- 20 Marks
Question
The following scenarios may threaten compliance with fundamental principles in auditing:
i. The audit supervisor is married to the daughter of the Managing Director of the client company;
ii. The audit firm’s Senior Partner holds shares in the client company;
iii. The assurance firm also provides valuation services, internal audit services, and taxation services to an assurance client;
iv. The assurance firm earns more than 50% of its annual revenue from one assurance client; and
v. The firm obtained motor vehicle financing from a client bank for its staff.
Required:
a. Explain why compliance with fundamental principles in auditing may be threatened in each of the above FIVE circumstances. (10 Marks)
b. Explain FIVE ethical requirements that would reduce or mitigate the threats to compliance with the fundamental principles in the above FIVE circumstances. (10 Marks)
Answer
a. Explanation of Ethical Threats:
i. Marriage of Audit Supervisor to MD’s Daughter: – Threats: Intimidation threat arises due to the familial relationship, as the MD could influence the supervisor. A familiarity threat exists because of close personal ties, and a self-interest threat could emerge if the MD’s shares eventually pass to the daughter.
ii. Senior Partner Holding Shares in Client Company: – Threat: A self-interest threat is present because the partner has a direct financial interest in the client, which may compromise objectivity and independence.
iii. Provision of Valuation, Internal Audit, and Tax Services: – Threats: Self-review threats may arise if the firm performs services such as valuation and internal audit, as it would later be required to audit its work. Tax services are typically less threatening but could still raise concerns if not handled cautiously.
iv. High Revenue Dependency on One Client: – Threat: A self-interest threat occurs when over 50% of the firm’s revenue comes from a single client, making the firm potentially overly reliant on this client and creating a conflict of interest.
v. Motor Vehicle Financing from Client Bank: – Threat: Generally minimal if the financing is provided on standard business terms; however, if preferential terms are given, it could create a self-interest threat, as the bank’s financial influence may affect impartiality.
b. Mitigation Strategies:
i. For Marriage of Audit Supervisor to MD’s Daughter: – The supervisor should be removed from the audit team to eliminate conflicts arising from personal relationships.
ii. For Senior Partner Holding Shares in Client Company: – The partner should either divest from the client company or reduce their holding to an inconsequential level, or the firm should retire from the audit engagement.
iii. For Providing Non-Audit Services to the Assurance Client: – Avoid engagement in valuation services, ensure separate teams handle internal and external audits, and clarify that tax services are limited to compliance-related matters only.
iv. For High Revenue Dependency on One Client: – Diversify the client base to reduce reliance on a single client for income and enhance firm stability and independence.
v. For Motor Vehicle Financing from Client Bank: – Ensure that financing terms are standard and not preferential to maintain independence and reduce any perception of a conflict.
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