- 20 Marks
AA – L2 – Q8 – Regulatory Framework for Auditing
Question
(a) State how legislation and the IESBA International Code of Ethics for Professional Accountants each seek to ensure the independence and objectivity of auditors at Apex Ventures.
(b) The following three situations have arisen in the audit firm of Pinnacle Partners:
(i) One of the partners, Mr. Thompson, and his wife, have been invited by the managing director of Summit Tiles, an audit client, to celebrate the company’s 20th anniversary with management over a long weekend at a beach resort. Mr. Thompson has been the engagement partner since incorporation of the company.
(ii) The firm has been approached and asked to accept appointment as auditors of Ridge Paints. One of the firm’s audit managers is company secretary of the company, although he takes no part in the management of the company. His parents are the directors and shareholders of Ridge Paints.
(iii) The directors of Crest Floors are unhappy with the level of fees charged by the firm. They are still refusing to agree an outstanding bill for taxation and advisory work and are demanding a reduction in the audit fee this year to match a quote they have received from another firm.
Required
Comment on the situations described above, recognising any threats to independence or objectivity, and suggesting what safeguards the firm should put in place to deal with such threats.
Answer
(a) Legislation
The Companies Act 2019 (Act 992) states that a person is ineligible to accept appointment as auditor of a company if he is not independent due to being:
- an officer of the company or of an associated company;
- a person who is a partner of, or in the employment of, an officer of the company or of an associated company;
- an infant;
- a person found by a court of competent jurisdiction to be a person of unsound mind;
- a body corporate, except that a member of an incorporated partnership may be appointed in the manner provided by subsection (2) of section 139;
- a one in respect of whom an order has been made under section 177 so long as the order remains in force unless leave to act as auditor of the company concerned has been granted by the Court in accordance with that section;
- an undischarged bankrupt, unless that person has been granted leave to act as auditor of the company concerned by the Court by which the adjudication as bankrupt was made; or
- a person who is for the time being disqualified from acting as auditor of a company by order of the Registrar.
The Companies Act 2019 (Act 992) Section 141 also provides statutory protection to auditors if threatened with removal, to ensure that their objectivity is not swayed by such threats. On removal, auditors usually have the right to:
- attend the meeting at which a resolution to remove them is being heard and make statements to the members, or
- require written statements to be circulated to members in advance of the meeting.
IESBA International Code of Ethics for Professional Accountants
IESBA’s Code identifies a number of circumstances where independence may be (or be seen to be) under threat. Examples of the main threats include:
- undue dependence on an audit client due to high levels of fees
- family and personal relationships
- the provision of other (non-audit) services
- loans and overdue fees
- long association of the audit partner with the audit client
- the acceptance of gifts or hospitality
- financial interests in shares or other investments.
It is up to individual audit firms to apply this guidance and to consider the use of safeguards to negate or reduce these threats.
(b) (i) Summit Tiles
In this situation there are two apparent threats to objectivity. The first is that being invited to the long weekend with his wife may constitute a significant gift to Mr. Thompson if the client offers to pay for it. This may create both self-interest, intimidation and familiarity threats. The IESBA Code specifies that hospitality should only be accepted if the value of it is trivial and inconsequential.
The second is that Mr. Thompson has been partner for 20 years on this engagement. This may create a familiarity threat such that Mr. Thompson may trust the client’s representations too much or be too sympathetic to problems it faces.
In order to mitigate the risks, the firm could insist that it or Mr. Thompson pays for the trip or Mr. Thompson should not go. More importantly, Mr. Thompson should be rotated off the audit and a different partner appointed as the engagement partner. Mr. Thompson could possibly become the client relationship partner provided that he is not in a position to exert influence over the new engagement partner.
(ii) Ridge Paints
Family and personal relationships may create self-interest, familiarity or intimidation threats to independence. The significance of these threats will depend on the individual’s responsibilities on the engagement, the closeness of the relationship, and the role of the other party at the client.
With this in mind, where an immediate family member of a member of the audit team is in a position to influence the financial statements at the client, the IESBA Code requires that the individual should be removed from the audit team. Although the audit manager is said to take no part in the management of the company, he may be in a position to influence the financial statements through his relationship with his parents.
Although the audit manager’s parents are not “immediate” family but “close” family, as defined by the Code, it does seem likely that there may be threats to the manager’s objectivity and independence as he could be intimidated by his parents or have some self-interest in their investment.
In addition, the IESBA Code states that an employee of an audit firm shall not serve as Company Secretary for an audit client of the firm, unless:
- This practice is specifically permitted under local law, professional rules or practice;
- Management makes all relevant decisions; and
- The duties and activities performed are limited to those of a routine and administrative nature, such as preparing minutes and maintaining statutory returns.
If the audit manager’s role as Company Secretary meets these requirements, the engagement could be accepted if the audit manager is not included in the audit team. However, if this is not the case, then Pinnacle Partners shall not accept appointment as auditors of Ridge Paints.
(iii) Crest Floors
The firm faces self-interest threats to independence from both the outstanding fees and the threat of losing the client. If it is worried about not receiving the fees or may lose the client, then it will want to keep the client happy and could relax its objectivity and independence to do so. The IESBA Code therefore recommends that any overdue fees are paid before next year’s auditor’s report is issued.
If the client’s demands are met, the firm may also open itself to intimidation in other areas such as the audit, and also the standard of audit work could fall if the fee is reduced to save costs. This is a threat to the principle of professional competence and due care.
The firm should ensure that its negotiations over fees are kept separate from all other considerations, especially the audit. It must not threaten objectivity to keep the audit.
If the relationship with the client has collapsed, the firm should consider resignation.
- Uploader: Samuel Duah