HI6026 Audit, Assurance and Compliance

You are an audit manager with Clarke & Johnson (CJI). For the past years CJ has been the auditor of luxury Travel Holidays LTD (LTH), a travel company. Geoff, the audit partner, has asked you the to contact Chris, LTH’s CEO, with a view to CJ being re-engaged as the auditor for the upcoming audit of the 30 June 2015 financial report.Geoff has also indicated that intends to allocate Michael, a first-year accountant, and Annette, an accountant in CJ’s tax advisory department, to the LTH audit for the first time. Geoff suggested that you discuss the audit with each of these staff, with a view to identifying any independence issues. You held talks with Chris, Michael and Annette of these conversations
were as follows:

Chris stated: ‘The board of directors were impressed with last year’s audit and would like to propose reappointing CJ as the auditor of the 30 June 2015 financial report audit. The board would also like to invite Geoff to give a speech about LTH at the next travel agency seminar, to assist in promoting LTH’s business to attract more investors.I understand that this is outside CJ’s normal practice; however, the board expressed the view that it will be very difficult for LTH to continue any business engagements with CJ should Geoff refuse to provide such assistance’.

Chris stated: ‘ To express our sincerity towards CJ and Geoff, and to maintain the good relationship in anticipation of another smooth audit for 2015, LTH would like to present a complimentary 14-day holiday package voucher for four people to the Greek isles for both Geoff’s and your family. All expenses, including accommodation and travelling cost, will be paid by LTH’.

Michael stated: ‘I am very excited to be part of the audit team. I believe that I will be a valuable asset to the team, as my dad is LTH’s financial controller. He is responsible for the preparation of LTH’s financial report.’

Annette stated: ‘I am glad that I have been allocated to this year’s LTH’s audit team.It’s going to be a very efficient audit this year! I was on a temporary assignment at LTH’s just a month ago, helping LTH with its tax calculations and preparing accounting entries that will be reflected in the 30 June 2015 financial report, so I don’t think there
will be much audit work required around the tax accounts. It will be great to catch up with everybody at LTH again, as they are so easy to work with.’

Required:
(a) For each situation, identify and evaluate any threats in relation to auditor independence .
(b) Identify any safeguards to those threats identified above

You are an audit senior with Crampton and Hasaad and you are planning the audit of Mining supplies LTD (MSL) for the year ended 30 June 2015. MSL sells mining equipment and spare parts to mining companies across Australia. MSL has operational centres in Perth, Newcastle, and Mt. Isa. Each operational centre warehouses the equipment and spare parts and provides sales and maintenance services. MSL’s head office is located in Melbourne where finance, IT and other corporate services are provided. 

MSL has equipment purchase order contracts with a number of manufacturing suppliers based in Europe, Us and China. These manufactures build the specialised, made- to-order equipment and spare parts and ship them to MSL’s operational centres. Each item of equipment purchased by a customer comes with a two-year spare parts and labour warranty from MSL. The warranty entitles the customer to a maximum of one free maintenance service per year during the warranty period.Depending on the type of equipment and customer’s location, a maintenance service can take
between one day and one week. MSL uses contracted mobile mechanics who travel to the customer’s location to carry out all maintenance services.

 

Some services require the mechanic to travel long distances, due to the remote locations. Any maintenance services that are inside that are outside the warranty conditions are billed to the customer. The billing covers a daily labour rate for the mechanic’s time, any parts replaced and reimbursement for travel, accommodation and living expenses incurred by the mechanic.

Required:
(a) In relation to the purchasing of equipment and spare parts, describe two business risks to MSL that Crampton and Hasaad will consider in planning the 2015 audit.
(b) For each business risk identified in (a) describe a specific audit risk that could arise.Each responses should include the identification of account balances that are impacted directly by the audit risk.

The audit threat identified in the said situation is the threat to compliance with the essential principles of auditing. As per this there is an obligation on the auditor to perform only those activities which he is competent to perform being a Member in Public Practice. Thus in this case the fact that Geoff is required to give a speech in the seminar held by LTH so as to secure more investors is acceptable but the fact that it will help Geoff to secure the audit of LTH would create the above mentioned threat. However the best possible way to overcome the said which may create a conflict of interest thus threatening the very independence of the auditor is by making it very clear to the client that he would not speak up anything that is not true and fair. This would help to reduce the risk to an acceptable level yet ensure that the work is secured as well from LTH (Apesb.org.au., 2010). But if the same is not acceptable by the client and he demands to give a speech in a manner which is rosy and beyond the actual scenario, then the said engagement should not be accepted.

