Threats to Auditor Independence

This situation has led the auditor of the company upon many matters relating to the authentication of financial statements and giving their opinion. In this situation the CEO of the company has informed the member of the audit team to convey to the audit partner that he has to promote the products and services offered by the company at the open seminar of the company where prospective buyers will come to understand what the company does and what are the positive and negatives things of the company. CEO further informed that the audit firm will not be engaged for audit if he fails to do so.

It implies the hundred percent presence of threat of advocacy or sale promotion or threat of having an economic bond (Edwin, 2015). This type of threat will happen only when the auditor do the promotion of that company of which he or she has to approve the financial statement and have to give opinion thereon. The percentage of presence of this type of risk will be comparatively high as the auditor will not want to lose his or her clients.      

After giving an option to the auditor to either promote the company at the seminar or else leaves the audit engagement, the CEO of the company have further tried to give an advantage to the audit partner with the free fourteen day package with free food and accommodation. This advantage has been extended to not only the family members of the audit partner but also to the members of the audit team. It exhibits that the company is trying to make healthy relations with the auditors of the company.

But to accept the same is against the guidelines issue for auditors by the Institute of Chartered Accountants of Australia and Sarbanes Oxley Act. Also there exists the threat of self interest (Parker, 2015). It is so because the auditors are getting the financial interest from the company in the form of the free services. While evaluating the threat, the financial interest which has been received or which is going to be received by the auditor is needs to be reworked and check whether the financial statements have been or will be affected. The percentage of effects will determine the risks covered. 

While having conversation with Michael, it is informed that his father who is presently working as Financial Controller, being responsible for the preparation and presentation of the financial statements, of the same company in which the Michael has come for the purpose of audit. There may be chances of getting him involved in suppression of facts, documents and others which might be in the normal course of audit will be very helpful. Due to suppression facts and other anomalies, there are chances of having the threat of familiarity and trust at the maximum level.    

First Conversation

Threat of trust occurs when there are chances of getting the fraud or any mischief conducted in order to save the long term lasting close relationship (UK Essays, 2013). The evaluation of such threat will totally depend upon the nature of relationship between the auditor and the auditee firm. If the nature of relationship is such that it can influence the decision of an auditor or mode of checking then the risk of threat will be high otherwise will be at acceptable level.   

Last member of the audit team is Annette. While conducting the audit, it has been informed that she has done the accounting work along with the computation of tax and filing of Income Tax returns for the same company for which she has been appointed as part of the audit team. She has done not for few days but for full two months. The type of work that she has done earlier have made easier for her to develop the healthy relations with the employees of the company engaged in finance department. These relations so developed may cause the auditor team to neglect some of the issues which may come during the course of audit.

This type of situation describes the threat of self review clubbed with the threat of trust. Its evaluation mainly depends on the nature of relationship and how much is the materiality of the issues observed during the course of audit. Thus, if the issues are material and it can avoid then the risk of having this type of threat will be high.  

Through the use of the proper and adequate safeguards the threats which can be imposed on the independence of an auditor can be avoided and the effects thereof can be mitigated. The safeguards are not to be imposed by the audit firm only but also by the audit client. Safeguards have been laid down through the three major ways which are as follows:

• Defining the codes which govern the behavior and deployment of the auditors. These are issued by the Institute of Chartered Accountants of the country governing it.
• Defining the rules, laws, and regulations for governing the same by the governments in the respective country.
• Defining the proper procedures of conducting the audit and planning the audit in such a manner which can consider the posing threats in many ways. 

The ways so quoted above includes further various ways through which the safeguards are defined in the clear and precise manner. These are as follows:

• The rotation of the members of the audit team shall be made on regular basis with due care.
• The team member performing the audit of the company shall not be appointed as team member for performing the non audit services.
• The provision for giving the non audit services shall be reduced to the bare minimum so that the relationship that creates the different type of threats may be avoided.
• The work culture shall be formal in nature. It is because the informal work culture can lead to only the healthy relations which in turn provide the chances of having more threats.
• The material misstatements if noticed shall be informed to the senior team member or audit partner immediately otherwise the chances of getting the issues resolved at the lower level or informal level will be high.
• The rotation of the auditors shall also be made so as to avoid the chances of having manipulating the books of accounts in order to save the company from the legal compliances, etc.
• The auditors shall not be given any kind of financial or non financial interest from the client. As the same may hurt the independence of auditor in many ways. (Livine, 2005).   

Risks are involved in any kind of business whether it is manufacturing or trading or even the service provider. Where there is the element of profit the element of risk is inbuilt added to it. Without taking the risk no business can run. But the risk should not be such that which can affect the continuity of the organization or company business. It means the risk shall not be materialistic rather it shall be at level which can be mitigated or controlled.

Second Conversation

In the given case of MSL Limited, the audit partner of the firm shall consider the following risks in relation to the purchase made by the company from the suppliers located in UK, USA and China.

