Auditing Issues - Assignment Example

Auditing Assignment Name: Institution: Course: Lecturer: Date: Part 1 (a) 1. The need of LTH to retain CJ as the auditor is likely to encourage the auditor to compromise their independence and fail to report any misrepresentation within the LTH’s financial statement. There is also likelihood that CJ may accept LTH’s proposal for a particular accounting treatment. In similar cases, knowledge spill-over in most of joint engagements for both audit as well as non-audit services, brings a possibility of consistent bias during review and reliance on previous audit work as well as non-audit activities. Thus, external parties as well as regulators have linked joint-audit service with the belief that impairs auditor’s independence. Moreover, if the auditor is mandated to perform non-audit services in light of mandatory audit-partner rotation, then the independence of the audit process is likely to be compromised. 2. In the performance of their duty, independent auditors are barred from accepting gifts or hospitality from their client. Such gifts are likely to affect the auditor’s work through the client’s influence. However, it is important to differentiate about the nature and materiality of gifts and hospitality advanced by the client. The auditor is not barred from accepting gifts or hospitality that is considered trivial and inconsequential, since their magnitude is minimal to act as a threat to their independence (Patel & Psaros 2000). However, in this case, a holiday offer to the auditor, audit partner and their family members is considered non-petty and significant. The acceptance of such offer will undermine the overall audit procedures and hence hampering auditor’s independence. 3. During the audit process, both personal as well as business relationship between auditor and the client should be gauged. In such a case, the existence of family relations and business relations is likely to compromise the audit process. This entails an audit-client relationship covering close family members, close relatives and business associates which impair the independence of the auditor. In this case, the fact that Michael will conduct the audit of LTH where his dad is the financial controller is likely to inhibit the whole process. This is because the mutual association between father and son is likely to cause coercion, mutual agreements and compensation schemes aimed at presenting an untrue state of affairs of the company’s accounts (Goodwin & Yeo 2001). 4. Familiarity and self interest of the auditor towards the client should be taken into consideration prior to audit engagement. Familiarity entails possessing high degree of overconfidence of the client’s practises as well as knowledge about potential client. Self-interest entails having unclear motives about the clients operations which a party may not wish to be ‘broken’. In this case, Annette had been engaged by LTH to perform some non-audit work. This is a common occurrence to many auditors. During the audit process, the auditor may be required to perform a thorough scrutiny of non-audit work carried out by her previous colleagues within the firm. The auditor may become reluctant in confronting her colleagues. Moreover, she may possess self-interest in minimizing exposure which could jeopardize audit firm’s reputation (Goodwin & Yeo 2001). Part 1 (b) 1. Modifications of the Selection Process – most of the companies in developed countries have been giving the managers prerogative of selecting auditors to conduct the audit process. This has been making auditors answerable to management rather than the shareholders. However, there is always a possibility of shifting such obligation to shareholders who nominates, appoint and renew the overall appointment of an auditor. According to research, appointments made by shareholders lead to greater independence of auditors. Moreover, instilling a regulatory oversight regarding the nomination process is a great remedy to breach of independence. Modern firms have embraced the practise of selecting an independent audit committee which is given mandate of nomination. However, in order for the nomination process to be possible and effective, the audit committee must be sufficiently independent (Carey, Subramaniam & Ching 2006). 2. Mandatory Rotation Rules – majority of countries such as the US, Australia and the United Kingdom have requirements that auditors must be replaced periodically. In Australia, a leading partner should not serve in his capacity in a period exceeding five years. The underlying reason is that new partner is likely to bring fresh look and input, being free from both familiarity as well as complacency threats. However, there are some issues perceived to be problematic with the rotation. First, the economic bond of partnership is unlikely to be impacted by rotation; that is, the audit fees are likely to remain despite the change. Secondly, it is argued that with the change of the audit partner, the company incurs setting-up costs as well as loss of the client specific knowledge, a situation which can weaken the entire process (Carey, Subramaniam & Ching 2006). 3. Corporate Governance Mechanisms – the embracement of corporate governance by the client is ideal to promote auditors independence by curbing cases of conflict and unwarranted associations. For instance, employing proper compensation plans which reduce incentives for managing earnings will definitely reduce other given incentives aimed at compromising auditor’s independence (Umar & Anandarajan). Some companies have taken extra steps where shareholders stipulate criminal charges to managers who sabotage the audit process by providing misleading information to the auditors. Further measures are instilled by setting up an independent audit committee. The auditor is then required to directly communicate to the members of the audit committee without manager’s intervention. 4. Monitoring the Auditors – there are many queries that have been posed globally whether there is a need of monitoring professional bodies. However, in both United States and United Kingdom, the activities of auditors are monitored by professional independent bodies. The motive behind this is to boost the overall effort of increasing auditor’s independence through threat of enforcement practice. In the United Kingdom, the role is performed by Audit Inspection Unit that forms part of professional oversight board. In the United States, this role is performed by PCAOB (Public Companies Accounting Oversight Board). These regulatory bodies centre their work particularly to quality of audit performed, whilst focus is given to areas such as fraud, ethical standards compliance, audit of revenue and expenses as well as the going-concern concepts. Part 2 (a) 1. The first potential business risk that the auditor may be exposed is inability to gain all information to understand the company. The main aim of understanding the firm’s goals and strategies is to identify business risks which could result to material misstatement of the accounts. In this case, the prevailing risk would be to deal with the implementation of the strategy as well as the effects that will crop up from