Importance of Independence to the Conduct of an Audit - Essay Example

Running Head: AUDIT REPORT Customer Inserts His/her Name Customer Inserts Grade Course Customer Inserts Tutor’s Name Date Executive summary The purpose of carrying out an audit is to provide assurance and credibility to the financial statements. Auditing also helps management improve on their efficiency of business through maintenance of complete and accurate records. Audited reports present a true and fair view. An audit plan shows what work needs to be done when and by whom, ensure that all necessary work has been done and nothing has been omitted, identification of errors or frauds that remain undetected. According to this case the findings clearly indicate that auditor independence is of great importance and an auditor should comply with the fundamental ethical principles of objectivity, integrity, confidentiality, professional behavior. It is clear from the findings that an auditor should consider certain issues before accepting an engagement such as client’s integrity, threats likely to occur and how to safeguard them. Importance of independence to the conduct of an audit Audited financial statements should present a true and fair view of the state of affaires on a company (Switzer, 2007). The reliability of the financial statement is only possible through auditor attestation that acts independently and is not influence by management or any other person. Attestation is forming an opinion leading to an audit report. It is required that internal auditors should be independent when obtain evidence and thus being free from direction or constraint by managers of business unit under audit. The importance of independence to the conduct of an audit includes: 1. Practical independence enables internal auditors to be objective in reporting findings without having to fear for their jobs. 2. It ensures that auditors are free from conflicts of interest and in a better position to promote the interest of the clients. 3. It ensures auditors are freed from pressure that could influence their activities. 4. It ensures that auditors are able to carry out effective monitoring of a company in conjunction with other auditors on behalf of their clients. 5. It ensures that an auditor is free from any influence, interest or relationship that might impair professional judgment or objectivity or in the view of reasonable investor. Requirements in the corporation act 2001 and in apes 110 code of ethics for professional accountants aimed at achieving independence within the audit relationship According to APES 110 members are required to ‘identify threats to compliance with the fundamental principal to evaluate their significance and if such threats are other than clearly insignificant to apply safeguard to eliminate or reduce to an acceptable level (Switzer, 2007). According to the IFAC’s code of ethics for professional accountants, “before accepting a new client relationship, a professional accountant in public practice shall determine whether acceptance would create any threats to compliance with fundamental principles (Switzer, 2007). Potential threats to integrity or professional behavior may be created from issues associated with the clients, management or activities (Switzer, 2007). According to APES 110 SECTION 200; 200.2 “a member in public practice shall not knowingly engaged in any business, occupation, or activity that impairs or might impair integrity, objectivity or the good reputation of the profession and as result would be incompatible with the fundamental principles.” In this case certain threats and safeguards are requirements which are aimed at achieving independence in audit relationship. In this case certain threats have occurred which potentially threaten the compliance with fundamentals principles. Such threats include: 1. Self -interest threats for a member in public practice. In this case discussions with the managements of X Limited, indicate that there is employment negotiation with audit client since the auditor is promised on acceptance he/she will be appointed to the board of the directors of the company. 2. Self -review threats. This include issues of an audit partner having been offered a position in the clients company where he/she will be in a position to exert significant influence over the subject matter of the engagement. In our case offer to be a member of the directors where he will be able to understand better a X’s business and give consulting advice when required. 3. Advocacy threat. This concerns issues where an audit firm is promoting shares in an audit client. In this case the managing partner holds a 16% interest in the contributed equity of X. even though he is not involved and will not be involved in any audit this amounts to a great threat as pertains to independence of audit firm. 4. Intimidation threats. This involves issues of being threatened with litigation by the clients, being pressured to reduce the work performed in order to reduce fees. In this case there is an out standing fees which the clients still owes the previous firm and the client does not intend to pay the fee. This amount to litigation of the matter with the client. Discovering the potential threats in this case does not mean turning down the client, instead safeguards could potentially reduce the threats to an acceptable level. According to section 200, (200.9) of the APES 110 safeguards fall into two categories 1. Safeguards created by the profession , legislation or regulation and 2. Safeguard in the work environment. In this case of X limited safeguard such as an explicitly stated duty to report breaches of ethical requirement, well publicized complaint systems which enable employers and members of the public to draw attention to unprofessional or un ethical behavior, continuing professional development requirement, cooperate governance regulation, professional standards, professional or regulatory monitoring and disciplinary procedures, external review will help reduce on the potential threats. Section 290 (290.1) of APES 110 addresses the independent requirements for audit engagement. Section 290.4 states that in the case of audit engagement it is in the public interest and therefore required by this code of ethics that members of audit teams and firms shall be independent of audit clients. Independence comprises of independence of mind and of appearance. Independence of mind is a state of mind that permits a conclusion without any influences that compromise of professional judgment allowing individual to act with integrity and exercise in objectivity (unbiased attitude). Independent of appearance is avoidance of facts and circumstances of significance that a reasonable and informed third party is likely to conclude, weighing all the specific facts and circumstances (result of others interpretations). Where appropriate safeguards are not available or can not be applied to eliminate threats or reduce, then there is need to eliminate the relationship creating the threats or decline /terminate the audit engagement (Section 290.7). Firms and members of audit teams are thus required to identify, evaluate and address threats to independence; this will help them comply with ethical requirements. According to the cooperation act 2001, Auditor independence requirements include: 1. General standard of auditor independence 2. Specific restrictions applying to employment, financial and business relationships. 