Practice Questions- SF Legal and Other Professional Regulations

Question 1

1. Requested a second opinion on the auditor’s report – the proposed audit report expresses an adverse opinion due to disagreement over the accounting policies adopted in the financial statements

Identify the ethical issues that may arise for your firm and state, with reasons, how your firm should deal with the request:

Answer 1

•May compromise the opinion of the existing auditor
•Client may be opinion shopping
•May be a threat to professional competence and due care, if not in possession of all the facts
•Audit firm may be tempted to give the opinion the client desires in order to obtain the audit in future
Deal with the request:
•Obtain client’s permission to contact the existing auditor
•Notify auditor of the work to be undertaken
•So that your firm is in full possession of all the facts
•If client refuses permission, decline to act

Question 2

If the regular fees from a client company or group of companies constitute a substantial proportion of the fee income of an audit firm, a self-interest threat is likely to arise so as to impair objectivity.

Set out the safeguards a firm should use to recognise this threat and the procedures available to offset it:

Answer 2

• To recognise threat: regularly review situation as client profile changes
• To offset threat: Consider whether the firm could be open to criticism and either: refuse appointment OR introduce safeguards, including independent review and disclosure to ethics partner and those charged with governance
• DO NOT accept the assignment if total fees regularly exceed 15% of annual fee income (or 10% for listed company), although it may be possible for another part of the firm to carry out the work

Question 3

You are planning the audit of Sports results-a-minute.com. You have ascertained that the company has overdue fees of £15,000 being the previous year’s audit fee.

Explain the threat to your firm’s independence and state the action your firm should take in respect of this matter

Answer 3

• Overdue fees constitute a self-interest threat to independence
• Issue of unmodified report this year may increase chance of collecting overdue fees
• Ideally arrange for settlement of the overdue fees
• Consider resigning from the engagement if not settled and fees are significant or in dispute
• If do not resign apply appropriate safeguards (eg, second partner review)
• And notify ethics partner

Question 4

During the audit of Cairn Ltd, the audit senior discovered that some of the company’s customers had paid invoices twice.
The overpayments had not been refunded and had been credited to the statement of profit or loss

The managing director told the audit senior that these customers, which are government bodies, periodically pay the same invoice twice.
He also told the audit senior that he has no intention of repaying the money unless the customers ask for it to be repaid.

State, with reasons, the action the audit senior should take in respect of this matter

Answer 4

• Report to Money Laundering Reporting Officer (MLRO) within the firm
• Report to National Crime Agency (NCA)
• Avoid tipping off the client
• So as not to prejudice legal proceedings
• Recommend repayment to customers
• Ensure included as liability not income

Reasons:
•Represents proceeds of crime/theft
•Criminal offence if auditor does not report

Question 5

A fraud has recently been discovered, involving the chief buyer in the purchasing department of Rodney Ltd and a purchase ledger clerk in the accounts department over a period of two years.

The managing director of Rodney Ltd has written to the company’s auditors claiming that they had a responsibility to detect frauds during the course of their audits and requesting an explanation as to how they could have missed it.

What points should the auditors make in response to the managing director?

Answer 5

• Duty is to report on financial statements, no responsibility as such to detect fraud
• An audit conducted in accordance with ISAs obtains reasonable assurance that the financial statements are free from material misstatement whether caused by fraud or error
• Auditors may not find material frauds
• Frauds involving collusion harder to detect
• Responsibility set out in engagement letter
• Management is responsible for implementing and monitoring the system of control

Question 6

Dimension Ltd is a software company providing e-commerce solutions to business.

It was incorporated on 1 April 20X8 and revenue has doubled each year. Rapid expansion is expected to continue for the next few years.

This growth requires heavy investment in working capital, particularly work in progress and receivables, and the company will be seeking a substantial increase in the borrowing facility from its bankers when the present facility is due for annual review in September 20X1.

