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November 15, 2024
Inquiry (1)
You hold the position of audit manager at Clarke & Johnson (CJI). CJ has served as the auditor for Luxury Travel Holidays LTD (LTH), a travel firm, for many years. Geoff, the audit partner, has requested that you reach out to Chris, LTH’s CEO, about the potential re-engagement of CJ as the auditor for the forthcoming audit of the 30 June 2015 financial report.
Geoff has also signaled his intention to assign Michael, a first-year accountant, and Annette, an accountant in CJ’s tax advising department, to the LTH audit for the first time. Geoff recommended that you confer with each staff member on the audit to ascertain any potential independence concerns. You engaged in discussions with Chris, Michael, and Annette, and the details of these exchanges were as follows:
1. Dialogue with Chris, scenario 1
Chris said that the board of directors was pleased with the previous year's audit and wishes to recommend the reappointment of CJ as the auditor for the financial report audit dated 30 June 2015. The board wishes to ask Geoff to deliver a speech on LTH at the next travel agency seminar, to aid in promoting LTH’s company and attract further investors. I acknowledge that this deviates from CJ's standard procedure; nonetheless, the board conveyed that it would be very challenging for LTH to have any economic relations with CJ if Geoff declines to provide such support.
2. Dialogue with Chris, scenario 2 Chris articulated: 'In order to convey our genuine regard for CJ and Geoff, and to preserve the amicable rapport in expectation of a seamless audit for 2015, LTH intends to offer a complimentary 14-day holiday package voucher for four individuals to the Greek Isles for both Geoff's and your family.' All expenditures, including hotel and travel costs, will be covered by LTH.
Dialogue with Michael
Michael expressed his enthusiasm for becoming a member of the audit team. I am certain that I will be a significant contributor to the team, given that my father is the financial controller at LTH. He is accountable for the compilation of LTH's financial report.
4. Dialogue with Annette Annette said, "I am pleased to have been assigned to this year's LTH audit team." This year's audit will be quite efficient. I just completed a brief project at LTH, assisting with tax computations and generating accounting entries for the financial report dated 30 June 2015; hence, I anticipate little audit work will be necessary concerning the tax accounts. Reconnecting with everyone at LTH will be delightful, since they are very collaborative.
Mandatory:
(a) For each scenario, identify and assess potential vulnerabilities to auditor independence.
(b) Specify any protective measures against the aforementioned dangers.
Task Question (2) You are an audit senior at Crampton and Hasaad, preparing for the audit of Mining Supplies Ltd (MSL) for the fiscal year ending 30 June 2015. MSL distributes mining equipment and components to mining enterprises across Australia. MSL operates centers in Perth, Newcastle, and Mt. Isa. Each operating center stores equipment and replacement parts while offering sales and maintenance services. MSL's headquarters is situated in Melbourne, where financial, IT, and other corporate functions are administered.
MSL has equipment purchase order contracts with many manufacturing suppliers located in Europe, the United States, and China. These manufacturers produce customized, made-to-order equipment and replacement components, subsequently shipping them to MSL's operations centers.
Every piece of equipment acquired by a client has a two-year guarantee for replacement parts and labor from MSL. The warranty grants the client one free maintenance service annually during the guarantee duration.
The duration of maintenance service might range from one day to one week, depending upon the kind of equipment and the customer's location. MSL employs hired mobile mechanics that visit the customer's site to perform all maintenance services. Certain services need the mechanic to go considerable distances, owing to the isolated sites. Any maintenance services not covered by the warranty terms will be charged to the consumer. The billing include a daily labor rate for the mechanic's services, costs for any changed components, and compensation for travel, lodging, and living expenses spent by the technician.
Mandatory:
(a) Regarding the procurement of equipment and replacement parts, identify two business risks that Crampton and Hasaad will evaluate in the preparation of the 2015 audit.
(b) For each business risk described in (a), delineate a corresponding audit risk that may emerge. Each answer should identify the account balances directly affected by the audit risk.
The relevant threat corresponding to each of the talks outlined below is specified as follows.
Dialogue 1: Chris, the CEO of LTH, informs the audit manager of CJI that the board intends to extend their partnership by granting the audit contract; however, this is contingent upon Geoff's agreement to deliver a promotional speech to benefit the client and attract more investors. Engaging in such promotional efforts is forbidden by APES 110 owing to the existence of an advocacy threat (Section 200-6). The consumers and investors may view the promotional speech with skepticism, so casting doubt on auditor independence; hence, the firm must implement appropriate precautions to mitigate the existing vulnerability (APES, 2010).
Conversation 2: The CEO of the client proposes a 14-day vacation package to the audit partner and manager, covering all costs and allowing for family accompaniment. Acceptance of high-value presents entails an inherent familiarity, as emphasized in section 200-7. The acceptance of gifts, particularly those of considerable financial value, should be avoided as it may compromise the auditor's objectivity, leading to potential bias in favor of corporate interests at the expense of user trust, thereby necessitating the implementation of appropriate measures (APES, 2010).
