Situation 1

In the first situation, it is seen that Chris, the CEO of LTH wants to hire the services of CJ Audit firm again for next term after being impressed with their services offered. However, they have imposed a limitation for their reappointment that the Audit partner Geoff of CJ has to give a speech in the annual travel seminar to attract investors. This limitation is basically a threat to the auditor independence with regard to appointment and termination process since CJ Firm will lose their audit engagement if Geoff does not perform the non-audit services as specified by LTH. An Auditor’s main objective is to express an unbiased opinion on the correctness of financial statements through the conduct of various Audit features like vouching & verification of bills and receipts, Scrutiny of Agreement and collaborations entered and other financial matters (Tepalagul & Lin, 2012).

The auditor should give an independent and unbiased view without getting influenced or forced by any offer or arrangement by the management. In case auditor gives any such speech, he would present only the good side of the company in front of the investors to attract them and may hide the negative points. In consequence of this, the investors may believe in the auditor’s statements and may invest in the company just on the basis of the reputation of the audit firm. However, the real picture may not be revealed (Blay et. al, 2011).  Hence, the Independence of Auditor will be hindered and may, in turn, present a fake position of the company’s financial statements just in order to save his audit engagement and this is totally against professional ethics.

In this situation, it is seen that Chris, the CEO of LTH has offered a 14-day holiday trip to Audit partner Geoff & his family including all expenses paid. This is a case of self- interest threat to the auditor’s independent views. The auditor is under the obligation to give an unbiased view on the nature of books of accounts, but accepting any other benefits in cash or in kind may affect his reporting. He may give an incorrect report so as to please the management for the benefit they have extended to him (Lapsley, 2012).

Michael is the son of LTH Financial Controller and Geoff- Audit partner of CJ has suggested him to appoint him in tax advisory department and include him in the audit of LTH. This is a case of familiarity threat. Being the son of Financial Controller of LTH, it is clear that Michael has a common interest in the financial matters of LTH. He also must be aware of the shortcomings of the company and if he is inducted into the audit team of LTH, he might be in a biased position while expressing opinions and conducting audit work (Wright & Charles, 2012). Michael’s father may also influence his son Michael to change the audit findings and to change it to show only the good points of the company. So our advice is to not allow Michael to be part of Audit team LTH.

Situation 2

Annette is an accountant who was working in accounts and tax entries of LTH for a temporary assignment and now it is planned by Geoff to put her in audit team of LTH for the current year. This is a case of self-review threat. Annette knows the workings and accounting calculations of LTH also she was an ex-employee of LTH. A person cannot audit his/her own accounting works. Annette shall have a biased view as she shall not be able to find any shortcomings in her own works. Auditor and Accountant cannot be the same person. So it is advised to Geoff not to include Annette in the Audit team of LTH.

The safeguards against above audit threats are mentioned below:

The Auditor should not accept the audit engagement only due to the reason that the audit engagement will be canceled if the auditor does not produce a speech for the investors and that too only showing the good side of the company accounts in order to attract the investors to invest in the audited firm (Holland & Lane, 2012). This is a non-audit task too and in order to present a fair opinion about the firm accounts, it is very important for the auditor not to perform non-audit tasks.

Further, there should be a proper and unbiased system of selection of audit team by the management of the Auditee Company/ firm and the selection should be based and limited to the audit of accounts only. 

An auditor should only accept any payments in form of his audit fees only. He should not accept any favors, benefits or help in any kind which may affect his opinion or may force or influence him to change his opinion. So any payments to auditors other than his fees and out of pocket reimbursements should not be accepted by the Auditors (Gilbert et. al, 2005). The auditor should disclose to the management of the auditee firm/ company the nature of services that he will offer and the fees that he will charge as an auditor.

The audit team should not include any person who is in any way related or close friend of any employee or owner of the audited firm. An auditor or audit team member should not be related to any management person. In this case auditor’s independence may be affected and auditor might not give the true position of books of accounts (Heeler, 2009).

The audit team should also not include any person who was an employee of auditee in the past. An ex- employee of the auditee shall not be able to check and audit his own work. He might not find any error or shortcomings in his own work. A person should be completely free from any relation from the auditee. His approach cannot be unbiased in case he is or was earlier a part of management team. Well-qualified personnel should be appointed other than the person who was involved with the management in preparing books of accounts, to check the work done by the management team (Fazal, 2013).

Situation 3

Hence, it is quite in the hands of auditor also whether to let his independence get affected or not while performing an audit.

 As an Auditor of M/s MSL, Crampton and Hazard shall consider following business risks associated with the outsourcing of manufacturing of equipment & spare parts.

 Firstly, MSL cannot ensure the quality of mining goods and equipment manufactured by the suppliers. The supplier’s manufacture products specialized as per order received, however, MSL has no mechanism to ensure the quality of the goods manufactured. They receive the goods in their warehouses and sell them from there warehouses. The company has no checking procedure placed to check whether the products manufactured are up to the mark and has no manufacturing defects. The low-quality products if any would be rejected or replaced by the customers thereby increasing the handling and transportation costs that will be incurred when the goods will be returned and new goods issued on their behalf. Further, the two-year warranty for spare parts and labor cost are provided by MSL on their behalf and not by the original manufacturers thereby increasing the warranty costs of MSL.

