Auditor Independence And Audit Quality Principles Essay

Question:

Discuss about the Auditor Independence and Audit Quality Principles.

Answer:

Introduction:

It can be observed from the first situation that because of last year’s impressive audit, the CEO of Luxury Travel Holidays Ltd would reappoint CJ (Clarke and Johnson) as the company’s auditor for the financial report of 30 June 2015. However, CJ would be reappointed subject to the condition that it would give an interesting speech about the company that can assist in enhancing its businesses, thereby attracting more investors as a whole (Hoffelder, 2012). Hence, it can be witnessed that CJ is restricted to frame an unbiased opinion on the company financials, as it would not procure the auditor’s job if the instructions of CEO were not duly complied with. Further, in the second situation, it can be observed that LTH had proposed a complimentary 14-day holiday package to the auditors for the anticipation of another smooth audit process in 2015. However, in reality, such anticipation of the smooth audit can be interpreted as a biased and unprofessional judgment on the company financials to be presented to its stakeholders. This implies a risk of familiarity threat because the company intends to alter the auditor’s judgment in lieu of their long-term engagement with the company (Bedard et. al, 2014). Further, in the third situation, Michael has been appointed as a part of the company’s audit team, and his father is already the financial controller of the company.

In other words, Michael’s father is responsible for the preparation of LTH’s financial reports. This situation also implies a familiarity threat because Michael as an auditor would hesitate to report any dubious activities on the part of the company, as the consequences of such reporting would result in the termination of his father’s job and other employees too (Fazal, 2013). Therefore, in this case, it would result in an unfair audit opinion regarding the financial statements of the company, and hence unacceptable as a whole. Lastly, it can be observed from the fourth situation that Annette has been chosen to be a part of LTH’s audit team, and previously she had temporarily assisted LTH in preparing accounting entries and tax calculations. Thus, Annette is under a non-delegable responsibility to scrutinize her own doings. Besides, this implies a threat of self-review on the part of Annette, as it is a compulsion to get the work scrutinized by another person instead of reviewing it by own. It needs to be noted a person cannot audit a work on his own. Annette will be engaged in a biased view because she will not be able to trace any deficiencies in her won work. Hence, it is imperative and essential that an auditor and accountant should not be the one and the same person. It is advisable for Geoff not to bring Annette in the team of LTH (Holland & Lane, 2012)

In lieu of the threats identified above, various safeguards can be implemented to avoid such threats. Therefore, in the first situation, since CJ is prevented to frame an independent judgment, the most effective safeguard is to resign from such assignments and avoid standing for the post of reappointment as an auditor (Fazal, 2013). Furthermore, making effective communications with the committee of independent directors can also assist in safeguarding such threat. Further, in the second situation, the most appropriate safeguard would be the removal, rotation, and reassignment of partner or staff from the audit assignments. In addition, steps may be initiated in order to design strict restrictions regarding acceptance of any other gifts other than fees for performed audit services. In the third situation, since Michael, as an auditor is working for the company with his father being the financial controller of the same, it can be stated that Michael is clearly pursuing a personal interest in the company that will restrict him to perform unbiased and fair audit processes. Therefore, the most appropriate safeguard in this scenario would be a discussion of the same with an independent audit committee because based on the SOX Act; no auditor can be selected as an auditor of the company wherein they possess any type of financial or personal interest. Moreover, the disclosure of such relevant interests with those charged with governance can also facilitate in safeguarding such threat (Gilbert et. al, 2005). In the last scenario, since Annette had to scrutinize her own doings being an auditor, it could result in an unfair audit process, and hence, instead of self-reviewing the work, some other qualified professional accountant or auditor must be selected in order to frame an independent and unbiased opinion (Church et. al, 2008). Therefore, in simple words, Annette must not be a member of the audit team of Luxury Travel Holidays Ltd.

All the previously mentioned safeguards are very crucial in relation to the independence of auditors because audit threats play an important role in hampering the audit opinion framed upon the company financials, and therefore, proper implementation of safeguards can assist in encountering such audit threats, thereby facilitating in an independent audit process (Coram et. al, 2011).

It is the primary responsibility of an auditor to take into account the prevalent business risks as well as the audit risks for the smooth functioning of an audit process. Therefore, in association with the purchase of equipment and spare parts, the major business risks to MSL are as follows. It can be observed that in association with the maintenance services offered by the company (MSL) to all its customers for the first two years after the purchase of a product, there was a failure to determine the true demand for the product. As a result, the key business risk can be subject to understatement or exaggeration of the requirement of spare parts. In relation to such business risk, the company (MSL) is under a non-delegable duty to evaluate the quantity of purchase in an effective manner because firstly, every product is offered with a warranty of two years and secondly, such products come from far-flung areas that can consume a massive amount of time. Therefore, proper evaluation of the quantity of spare parts can avoid occlusion of resources, thereby safeguard the lessening of the quantity of purchased equipment. Furthermore, if such action were not initiated, the advantage of interest income would also have vanished. Besides, this could have resulted in affecting the financials of the company because of improper expectation of the demand of spares. All these could also result in hampering the competitive advantage of the company because the adequate quantity of equipment would not be prevalent in order to address the needs of customers.