3. Provision of non audit service 4. Employment restriction applying to former audit partners and senior audit personnel 5. Auditor rotation. Issues considered when deciding to accept or reject the audit engagement According to ISA/ISQC 1 (ISQC 1.26) a firm shall establish policies and procedure for the acceptance and continuance of client relationship and specific engagement, designed to provide the firm with reasonable assurance that it will only undertake or continue relationship and engagements where the firm-; a. Is competent to perform the engagement and has the capabilities including time and resource to do so (paragraph A 1, A 23) b. Can comply with relevant ethical requirement c. Has considered the integrity of the client and does not have information that would lead it to conclude that the client lacks integrity (paragraph A 19-A 20, A23). Further ISQC 1.27 requires that such policies and procedures shall require-: a. The firm to obtain such information as it considers necessary in the circumstances before accepting the engagement with new client when deciding whether to continue an existing engagement, and when considering acceptance of a new engagement with an existing client (paragraph A 21, A 23). b. If a potential conflict of interest is identified in accepting engagement from a new or an existing client, the firm to determine whether it is appropriate to accept the engagement. c. If issues have been identified, and the firm decide to accept or continue the client relationship or a specific engagement, the firm to document how the issues were resolved The issues which arise and which should be considered include: 1. Lack of clients’ integrity. Integrity refers to straight forward dealing and completeness. When considering the integrity of the client the nature of the trusties operations and investment, trustee’s attitudes towards the requirement, the reason for changing auditors or for recurring audits, passed history with trusties is of great importance. In this case the client does not disclose the information that it has breached the corporation act 2001 and has outstanding fees not paid to their previous auditors even though this might lead to breaking one of the fundamental principles of confidentiality. As a senior auditor with the firm since I have information that the clients lack integrity I would recommend rejection of the engagement. The various issues as stated above like change of auditors is also an indication of lack of clients integrity. 2. Establish whether the precondition for an audit is present. A precondition for an audit is the use by management of an acceptable financial reporting framework in the preparation of the financial statements and the agreement of management and where appropriate, those charged with governance o the premise on which an audit is conducted. To determine whether the preconditions for an audit are present the auditor shall-: determine whether the financial reporting framework to be applied in the preparation of the financial statements is acceptable and (paragraph A2-A9) Obtain the agreement of management that it acknowledges and understands its responsibility (paragraph A10-A13, A19) for the preparations of financial statements in accordance with the applicable financial reporting framework , including where relevant their fair presentation (paragraph A14); for such internal control as management determine is necessary to enable the preparation of financial statements that are free from material misstatements, whether due to fraud or error . In this case the prior auditors identified that the company compliance with accounting standards was unacceptable and thus this could lead to rejection of an audit engagement. 3. Confirmation of a common understanding between the auditor and management and those charged with the governance of the terms of the audit engagement. In this case there is a conflict of interest; it is put as a condition of acceptance of the audit that will lead to the appointment of the audit partner to the boards of directors. The management of X limited is working towards achieving its own benefits since it believes that if it gives the audit partner a better understanding of the business and hence placing him or her in a better position to give consulting advice when required. This is to the advantage of company X where it takes an opportunity for its benefits and this leads to unbiasness. As senior auditor there is no common understanding but a condition leading to conflict of interest hence the engagement can be rejected. It is recommended that if a potential conflict of interest is identified in accepting an engagement from a new or an existing client, the firm should determine whether it is appropriate to accept the engagement. 4. Consider qualification of the appointment in terms of whether there is valid appointment as an auditor. In this case of X pty limited the appointment as an auditor to carry out the audit does not qualify. This is because the previous auditors of X limited identify various professional reasons for rejection of the appointment. X pty limited appointment is not valid since it is trying to escape from the truth of the previous auditors on non –compliance, breach of corporation act 2001 and outstanding fees. According to ISA 220; 300.13 an auditor should perform procedures required by ISA220 regarding the acceptance of the client relationship and the specific audit engagement and communicate with the predecessor auditor, where there has been a change of auditors, in compliance with relevant ethical requirements (paragraph A 20). Conclusion and summary of findings Auditor independence is a very important aspect regarding to this case which ensures that an auditor does not behave unprofessionally or engage in unethical behavior. In this case the fundamental principles of integrity, objectivity, confidentiality and professional behavior must be complied with whatever the situation. The findings regarding this case is that as a senior auditor should not accept the engagement since the previous auditors had identified certain issues which were not in accordance with the standards. It is clear that the clients lack integrity and thus impose certain threats to the acceptance of engagement. References: Switzer Susan, (2007), Internal audit reports post Sarbanes-Oxley: a guide to process-driven reporting, John Wiley and Sons. Read More