 27 April 2017 https://pakaccountants.com/what-is-intimidation-threat-in-auditing/.
Gilbert, W. Joseph J & Terry J. E 2005, The Use of Control Self-Assessment by Independent Auditors, The CPA Journal, vol.3, pp. 66-92
Guan, L, Kaminski, K. A & Wetzel, T. S 2008, ‘Can Investors Detect Fraud Using Financial Statements: An Exploratory Study’, Advances in Public Interest Accounting vol. 13, pp. 17-34.
Hoffelder, K 2012, New Audit Standard Encourages More Talking, Harvard Press.
Lapsley, I. 2012, Commentary: Financial Accountability & Management, Qualitative Research in Accounting & Management, vol. 9, no. 3, pp. 291-292.
Livne, G 2015, Threats to Auditor Independence and Possible Remedies, viewed 28 April 2017
https://www.financepractitioner.com/auditing-best-practice/threats-to-auditor-independence-and-possible-remedies?full.
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