The company MSL has no suppliers available in Australia. All its suppliers are located outside Australia. The goods suppliers manufacture the goods and send them to MSL warehouses. There exists a business risk that goods may get lost or get destroyed during transportation of goods. A goods transported does not have insurance against theft or loss due to destruction (Church et. al, 2008). Hence there always exists a business risk that goods might not reach the warehouse safely.

Secondly, the mechanics that provide maintenance services on the behalf of MSL may charge undue service charges from the customers. The reason being that they are mobile mechanics and no tracking process can be easily implemented by MSL to check how much area they have traveled, have they used original spare parts or not, the accuracy of accommodation bills and food expenses of the mechanics. Maintenance costs consist of major part of expenses of the company and these costs might get inflated due to non-tracking of expenses incurred by mechanics (Carcello, 2012). Further, the company can also not judge the quality of services provided by the mechanics, which can further worsen the image of the company in front of the customers.

Such business risks would increase the administrative costs and transportation costs of the company MSL. Also, as the products are purchased from suppliers directly, there are no methods available to the company by which it could reduce its costs of manufacturing.

For the first business risk of MSL, Audit risk associated is that the auditor can`t consider whether the warranty cost incurred by the MSL is correct or not. The company may charge excessive warranty cost or the mechanics may produce excessive fake bills because there is no mechanism of checking at the time of selling of the product. MSL provide minimum one free service to its customers. The mobile mechanics also know this fact hence the company shall always bear the charge of one free service. The auditor shall not be knowing whether the warranty expenses charged to the company are correct or not. This can bring down the profits of MSL. Mobile mechanics are required to go to remote locations which are sometimes not paid by customers and are born by the MSL. Also, both maintenance sites and finance sites are located separately, both divisions don’t know the workings of each other (Cappelleto, 2010). The reimbursements bills are submitted to finance office in Melbourne which can`t be verified by warehouses. There is huge administrative gap among departments. So Auditor can`t question the bills paid by Head office because warehouses have no control on warranty costs.

The supplier’s payments should be deducted or stopped in case of faulty supplies. Their account balance should be subject to quality checks and should be cleared when warehouses give the approval to Finance department.

The account balances that can get impacted directly in such case are warranty costs, maintenance costs and costs of spare parts. The irrelevant increase in such goods will affect profitability.     Second Audit risk is that Auditor can`t judge the actual written down value of closing stock because as the management itself has not verified the correct pricing of goods produced by the suppliers and has totally relied on the parts used in the manufactured products. The warehouses have not placed any mechanism of price checks. An auditor judgment of the closing stock figure may affect profits of the company. In case the auditor over values the closing stock, profits of the company may increase. On the other hand in case the auditor undervalues the closing stock, profits shall decrease and may affect in loss of confidence of stakeholders. The Auditor is an important person to decide the true position and in case there is an error in his judgment, it may prove detrimental to the company (Cameran et. al, 2016).

The account balances that can get impacted directly in such case are Supplier Balances, Closing Stock balances and consequently profit figures.

References

Blay, A. D, Geiger, M. A. & North, D. S 2011, ‘The Auditor’s Going-Concern Opinion as a Communication of Risk’, Auditing: A Journal of Practice & Theory vol. 30, no. 2, pp. 77- 102.

Cameran, M., Prencipe, A. & Trombetta, M., 2016, ‘Mandatory audit firm rotation and audit quality’, European accounting review, vol. 25, no. 1, pp.35-58.

Cappelleto, G. 2010, Challenges Facing Accounting Education in Australia, AFAANZ, Melbourne

Carcello, J 2012, ‘What do investors want from the standard audit report?’, CPA Journal vol. 82, no. 2, pp. 7-12

Church, B., Davis, S & McCracken, S 2008, ‘The auditor’s reporting model: A literature overview and research synthesis’, Accounting Horizons vol. 22, no. 1, pp. 69-90.

Fazal, H 2013,  What is Intimidation threat in auditing?, viewed 25 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, no. 2, pp. 66-92

Heeler, D  2009, Audit Principles, Risk Assessment & Effective Reporting. Pearson Press

Holland, K. & Lane, J 2012, ‘Perceived auditor independence and audit firm fees’, Accounting and Business Research, vol. 42, no. 2, pp. pp.115-141.

Lapsley, I 2012, ‘Commentary: Financial Accountability & Management’,  Qualitative Research in Accounting & Management vol. 9, no. 3, pp. 291-292.

Tepalagul, N. & Lin, L 2015, ‘Auditor Independence and Audit Quality A Literature Review’, Journal of Accounting, Auditing & Finance, vol. 30, no. 1,  pp.101-121.

Wright, M.K. & Charles, J 2012, ‘Auditor independence and internal information systems audit quality’, Business Studies Journal, vol. 4, no. 2, pp.63-84.