Accepting of the holiday package offered as a gift by LTH to CJ and Geoff would give rise to self-interest threat to impartiality which may take place if the same is accepted. Here the threat is consequential since the same is being offered so as to ensure that the current year’s audit is being conducted smoothly. However the said threat can be overcome and independence of the auditor can be protected after duly understanding the nature, value and the intention behind the said gift. The threat can be safeguarded if the same is made clear to the client before accepting the gift that they would ensure that the audit is being conducted in a smooth manner but at the same time would not compromise upon demanding for any data or document with regards the audit work (Accaglobal.com., 2015). Thus ensuring the same to LTH and the same being accepted by the client would give the auditor a right to accept the gift else if the same cannot be safeguarded to an acceptable level then the same should not be accepted by the auditor.

In the said situation since the auditor, Michael’s father is a financial controller of LTH who is even entrusted with the work of preparing the financial report, thus appointing Michael to be a part of the said audit would create self-interest threat to the auditor’s independence. It is quite natural that he would try to safeguard his father while auditing the financials of the company and thus hide any kind of misstatements or frauds being conducted by his father. Thus this task would impact his duty to conduct an audit independently and objectively as well.

However, the same can be safeguarded if the company is made aware of the relationship preceding to his appointment and prior permission is obtained with regards Michael being appointed to conduct the audit. If LTH agrees to the same even after knowing the relationship then Michael is allowed to perform the task. But at the same time CJ should ensure that the work conducted by Michael is being reviewed by another independent auditor so as to check if he has performed his duty in accordance with the Coe of Ethics and maintaining integrity and independence in his performance to the highest standards (American Institute of Certified Public Accountants., 2016).

The said situation calls for self review and advocacy threats to independence, even though an auditor is allowed to perform certain non-audit services as well such as helping in tax related matters to a firm. Therefore in this situation appointing Annette as an auditor as well who had prepared the tax calculations and accounting entries as well would threaten the basic integrity with which an audit should be conducted. The said threat can be overcome by making the client aware of the said fact that she had worked on the accounting entries of the firm as well as the tax calculations and explaining them the kind of threat it poses to independence of the work (Kueppers, & Sullivan, 2010). Once the client gives permission she is allowed to work but her work should be further checked by another independent auditor so as to eliminate the threat associated.

Since, for MSL equipments and spare parts would be treated as trading items therefore these would be categorized under the heading inventories in the financial statements. Inventory is generally considered to be a high risk account balance item because of the fact that they have a straight impact on the profits being earned by the company. Thus the two business risks that Crampton and Hassad will consider while planning their 2015 audit for MSL would be as under:

1. Movement of inventory due to many locations where the goods are being manufactured and the various locations where they are stored and despatched from may pose a major business risk of misstatement of the balances of the inventory i.e. finished goods, work in progress etc (Moyes, 1997).
2. The second business risk to be taken into account while conducting the audit is with regards rationing and assignment of value to the stocks basis the flow supposition, obsolescence and pace at which the stock is moving. Thus the main conflict between the auditor and the client is with regards the need for declaring a stock as obsolete and the value at which an item of the inventory should be devalued (Wendy 2013).

The audit risk that could arise with each of the above mentioned business risk are:

1. First and foremost is the risk with regards how the recording is being done in the books of accounts i.e. whether immediately or after a time lag and if all recording has been done accurately. The method of counting of the same specifically since the stock taking has to be done from three locations is what the auditor is trying to deal with (Auasb.gov.au., 2005).
2. The main audit risk with regards the second business risk is associated with estimation of cost of obsolete and slow moving items. The method via which the stock value would be written down and the method that would be used is a big risk that the auditor faces. Bifurcating the stock as usable, obsolete or slow moving is a task of an expert and thus the auditor will have to take the help of an expert for the same thus there is always a risk of the same not being conducted properly (Hamlett, 2016). Thus here the risk of misstatement arises since if the accounting estimate is incorrect then the entire financial statement would reflect a rosy and untrue picture. Thus there is a risk of incorrect estimation of stock value.

References

Auasb.gov.au., (2005), Proposed Auditing Standard : Existence and Valuation of Inventory (Reissuance of AUS 506), Available at http://www.auasb.gov.au/admin/file/content102/c3/AUASB_ED5%20-%2005%20(Revision%20of%20AUS%20506).pdf (Accessed 26^th April 2017)

Hamlett,K., (2016), Inventory Control Risk, Available at http://smallbusiness.chron.com/inventory-control-risk-2225.html (accessed 26th April 2017)

Moyes,G.D., (1997), Audit techniques and Inventory Fraud Detection In Accounting Information Systems, Review of Accounting Information System, vol.1, no. 1, pp. 63-76

Wendy J. G (2013) Key Considerations in the Audit of Inventory: A Practice-Oriented Learning Case Utilizing “Diamonds”. Issues in Accounting Education, Vol. 28, No. 4, pp. 945-964.