the accounting treatment requirements. The potential risk would be that the strategy may fail due to the disgruntled customers who would not want to meet additional cost. As a result, the business is likely to suffer a loss out of the huge expenses incurred to meet the customers’ demands. The other risk that the business is likely to face is risk of non-disclosure of financial items. After performing the maintenance work, the mechanical personnel may deliberately or un-deliberately fail to disclose the work performed. There is also a high chance that the personnel may collude with the consumers in the process of work, so that the proceeds of payment of work done is divided between the worker and the client (Patel & Psaros 2000). Such risks could bring about material misstatements during the financial statement level, and hence affecting many accounts as well as disclosures within the financial statements. For instance, loss profitability and declining revenue could impact on the company due to its inability to settle its obligations. This in turn could affect the risk of material misstatements such as classification of non-current liabilities or the valuation of non-current assets. The risk could lead to a doubt whether the firm could proceed as a going concern. 2. The risk of material misstatement may arise from a number of sources. This includes external factors; that is, conditions within the industry and its environment and conditions that are company specific, example is nature of company, her activities as well as the internal control regarding financial reporting. Both external and internal factors can impact of the judgement entailing accounting estimates and or create coercion of manipulating financial accounts with an aim of achieving some specific financial targets (Patel & Psaros 2000). Furthermore, the risks related to material misstatements may arise due to existence of personnel who lack the required financial reporting competencies, lack of information technology systems which fails to capture relevant business transactions and or financial reporting process which are not properly aligned with overall requirements of the valid financial reporting framework. This may lead to failure of the product. In case of failure of a product, the risk which is likely to cause material misstatement is related to valuation of inventory as well as other assets. Thus, audit procedures which are necessary for identification as well as assessment of risk regarding material misstatement must consider both internal and external factors of the company. The audit procedure in such a scenario include; first, gaining a thorough understanding of the company and her environment. Secondly, gain a thorough understanding of the company’s internal controls. Thirdly, consider accessing information from client acceptance, past audits as well as other engagements performed by the company. Fourthly, perform the analytical procedure. Fifthly, conduct a discussion with the engaged team members about the risks emanating from material misstatement Part 2 (b) 1. Control Risk This is a type of audit risk whereby the existing internal controls of the company may not be in a position either to detect or protect the significant errors or material misstatement that has been made in the financial statements. On basic terms, it is the duty of the management to set up as well as assess internal control of the financial reporting ensuring that the reports are free from significant material misstatements. MSL has its headquarters in Melbourne. The headquarters house the accounting department where all the accounts work is performed. However, each operational centres if located far from the head-office. Moreover, the contracted mechanics perform their service at distant locations from the main office. The case study does not highlight whether the company has specialised accountants as well as equipments to perform proper, accurate and timely accounting work. Therefore, the risk of potential errors and lack of recording of accounting entries may persist. This forms a basis of control risk that the auditor should consider (Patel & Psaros 2000). Apparently, a situation whereby the control system is weak means that a high chance exist that financial statements could be misstated. Subsequently, it means that there is a high chance that the auditor may fail to recognise all these kind of risks. That means that control risk is a major cause of audit risk. An auditor should perform a thorough analysis of the client’s controls in order to ascertain whether those controls should be relied upon or not. If the confirmation of the controls states that the controls are weak, then the auditor should confirm whether the controls work by testing them. 2. Inherent Risks Inherent risks are those risks that both the auditor and the client cannot control. Inherent risk arise due to the complexity of the client business or nature of the client work or business transactions which require high involvement or auditors judgement. The risk is normally rampant is the transactions requires high human judgement. The type of risk is also caused by the external environment such as climate change and geographical conditions. An auditor needs to assess this type of risk in order to set-up the necessary audit procedure to address them (Umar & Anandarajan). For instance, this case entails outsourcing of maintenance work. The nature of this work compels the firm to source services of specialists who travel long distance locations. The auditor should consider both contractual work and geographical locations in regard to recording of financial items. 3. Detection Risk This is the risk that the auditor may completely fail to detect material misstatement within the financial statements making him issue incorrect opinion pertaining to the statements. The main causes of this type of risk is when the audit process is improperly done, poor engagement management, low competency, wrong audit methodology as well as lack of thorough comprehension of the client. However, a big percentage of detection risk emanates from the auditor’s fault. This done not mean that this type of risk is not caused by the business, but poor audit plan is the major contributing factor. For instance, if at the entire audit plan is poor, then it means that not all risks will be defined while the audit program used to detect the risks will be deployed incorrectly. References Patel, C. and Psaros, J., 2000. PERCEPTIONS OF EXTERNAL AUDITORS’INDEPENDENCE: SOME CROSS-CULTURAL EVIDENCE. The British Accounting Review, 32(3), pp.311-338. Umar, A. and Anandarajan, A., 2004. Dimensions of pressures faced by auditors and its impact on auditors’ independence: a comparative study of the USA and Australia. Managerial auditing journal, 19(1), pp.99-116. https://pcaobus.org/Standards/Auditing/Pages/Auditing_Standard_12.aspx Carey, P., Subramaniam, N. and Ching, K.C.W., 2006. Internal audit outsourcing in Australia. Accounting & Finance, 46(1), pp.11-30. Goodwin, J. and Yeo, T.Y., 2001. Two factors affecting internal audit independence and objectivity: Evidence from Singapore. International Journal of Auditing, 5(2), pp.107-125. Read More