Along with the previously mentioned business risk, there is another risk of theft or fraud that can be experienced by the company (Heeler, 2009). Such risk could generate during the purchase of equipment from global markets, and instruct the staff to go far away areas in order to complete the maintenance services.

MSL has no presence of supplier based in Australia. The presence of suppliers can be traced outside Australia. The supplier of goods manufactures the goods and provides them to the warehouse of the MSL. The existence of risk in business is present in the form of destruction during the time of transport. It needs to be noted that appears no insurance of the goods from theft or destruction due to a loss in transport (Horngren, 2013). Thus, the amount of fraud or theft must be taken into account in relation to the previous years, in order to create an ideology to determine whether the company had initiated any corrective actions. In addition, it must also be determined whether the company had entered into any type of insurance policies to tackle fraud or theft. This could be done by investigating the amount of purchased quantities of equipment.


In relation to the previously mentioned business risks, there are various audit risks in response to them. Thus, in association with the first business risk, the most crucial audit risk prevailing relates to a misstatement of the company’s financial statements. This is because such business risk is directly associated with the condition of the sale of the equipment, and therefore, it is the auditor’s responsibility to verify whether such product’s sale price must be lessened or need it be depicted as costs in the company’s P/L account (Carcello, 2012). The auditor needs to consider the aspect of risk that is present in the given scenario. Moreover, such spare parts could not be depicted under stock-in-trade because the part of such product that has been procured for want of free warranty will be depicted under liquid assets in the company’s financials. Furthermore, various spare parts are not being covered under maintenance services provided by the company and hence, the auditor must consider such maintenance contracts as it will assist in highlighting what spare parts can generate funds, and what parts can be depicted as an expense. This is because charging an expense as revenue would exaggerate the company’s resources, and charging revenues as an expense would understate the company’s resources, thereby misguiding the stakeholders as a whole (Carcello, 2012). In both the scenario, there appears a difference and the difference will tend to affect the position of the balance sheet. In relation to the second business risk of theft or fraud, because mobile contractors travel to faraway locations, it consumes immense time, and therefore, it can ultimately lead in the falsification of truth, thereby hampering the faith of company upon the auditors (Mock et. al, 2013). When there is a longer time span there is always a possibility of tampering with the data as the evidence is difficult to be estimated.


Therefore, in lieu of such scenario, it may be feasible for the auditors to travel to such locations of their own, so that proper evaluations of costs can be done, and the same can be compared to that of the mobile contractors to verify the truthfulness of their statements (Blay et. al, 2011). The account balance that is influenced directly comprises of the cost of the warranty, the cost of maintenance and the spare part cost. The irrelevant increment in the goods mentioned will ultimately affect the profitability. Audit risk can be described as the one that the auditor cannot judge the actual WDV of the closing stock because the management could not verify the right type of pricing that is produced and completely depends on the parts that are present in the manufactured products (Wright & Charles, 2012). Furthermore, proper investigation of the company’s engineers is not done, as they are not on the company’s register of payroll. Besides, carrying spare parts for completing maintenance services can result in theft because the customers might not utilize such parts (Tepalagul & Lin, 2015). Hence, the auditor must consider whether insurance policies are able to cover the equipment and spare parts of the company, and the time when consumers procure these items. In addition, the auditor must also scrutinize whether fraud has been created on the part of the company through improper arrangements with contractors in order to attain insurance benefits.

References

Bedard, J. N, Gonthier, B, & Schatt, A. (2014). Costs and Benefits of Reporting Key, Harvard Press

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, 30 (2): 77- 102.

Carcello, J. (2012). What do investors want from the standard audit report? CPA Journal 82 (1),7.

Church, B., Davis, S. & McCracken, S. (2008). The auditor’s reporting model: A literature overview and research synthesis. Accounting Horizons, 22(1), 69-90.

Coram, P, Mock, T. J, Turner, J. & Gray, G. (2011). The communicative value of the auditor’s report. Australian Accounting Review 21(3), 235-252.

Holland, K. & Lane, J. (2012). Perceived auditor independence and audit firm fees’, Accounting and Business Research. 42(2), 115-141.

Hoffelder, K. (2012). New Audit Standard Encourages More Talking. Harvard Press.

Fazal, H. (2013). What is Intimidation threat in auditing?. Retrieved April 26, 2017 from <

Gilbert, W. Joseph J & Terry J. E. (2005). The Use of Control Self-Assessment by Independent Auditors. The CPA Journal, 3, pp. 66-92

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

Horngren, C. (2013). Financial accounting. Frenchs Forest, N.S.W, Pearson Australia Group.

Mock, T. J, B?dard, J, Coram, P, Davis, S, Espahbodi, R. & Warne, R. (2013). The audit reporting model: Current research synthesis and implications. Auditing: A Journal of Practice and Theory, 32, 323-351.

Tepalagul, N. & Lin, L. (2015). Auditor Independence and Audit Quality A Literature Review’, Journal of Accounting, Auditing & Finance, 30(1), 101-121.

Wright, M.K. & Charles, J. (2012). Auditor independence and internal information systems audit quality, Business Studies Journal. 4(2), 63-84.

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