Fact – Chris acting as the CEO of LTH

Fact – Chris acting as the CEO of LTH,  has made it a precondition that Geoff (the audit partner) must necessarily offer a speech at a seminar for promoting the company so that higher number of investors could be attracted to the company.  It seems that the CEO already knows that an auditor cannot indulge in such promotional speeches and hence intends to use the audit contract as a bargaining chip.

Threat – Section 200-6 of APES code of ethics highlights the advocacy threat which would be relevant here. This is because no member of the accounting and auditing profession is allowed to engage in any promotional speeches for the interest of the client as this tends to atleast undermine the perceived independence on the part of outsiders even though the actual independence may not be compromised.  Since, the actual independence may not be compromised, hence the risk is not deemed to be significant (APES, 2010).

Mitigation – Potential safeguards are available to deal with the given situation.  A safeguard at the level of the firm could be through internal policy and conduct rules implementation whereby any firm member is forbidden from indulging in any promotional speech or campaign representing the client.  Potent safeguard at the firm side is also possible by ensuring that auditor appointment is an inclusive process taken at the board level in consultation with the top management rather than placing the matter solely in the hands of the management which could develop a quid pro quo relation with the external auditor (Arens et. al., 2012).

Fact:  LTH’s CEO Chris is satisfied with the audit services provided by the firm in the past year and wants to ensure that this trend continues in the future.  There is an intention on the part of the client to offer Geoff and myself an all paid 14 day trip to Greek Isles in lieu of the our services.

Threat – Section 200-7 of APES code of ethics highlights the familiarity threat which would be relevant here. This is because no member of the accounting and auditing profession is allowed to accept gifts of material value from their clients as this may not lead to comprise in perceived independence but can potentially result in compromised actual independence as well. Hence, the given threat to auditor independence would be perceived  as significant and would require that appropriate safeguards be undertaken to deal with such situations (APES, 2010).

Mitigation – Potential safeguards are available to deal with the given situation.  A safeguard at the level of the firm could be through internal policy and conduct rules implementation whereby any firm member is forbidden from  accepting any material gift from the client irrespective of the underlying intention. Besides, safeguard at client side is also available primarily due to corporate governance regulations which would forbade the presentation of material gifts to external auditor (Gay and Simnett, 2012).

Fact:  When it was revealed that Michael would be part of audit team , he responded that he would be very excited about the engagement primarily because his father was employed with the client firm in the capacity of the financial controller. In the given profile, he was the person concerned entrusted with the task of financial statements preparation.

Fact:  LTH’s CEO Chris is satisfied with the audit services provided

Threat- Section 200-7 of APES code of ethics highlights the familiarity threat which would be relevant here. This is because no member of the accounting and auditing profession is allowed to engage with a client where a family member is employed with the client in a significant position which could potentially compromise the underlying objectivity associated with the audit (APES, 2010). In the given case, the extent of threat is quite significant as through Michael his father can result in a compromised audit and hence necessary safeguards need to be erected in the given situation (CPA, 2013).

Mitigation:  The firm specific safeguards would be applicable for the given situation. Hence, it is critical that the firm should have policy that mandates that all new recruits would have to make disclosure to the company highlighting where the immediate family members were employed. Further,  at the time of joining the audit team for a particular client, an undertaking from the members of the team would be required on an individual basis so as to highlight that no relative occupies any post of significance in the audit company. Failure to give undertaking or furnishing incorrect undertaking should attract punitive action including termination of employment for repeat offenders (Caanz, 2016).

Fact:  During a conversation session to disclose her inclusion in the audit team, she is visibly excited that she would get to meet her ex-colleagues at the company as till about a month back, she was providing commercial services to the client in the form of accounting and taxation work.  Further, she is familiar with the staff and the management of the company.