In Conversation 3, upon discovering his inclusion in LTH's audit team, Michael asserts that his contribution would be significantly beneficial due to his father's previous role as financial controller for LTH. Michael ought to be removed from the team; otherwise, the risk of familiarity (Section 200(7)) would be considerable. Michael may encounter a scenario in which his professional ethics are challenged as he balances the interests of his father, resulting in a conflict of interest; thus, appropriate protections must be implemented to mitigate the hazard (CPA, 2013).
In Conversation 4, Annette expresses that her involvement in LTH's audit team is not anticipated to be time-consuming. She also notes that this opportunity will facilitate her interaction with former colleagues, given that she joined CJI only a month ago and LTH was her previous employer. The relevant dangers are section 200(5) (self-review threat) and section 200(7) (familiarity threat). A self-review danger exists here, since certain statements reviewed by Annette may have been produced by her, making it probable that she overlooks or consciously disregards flaws. The involvement of Annette would pose risks of familiarity due to her reputation among senior personnel. The dangers are significant and need suitable mitigation strategies. (CPA, 2013).
The necessary measures for mitigating the aforementioned identified threat are outlined below.
Dialogue1: At the organizational level, the suitable solution would be to implement a policy, if absent, to generally adhere to the APES 110 principles and therefore guarantee zero tolerance for participation in any promotional activities. This policy will be strictly enforced. The client must guarantee that bias and unethical demands are not anticipated in the auditor selection process, since such misconduct might ultimately jeopardize the organization (Arens et al., 2013).
Conversation 2: At the organizational level, the suitable strategy would be to implement a policy if one is absent, thereby broadly committing to the APES 110 principles. This would ensure that employees accept no gifts from clients, regardless of their value, and if a specific gift is retained, it must be disclosed to the company. Furthermore, there must be stringent enforcement of these policy measures, with no deviations permitted (Gay & Simnett, 2012).
Dialogue 3
The necessary precaution at the firm level is to guarantee that the audit firm has comprehensive data about the employment of close relatives, so enabling the company to implement further safeguards to preserve independence. Employees are expected to update this using an online database as needed. Additionally, a statement from the applicants is necessary prior to the selection of any member for an audit team to confirm that no direct or distant family member has been engaged in any capacity by the client (Caanz, 2016).
Dialogue 4
The necessary protection at the company level is to guarantee that the audit firm has comprehensive data about member employment, therefore enabling the business to implement further safeguards to protect privacy. Additionally, a statement from the applicants is necessary prior to the selection of any member for an audit team to confirm that the person has not had any role with the client (Leung, Coram & Cooper, 2012).
The corporation maintains relationships with international vendors with whom it has established long-term procurement agreements. Consequently, the bulk of replacement parts and equipment are procured by maritime transport from abroad partners, leading to a delay between order placement and receipt. Therefore, it is essential for the firm to make a genuine effort to prevent any shortages, since this would impede the services provided by the organization. Excess inventory presents many challenges, including elevated carrying costs, risk of obsolescence, maintenance and repair expenses, increased security and insurance fees, as well as the opportunity cost associated with idle capital. Therefore, balance must be maintained between the aforementioned two endeavors; otherwise, the organization may incur significant losses (Arens et al., 2013).
Potential for liquidity shortage
It is evident that MSL has established long-term procurement agreements with international suppliers, necessitating the acquisition of certain quantities of replacement parts and equipment. However, given that mining is a cyclical industry, the firm has a credit crisis as it must fulfill payments to suppliers while consumers refrain from purchasing new equipment, resulting in increased inventory, the risks of which have been documented previously. Simultaneously, revenues would decline, and the absence of further sales would lead to diminished operating cash flows. In this case, the firm may have a short-term financial difficulty, particularly if the ongoing pessimism in mining persists (Caanz, 2016).
b) Risk of inaccurate demand estimate
Inherent Risk: A component of audit risk that is heightened is inherent risk, since accurately estimating the need for spare parts is especially challenging, leading to an inherent business risk.
Detection Risk - The auditor may find it challenging to ascertain the accuracy of a demand estimate for a certain time owing to several influencing elements associated with the estimating process.
The affected accounts that may be misconstrued are listed below (Leung, Coram, and Cooper, 2012).
Inherent Risk - The company's clientele operates in a cyclical industry, and due to the specialized nature of the goods and services provided, there exists an inherent risk of suboptimal business performance.
Control Risk - The corporation has limited options to enhance the probable decline and worsening financial condition of its consumers and so must accept this reality.
The accounts predominantly impacted in a significant way are listed below (Gay & Simnett, 2012).
APES (2010), APES 110 Code of Ethics for Professional Accountants, APESB Website, Retrieved on May 02, 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 (2nd ed.), Sydney: Pearson Australia
Caanz, S. (2016), Auditing And Assurance Handbook 2016 Australia (3rd ed.), Sydney: John Wiley &Sons
CPA (2013), Independence Guide, CPA Website, Retrieved on May 02, 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 (5th ed.), Sydney: McGraw-Hill Education
Leung, P., Coram, P. & Cooper, B.J. (2012), Modern Auditing and Assurance Services (4th ed.), New York: John Wiley and Sons
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