ISB Conceptual Framework: Auditor Independence Essay

Question:

Discuss about the ISB Conceptual Framework for Auditor Independence.

Answer:

Introduction:

LTH makes an offer to Clarke & Johnson that its audit partner Geoff should address the travel agency seminar on behalf of the company in return of the audit firm being awarded the audit contract. LTH intends to leverage through the presence of the audit partner in the seminar who will be apprising the audience with the transparent manner in which the company is being operated. In other words the company is actually trying to use Geoff, the audit partner to promote their business. This situation actually creates a threat known as advocacy threat. Advocacy in this context implies an audit firm trying to support or promote the interest of their client. However the problem arises when senior members get in to the business of promoting the client. Such situations may lead to ethical compromise, affecting the independence of the auditor as well as the objectivity of the audit. (Islam et al, 2005)

Safeguard from such situations are generally not easy when a client gives an option between the job and advocacy for the client. Each audit firm should have their own set of provision regarding independence of auditors and all engagement should explicitly be based on the same. If the company shows reluctance to exclude such unfair provision which increases thereat above the acceptable level, then it is better for the audit firm to withdraw from the engagement then performing without independence. (Moore et al, 2006)

LTH in order to recognize the smooth audit conducted by Geoff has decided to send him along with his family to an all expenses paid trip to Greek Isles. The company intends to gift him with a voucher for the trip with duration of 14 days. The main logic behind spending such a high amount for the auditor is to ensure that there is not much negative feedback from the auditor’s side. In other words Geoff after spending a memorable holiday with his family at the expense of the company is expected to act as per the direction of the company and give favorable judgment during the audit. This is a typical example of self interest threat. In other words anything that is supposed to give undue benefit to the audit firm or the audit partner other than the designated audit fee is said to create conflict of interest.

The audit firm should create safeguard and policies which prevents any partner from accepting any financial or non financial benefit which can reduce the objectivity in the audit or create a conflict of interest. Any such gift accepted by the partner or the team members should be declared and documented along with the monetary value and the purpose of such hospitality or gift. (Basu, 2016).

Michael who is also part of the audit team sent by Clarke & Johnson to LTH, is the son of the financial controller of LTH. The audit team visiting the company is responsible for examination of the accounting entries, accuracy of the internal control, examining accuracy of the book of accounts, checking the inclusion of all the accounting transaction in the final accounts, examining the disclosure, existence and valuation of assets and liabilities and truth and fair view of the overall statements. All these activities are time consuming and often require long hours of discussion with the management. Michael here feels that he has an advantage as his father has been leading the team who is preparing the financial statements. This exact kind of situation leads to the risk of Familiarity and Trust threat. (Islam et al, 2005)When the auditor has excessive trust or faith on the integrity of the client he turns sympathetic and takes a lax attitude towards the errors and misrepresentation. He then starts accepting explanation at the face value. It is obvious here that Michael will have an unconditional faith and confidence on his father’s ability and hence he will try to reduce effort of going through the above mentioned procedure of auditing to save time and effort. Needless to say, even if mistakes are detected a simple explanation from his father or the financial controller will suffice. (Myring and Bloom, 2003)

The first and most important safeguard which should be initiated by the audit firm is not to nominate any member to the audit team who has any personal connection with the members of the client company. No amount of guidelines can stop the undue influence the member of the client company will have on the member of the audit team with a blood relation. Secondly even if there is no blood relation in order to avoid over closeness with the client company, partners and audit team members should be rotated periodically as a safe guard to this threat. Thirdly as followed globally audit firms are rotated mandatorily to avoid familiarity and trust threat affecting the audit result presented in the annual statement. (Icaew, 2003)

Annette had a short stint at Luxury Travel Holidays where she was mainly involved in calculation of taxes and in the process of preparing accounting entries. These calculations and accounting treatments are supposed to be a part of the financial statements in the annual report for the year ended 30th June 2015. Now she is working in the tax advisory department of Clarke & Johnson and happens to be a part of the audit team who will responsible for auditing the accounts of the company including the tax calculation and the accounting treatment prepared by her during her tenure at the company.

