- 20 Marks
AA – L2 – Q14 – Professional Ethics and Code of Conduct for Auditors
Question
(a) You are a manager in the audit firm of XYZ & Co; and this is your first time you have worked on one of the firm’s established clients, Vark Co. The main activity of Vark Co is providing investment advice to individuals regarding saving for retirement, purchase of shares and securities and investing in tax efficient savings schemes. Vark is regulated by the relevant financial services authority.
You have been asked to start the audit planning for Vark Co, by Mr. Lee, a partner in XYZ & Co. Mr. Lee has been the engagement partner for Vark Co, for the past nine years and so has excellent knowledge of the client. Mr. Lee informs you that Mr. Tan, the audit senior, received investment advice from Vark Co during the year and intends to do the same next year.
In an initial meeting with the finance director of Vark Co, you learnt that the audit team will not be entertained on Vark 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 trust that your firm will accept a fixed fee for representing Vark Co in court in a dispute regarding the amount of sales tax payable to the taxation authorities. Sales tax payable is material to the current year financial statements.
Required:
(i) Explain the ethical threats which may affect the auditor of Vark Co.
(ii) For each ethical threat, discuss how the effect of the threat can be mitigated.
You have been asked to start the audit planning for Vark Co, by Mr. Lee, a partner in XYZ & Co. Mr. Lee has been the engagement partner for Vark Co, for the past nine years and so has excellent knowledge of the client. Mr. Lee informs you that Mr. Tan, the audit senior, received investment advice from Vark Co during the year and intends to do the same next year.
In an initial meeting with the finance director of Vark Co, you learnt that the audit team will not be entertained on Vark 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 trust that your firm will accept a fixed fee for representing Vark Co in court in a dispute regarding the amount of sales tax payable to the taxation authorities. Sales tax payable is material to the current year financial statements.
Required:
(i) Explain the ethical threats which may affect the auditor of Vark Co.
(ii) For each ethical threat, discuss how the effect of the threat can be mitigated.
(b) Discuss the benefits of Vark Co establishing an internal audit function.
Answer
(a)
| (i) | Ethical threats | (ii) | Possible safeguards |
|---|---|---|---|
| (1) | Familiarity and self-interest<br>Mr. Lee has been the engagement partner for Vark for the past nine years.<br>This gives rise to a familiarity threat because of his long association with this one client which could impair his objectivity and independence.<br>A self-interest threat may also be created as Mr. Lee might be less willing to challenge Vark due to concerns about losing a longstanding client. | ABC & Co must implement safeguards to address the self-interest and familiarity threats.<br>Since Vark is not a listed client, XYZ & Co is not required to rotate the engagement partner after seven years as required by the IESBA International Code of Ethics for Professional Accountants. However, in this case, rotating Mr. Lee off the engagement team will eliminate the threat entirely and so this safeguard should still be implemented. | |
| (2) | Self-interest and intimidation<br>The finance director of Vark has requested that the fee for taxation services is based on a percentage of the tax saved. This is a contingent fee. Contingent fees can create a self-interest threat to objectivity because the firm will want to save as much tax as possible in order to charge as high a tax fee as possible.<br>There may be an intimidation threat from the finance director of Vark if he threatens to take the audit or other work to another firm if his wishes are not met. | The IESBA International Code of Ethics for Professional Accountants prohibits audit firms from charging contingent fees for non-assurance work carried out for audit clients.<br>Thus, charging a contingent fee for the tax work is not allowed.<br>Mr. Lee should explain to the finance director that the fees charged must be based on the experience of the individual and the time spent performing the work. | |
| (3) | Self-interest and advocacy<br>The finance director has suggested that the firm represents Vark in court in a dispute with the taxation authorities over the amount of sales tax due. This creates an advocacy threat because XYZ & Co would be promoting the interests of its client to third parties.<br>Since the sales tax is material to the financial statements, there is also a self-review threat because the audit team would be required to audit the amount of sales tax due which is the subject of the court case in which the firm is representing Vark. | The IESBA International Code of Ethics for Professional Accountants prohibits auditors from acting as an advocate in the resolution of material disputes before a court or tribunal for audit clients.<br>Thus, XYZ & Co should refuse to represent Vark in court. | |
| (4) | Self-interest<br>The finance director has offered to provide a balloon flight to the audit team. This creates a self-interest threat because the audit team may feel obligated to the client and this may impair their objectivity and independence. | The IESBA International Code of Ethics for Professional Accountants states that an auditor should not accept gifts or hospitality unless the value is trivial or inconsequential.<br>Although the finance director has stated that the cost of the balloon flight is significantly less than the cost of the yacht, it is still likely to be significant.<br>Thus, XYZ & Co should politely refuse the offer of the balloon flight. | |
| (5) | Self-interest and self-review<br>Mr. Tan, the audit senior, has received investment advice from Vark during the year and plans to do so again next year. This creates a self-interest threat because Mr. Tan may not wish to challenge the client for fear of losing the investment advice, or because he may benefit from that advice.<br>There is also a self-review threat because Mr. Tan may have to audit the investment advice systems that he has personally used. | Mr. Tan should either be removed from the audit team or he should stop receiving investment advice from Vark.<br>One of these safeguards must be implemented before the audit starts. |
(b) Benefits of an internal audit function
An internal audit function could look at existing procedures and systems in operation at Vark and make lots of useful recommendations to tighten up areas where there are deficiencies in controls.
An internal audit function could carry out value for money audits, looking at the economy, efficiency and effectiveness of processes and activities within the entity.
The internal auditors could examine the IT systems in place and make recommendations regarding these, including looking at the programmed controls.
The internal auditors could undertake financial audits to substantiate information in management and financial reporting.
The internal audit function could make recommendations in respect of good corporate governance, even though the company may not be required to comply with corporate governance guidelines.
The external auditors might be able to rely on work undertaken by the company’s internal auditors and this in turn could result in a reduced audit fee.
The company has to comply with financial services regulations so an internal audit function could undertake work to ensure that it is complying with all required legislation and regulations.
The presence of an internal audit function within the company would present a positive image to clients of the company and to shareholders.
- Topic: Internal Audits
- Uploader: Samuel Duah