- 20 Marks
Question
The auditors of Sunsit Manufacturers Limited had disagreements with the company on various issues. This came to a climax with the withholding of a part of the payment of the last audit fees. The auditors had also been disenchanted with the undue pressures of management and have decided that, as a result of this and the withheld fees, they would disengage from the client.
The company’s chairman, in consideration of past issues, has considered the size of the audit firm as being partly responsible for its inability to manage adequately the pressures from the company’s accounting and management team. He has subsequently approached your firm for a change, and the partners have accepted the engagement despite the predecessor auditor’s declaration of the forfeiture of the firm’s outstanding fees and no further involvement with the client and issues relating to the company.
Required:
a. Following the background to the client and the engagement, evaluate the internal and external business risks that need to be considered with respect to the client. (10 Marks)
b. Discuss the pre-engagement activities to be carried on the client. (10 Marks)
Answer
a. Internal and External Business Risks:
- Internal Risks:
- Management Pressure: Due to previous disagreements and fee disputes, there is potential for undue pressure from management, which may affect audit independence and objectivity.
- Corporate Governance Concerns: The disengagement of the previous auditor raises questions about the company’s governance practices and potential issues in the accounting department.
- Accounting and Financial Reporting Practices: Historical disputes suggest there may be aggressive accounting practices or difficulties in obtaining accurate financial data from the client.
- Employee Competence: The previous auditor’s challenges might indicate a lack of competence or ethical concerns within the accounting team.
- External Risks:
- Reputational Risk: Taking on a client with prior auditor disputes could impact the audit firm’s reputation if similar issues arise.
- Legal and Compliance Risks: The history of disagreements suggests possible legal issues or non-compliance with regulations, increasing the audit risk.
- Market Conditions: An understanding of the industry risks, competitive pressures, and financial stability is critical, especially if the company operates in a volatile or high-risk sector.
- Stakeholder Pressure: Potential conflicts with stakeholders and financial backers due to previous auditor issues and management’s actions.
b. Pre-Engagement Activities:
- Client Integrity Assessment: Conduct thorough background checks to assess management’s integrity, especially regarding disputes and past auditor issues.
- Independence and Ethical Compliance: Review ethical guidelines to ensure independence and evaluate any conflicts of interest within the audit team.
- Engagement Letter Review: Draft and agree upon an engagement letter that specifies the scope, limitations, and terms of the engagement to prevent misunderstandings.
- Review of Predecessor Auditor’s Working Papers: Request access to prior audit files from the previous auditor (subject to client approval) to understand key issues and potential audit risks.
- Audit Fee Arrangements: Clearly outline the fee structure and terms of payment to avoid fee disputes, documenting this in the engagement contract.
- Risk Assessment Procedures: Establish risk assessment procedures early, including understanding the company’s industry and regulatory environment, to identify areas of high risk before beginning the audit.
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