In the case study, we find an obvious situation where Annette feels that since she had prepared the accounts and calculated taxes it doesn’t require further auditing. This kind of behavior or attitude is popularly known as the Self Review Threat. It is quite impossible to maintain the same level of objectivity to one’s own work as it is maintained for other’s work. People generally refuse to acknowledge drawback in there own work. Therefore the probability is very high that Annette would ignore auditing the work done by her during her association. The immediate impact would be that any mistake in it would go unnoticed. (Icaew, 2003)

Some of the safeguards could be in the form of rule that any person involved in finalization of account should under no circumstances be part of the audit team. Further for large companies a suitably qualified person may be appointed to conduct surprise checks or review the work which has been carried out. The audit firm also may ask for source data to the client for various accounting treatments specially the unusual ones. Moreover all underlying assumptions should ideally be declared by the audit client. (Cpaireland.ie, 2017)

Identification of Business Risk

Business risk refers to happening of any significant event, actions or conditions that act as a deterrent toward the mission of the company to achieve its goal and objectives.

MSL has signed contract for purchasing equipment and spare parts from suppliers globally who send the shipment to MSL operational centers. The process of purchasing from foreign suppliers attracts numerous business risks which are stated as follows (Gaffigan, 2014)

When dealing with foreign clients liquidity is a very important factor. Generally cash is paid in advance to the suppliers, which are often tied for a considerable long time before the goods are actually received by the company. While the company has to bear the pressure of the advance payment often these suppliers fail to deliver the contract and it becomes difficult to recover the same from them. Moreover in spite of huge investment, suppliers are often are seen to fail on delivering quality products to enhance their own profit. The company then has to spend substantial amount on correcting the same as per the specifications.

Significantly different laws and regulations provide a business risk for companies like MSL which are sourcing their products from vendors across the globe. Accordingly the company needs to have a thorough understanding of the rules regarding environmental issues, taxes and other property rights in order to save themselves from legal issues. It must be noted that prior legal judgments, internal treaties and local customs have a significant bearing on the method in with which contracts are executed. (Gay and Simnett, 2000)

Audit Risk arising from Business Risk

Huge amount of cash flows happens much before the goods are physically delivered to the company by the suppliers. In the time gap between the payment and physical possession of the goods price of material are often altered which might have to be borne by the company. Such situation of additional payment increases the problem of valuation of the inputs whose impact is directly seen in the purchase account of the company. Moreover it is often difficult for the auditor to keep a track of purchases with reference to the advance paid from the cash a/c due to the time lag in receiving the goods. (Ainapure and Ainapure, 2009)

The auditor in order to mitigate the risk should have a considerable idea on foreign rules and regulations. Purchase of goods from foreign suppliers generally involve huge amount of money. The auditor needs to check that the amount drawn from bank or cash paid are routed through proper channels and are paid keeping in mind the foreign regulations. Since the company often makes provisions as a safeguard till goods are received, it should be checked that the provisions are appropriately treated in case of contingency or if goods are received as per the order. (Bansal, 2012)

References

Ainapure, V., & Ainapure, M. (2009). Auditing and assurance. PHI Learning Pvt. Ltd..

Bansal, S. (2012). Auditing and Assurance. 10th ed. New Delhi: Bestword Publishers.

Basu, S. K. (2016). Auditing & Assurance. Pearson Education India.

Cpaireland.ie. (2017). Accounting Services- Examples of Threats and Safeguards. [online] Available at: [Accessed 20 Apr. 2017].

Gaffigan, V. (2014). 12 Considerations for Managing Foreign Supplier Risk. [online] Lockton Companies. Available at: [Accessed 20 Apr. 2017].

Gay, G.E. and Simnett, R., 2000. Auditing and assurance services in Australia. Sydney: Mcgraw-hill.

Icaew. (2003). Reviewing Auditor Independence. [online] Available at: [Accessed 19 Apr. 2017].

Islam, A., Karim, W. and Van Zijl, T. (2005). Auditor Independence and NAS: A comparative Analysis of Selected Current Regulatory Frameworks. [online] Wellington: Victoria University of Wellington. Available at: [Accessed 21 Apr. 2017].

Moore, D.A., Tetlock, P.E., Tanlu, L. and Bazerman, M.H., (2006). Conflicts of interest and the case of auditor independence: Moral seduction and strategic issue cycling. Academy of Management Review, 31(1), pp.10-29.

Myring, M. and Bloom, R., (2003). ISB's conceptual framework for auditor independence. The CPA journal, 73(1), p.30.

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