AA – May 2016 – L2 – Q2a – Professional and Ethical Considerations

This question examines ethical threats and their mitigation in the context of audit engagements.

Question

(a) You are a manager in the audit firm of ABC & Co; and this is your first time you have worked on one of the firm’s established clients, Tark Co. The main activity of Tark Co is providing investment advice to individuals regarding saving for retirement, purchase of shares and securities, and investing in tax-efficient savings schemes. Tark is regulated by the relevant financial services authority.

You have been asked to start the audit planning for Tark Co, by Mr. Soon, a partner in ABC & Co. Mr. Soon has been the engagement partner for Tark Co for the past nine years and has excellent knowledge of the client. Mr. Soon has informed you that he would like his daughter, Afi, to be part of the audit team this year; Afi is currently studying for her first set of knowledge-level papers for her ICAG qualification. Mr. Soon also informs you that Mr. Fac, the audit senior, received investment advice from Tark Co during the year and intends to do the same next year.

In an initial meeting with the finance director of Tark Co, you learned that the audit team will not be entertained on Tark Co.’s yacht this year as this could appear to be an attempt to influence the opinion of the audit. Instead, he has arranged a balloon flight costing less than one-tenth of the expenses of using the yacht and hopes this will be acceptable. The director also states that the fee for taxation services this year should be based on a percentage of tax saved, and he trusts that your firm will accept a fixed fee for representing Tark Co in a dispute regarding the amount of sales tax payable to the taxation authorities.

Required:

(i) Explain the ethical threats which may affect the auditor of Tark Co. (6 marks)

(ii) For each ethical threat, discuss how the effect of the threat can be mitigated. (6 marks)

Answer

(i) Ethical threats which may affect the auditor of Tark Co:

Familiarity Threat:
- Mr. Soon has been the engagement partner for Tark Co for nine years, which creates a familiarity threat, potentially impairing his objectivity.
- Additionally, having Mr. Soon’s daughter, Afi, as part of the audit team creates another familiarity threat as family members on the same engagement could affect professional skepticism.
Self-interest Threat:
- Mr. Fac, the audit senior, received investment advice from Tark Co and plans to do so again, creating a self-interest threat since he might prioritize his personal interests over his audit responsibilities.
Advocacy Threat:
- The client expects ABC & Co to represent them in a dispute with the taxation authorities, which could create an advocacy threat, where the auditor could be seen as supporting the client’s position, compromising independence.
Self-review Threat:
- ABC & Co provides taxation services to Tark Co. The fee for these services is based on a percentage of the tax saved, creating a self-review threat, especially if audit staff review their own tax work in the audit of the financial statements.
Intimidation Threat:
- The client offering a balloon flight could be seen as an intimidation or undue influence threat, where the audit team feels pressured to maintain a good relationship with Tark Co in exchange for gifts.

(ii) Mitigation of each ethical threat:

Familiarity Threat:
- Rotation of Engagement Partner: Mr. Soon should be rotated off the audit engagement since ICAG ethical guidelines recommend a maximum of seven years for engagement partners with listed clients.
- Avoid Involving Afi: Afi should not be part of the audit team to avoid compromising independence due to family ties.
Self-interest Threat:
- No Further Engagement with Client: Mr. Fac should be advised not to seek further investment advice from Tark Co, as receiving services from the audit client could impair his objectivity.
- Review by Another Team: If services have already been received, the audit work done by Mr. Fac should be reviewed by another team member to ensure impartiality.
Advocacy Threat:
- Decline Representation: ABC & Co should decline representing Tark Co in the tax dispute to avoid acting as an advocate for the client, which would impair independence.
Self-review Threat:
- Separate Teams: ABC & Co should create separate teams for tax services and audit work. The audit team should not be involved in reviewing work related to tax services performed by the firm.
Intimidation Threat:
- Reject Balloon Flight: The audit team should decline the balloon flight offer, as ICAG’s code of ethics indicates that auditors should not accept gifts unless they are clearly insignificant in value. This will ensure the auditor remains independent and unbiased.

Tags: Conflict of Interest, Ethical Threats, Independence, Professional Ethics, Safeguards
Level: Level 2

Topic: Professional and Ethical Considerations
Series: MAY 2016

Uploader: Dotse