Loss of Main Equipment – The suppliers of the company MSL Limited are located at UK, USA and China which supplies the equipment to the company for its mining operations. The purchase so made depends on the requirement specified by the vendor who is the purchasing party of the company. The specifications so made are informed to the suppliers who then after making the equipments send the equipments to the company. The suppliers provide the one year warranty for the spare parts in case it is damaged or defect therein is observed later. After one year warranty the company will do it after charging the price mentioned in the bill. But the company has not received any sort of warranty or the provision for replacement for the equipment that the customers purchase from the company. Due to this the company might have the chances to be in losses on case there are the cases where the defects has been noticed and observed in the main equipment and the company has to either replace the equipment or else leave the customer. Thus, in order to sustain in the market, the company has to retain the customers and bear the loss.

Becoming the Equipment useless: Continuing with the above risks, in case due to continuing defects being observed in the equipment the vendor will declined to take the order and decided not deal with the company then the company will be facing the risk of   Further the equipments of the company will be become obsolete which cannot be exchanged in the market due to specifications of the equipment mentioned by the vendors to whom the company supplies the equipment. Another major risk which is encountered by the company is that the risk of getting the equipments obsolete due to change in fashion or technology due to which the company might be facing the problem of liquidity also. Due to this the working capital of the company may go negative which in turn can lead the company in the situation of debt trap and even more with the case of shut down of the company or winding up of the company. Thus, the company shall purchase the equipment from the suppliers very wisely otherwise they will end up with the closure of the business without even having the situation of breakeven. (EY, 2016). 

Third Conversation

Every auditor shall consider the audit risk as defined in the code of conduct defined by the Institute of Chartered Accountants while planning for audit or going for the audit. Otherwise the audit so formed will always hamper the objectivity, integrity and independence of the auditors. The following audit risks shall be considered by the auditor before proceeding for any audit of any company:

The auditor shall consider all type of risks while planning for the audit. In the first case where it has been described that the company has not provided any warranty or replacement of the equipment the auditor shall consider the detection risk. Detection risk is the risk which is considered or encountered by the auditor when the company is not able to provide the documents or supporting evidences to the fact that whether the situation exist or not (Long, 2015). In the given case the company will not be able to substantiate that the warranty is being given by the suppliers to the company as the same is not noticeable from the available documents. And the company is in urge to have good reporting from the auditor, will always try to conceal the facts which in actual is so material which can affect the going concern assumption of preparation of books of accounts.

The account balances which can be affected are provision for warranty, provision for guarantee and stock in hand.

Inherent Risk – Inherent risk is defined as the risk occurring in the financial statements only because of the inherent limitations present in the functioning of the company in relation to the procedures and maintenance of books of accounts (Becker, 2015). As in the second situation the company might have the problem of getting stock of the company lost on becoming the useless, this is mainly because of the internal controls and procedures that the company have put in place in order to avoid any miss happening. But in the given situation it is revealed that the company’s internal control is not much effective which can protect the company from any harm and the same is prevalent in the company since its incorporation. It implies that the company shall not only consider the inherent risk but shall also consider the risk of affecting the going concern assumption of the company. This may lead the auditor to give the qualify report. Thus, the auditor shall consider this type of risk when planning for audit otherwise the reporting which will be given by the auditor in the near future will not serve the purpose.

The account balances which may be affected by the inherent risk are stock in hand, loss for obsolete stock, sundry creditors and the accounts receivables.  

References 

Becker E, (2015), “Audit Risk vs. Business Risk”, available at https://www.osyb.com/blog/small-business/audit-risk-vs-business-risk/  accessed on 25/04/2017. 

Edwin M, (2015), “Analysis of Threats to Auditor Independence and Available Safeguards against those threats”, available at https://www.academia.edu/9406967/THREATS_TO_AUDITORS_INDEPENDENCE  accessed on 25/04/2017

EY, (2016), “Top 10 Business Risks”, available at https://www.ey.com/Publication/vwLUAssets/EY-business-risks-in-mining-and-metals-2016-2017/%24FILE/EY-business-risks-in-mining-and-metals-2016-2017.pdf accessed on 25/04/2017.  

Livine G, (2015), “Threats to Auditor Independence and Possible Remedies”, available on https://www.financepractitioner.com/auditing-best-practice/threats-to-auditor-independence-and-possible-remedies?full   accessed on 25/04/2017. 

Long G, (2015), “Audit Risk and Business Risk”, available at https://www.cpaireland.ie/docs/default-source/Students/Study-Support/P2-Audit-Practice-Assurance-Services/audit-risk-and-business-risk.pdf?sfvrsn=0   accessed on 25/04/2017.  

Parker A, (2015), “6 Key Threat to Auditor Independence”, available on https://www.intheblack.com/articles/2015/01/06/6-key-threats-to-auditor-independence   accessed on 25/04/2017. 

UK Essays, (2013), “Threat To Auditor Independence Accounting Essay.” Available at https://www.uniassignment.com/essay-samples/accounting/threat-to-auditor-independence-accounting-essay.php?cref=1 Accessed on 25/04/2017