Threat:  The applicable threat to auditor independence as per the facts stated above would be self-review threat (APES, 2010).  This would arise as Annette herself was involved in preparing the books of account for the company to some extent and now she has to review her own work which she might not be very critical about.  This would tend to enhance the overall audit risk and would be categorized as a significant threat  to auditor independence both in appearance and form (CPA, 2013).

Mitigation: The firm specific safeguards would be applicable for the given situation. Hence, it is critical that the firm should have policy that mandates that all new recruits would have to make disclosure to the company highlighting where they were previously employed either part time or full time. Further, at the time of joining the audit team for a particular client, an undertaking from the members of the team would be required on an individual basis so as to highlight that thye have not been employed in any capacity by the audit company in the past. Failure to give undertaking or furnishing incorrect undertaking should attract punitive action including termination of employment for repeat offenders (Leung, Coram and Cooper, 2012).

• Based on the information provided, it is noteworthy that MSL provides a host of mining equipment to various companies engaged in mining. Additionally, MSL also provided after sales services in the form of maintenance and also provides the requisite spare parts that may be required.  In order to provide maintenance, the company mechanics at times have to travel to far off places. Two major business risks in accordance with the business description of the client are highlighted below.
• Reduction in sales –  The sale of the mining equipments would depend on the underlying mining activities which are currently at their lows as the commodity prices have soften to a great extent. Also, there is limited demand from international markets particularly China which implies that the mining companies are continuing to operate at less than 100% capacity and this tends to impact the overall profit. Further, since 100% capacity is also not required, thus, the company may refer delaying the  equipment purchase  (Arens et. al., 2012).
• Issues with short term liquidity – It is quite possible that under the given circumstances, MSL may issues liquidity issues due to lower offtake of machines and other spare parts besides drop in profits. The company tends to purchase the various machines through contract and hence it needs to offtake the machines from the suppliers and also to make the payment for the same in a timely manner. However, this trading stock would not be sold further which may give rise to liquidity issues that may worsen up as the recovery in the mining sector is delayed (Gay and Simnett, 2012).
• In relation to the trading environment related business risk, the audit risk would tend to increase as a result of the overall control risk. This is primarily because of the business slowdown it is quite possible that the company in order to project a favorable picture to key stakeholders such as investors, creditors and lenders may tend to intentionally misrepresent the financial statements to indicate that the company is stable even though such pressure might be mounting (Caanz, 2016).

In relation to the reduced liquidity for MSL, the audit risk would tend to increase as a result of the overall control risk.  This is because there would be tightening of liquidity which would warrant additional working capital which may be hard to come by especially in wake of higher liquidity crunch. Thus, the inventories may be misstated along with the sales account so as to book sale even though the concerned item may still be in inventory only. Besides, there could also be some obsolescence of inventory particularly for the spare parts and incremental maintenance expenditure for the equipments (Arens et. al., 2012). Further, the accounts payable balance may also be misrepresented in order ot obtain incremental financing for meeting the short term credit needs till the business improves. It is quite possible that going concern assumption risk would enhance and the same needs to be capture by way of the auditor report in the annual report (Leung, Coram and Cooper, 2012).

References

APES (2010), APES 110 Code of Ethics for Professional Accountants, APESB Website, Retrieved on April 20, 2017 from https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf 

Arens, A., Best, P., Shailer, G. & Fiedler,I. (2013). Auditing, Assurance Services and Ethics in Australia( 2^nd ed.), Sydney: Pearson Australia

Caanz, S. (2016), Auditing And Assurance Handbook 2016 Australia (3^rd ed.), Sydney: John Wiley &Sons

CPA (2013), Independence Guide, CPA Website, Retrieved on April 20, 2017 from https://www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional-resources/auditing-assurance/independence-guide.pdf?la=en 

Gay, G. & Simnett, R. (2012), Auditing and Assurance Services in Australia (5^th ed.), Sydney: McGraw-Hill Education

Leung, P., Coram, P. & Cooper, B.J. (2012), Modern Auditing and Assurance Services (4^th ed.), New York: John Wiley and Sons.