The increase in revenue in the year ended 31 march 20X1 has taken the company over the exemption threshold, and it is obliged to have a statutory audit for the first time. – List the benefits that the company may obtain from the statutory audit

Answer 6

• Independent confirmation of profits earned/net assets
• Assurance of compliance with Companies Act
• Recommendations on systems via management letter
• Added credibility of accounts will help negotiations with bank
• Reliable financial information for business decisions

Question 7

You have been invited to tender for the audit of Data plc, a company that owns and operates 35 hotels in the south west of England.

You have not previously acted for Data plc, but you are the current auditors of Lodge ltd, a company that owns and operates hotels in 30 out of the 35 towns in which Data plc operates. The hotels operated by each company offer similar facilities to each other at a similar price.

Identify and explain the principal ethical issue that you may need to consider when deciding whether or not to tender for the audit of Data plc and state the procedures you may need to implement in the event that your tender was successful.

Answer 7

•Main issue: Confidentiality. Data and Lodge may perceive threat of disclosure/use of information. Conflict of interest for audit firm. Difficult to act in best interest of both clients.
•Procedures:
- Ensure staff are aware of confidentiality issues
- Staff to certify they are aware of procedures
- Obtain informed consent of both clients/inform both clients
- Use different partners and teams
- Independent review of arrangements for ensuring confidentiality maintained
- Information barriers in place

Question 8

You are the auditor of Royale Ltd, a manufacturer of fireworks. Following a disappointing last three months of trading, the company has requested an extension to its overdraft facility from its bankers.

The bank has in turn asked your firm to provide a report on the company’s working capital, focusing on the recoverability of trade receivables and inventory.

Explain the benefits and limitations to both the bank and Royale Limited of obtaining the working capital report.

Answer 8

Bank: Benefits
•Provides assurance to the bank through increased credibility
•Reduces the risk of management bias/independent
•Enables bank to determine risk in advancing more money to Royale

Royale: Benefits
•Enables them to obtain the overdraft which may not be possible without the report

Limitations:
Bank:
•Not all receivable and inventory balances will be looked at by your firm
•Possibility of collusion or misrepresentation
•Evidence likely to be persuasive rather than the conclusive/assurance not absolute-reasonable or limited level of assurance depending on scope of work
•Report may not highlight full extent of problem/lack of sufficient information
•Inherent limitations of accounting system/integrity of data

Question 9

Mrs Wallace is the audit partner in her firm for Racdale Ltd. She has just been appointed a trustee of the Racdale Family trust, which owns 20% of the shares in Racdale Ltd.

She replaces the family solicitor who has just retired. In addition, Mr Netwater, the audit manager for Racdale Ltd, has given one month’s notice that he will be leaving the firm to become finance director of the company.

State the threats to independence that these situations pose, and the safeguards that the firm should employ to maintain objectivity

Answer 9

Mrs Wallace:
•Self-interest threat
•Trustee held by a person in a position to influence the audit is only allowed by ES S2 where:
-Mrs Wallace not a beneficiary of the trust
-The financial interest held by the trust in Racdale Ltd is not material to the trust
-Trust is not able to exercise significant influence over investment decisions made by the trust
•Therefore transfer audit responsibility to another partner

Mr Netwater:
•Familiarity/self-interest/intimidation threat
•Should be removed immediately from audit role
•Review of the audit work performed by Mr Netwater in the current year and, where appropriate, most recent audit
•Firm should reassess composition of audit team

Question 10

The following is an extract from an independent accountant’s unmodified report on a profit forecast:

‘Based on our examination of the evidence supporting the assumptions, nothing has come to our attention which causes us to believe that these assumptions do not provide a reasonable basis for the forecast.’

Describe the level of assurance provided by this statement and explain how and why it differs from the level of assurance provided by an auditor’s report on annual historical financial statements

Answer 10

Comment

Negative assurance which is limited assurance •

How it differs

Audit provides high level of assurance which is reasonable/not absolute assurance
Opinion expressed in positive terms
Give a true and fair view/prepared in accordance with Companies Act/directors’ report –consistent

Why it differs

Financial statements are based on fact as well as judgement •
Persuasive evidence available •
Often the delay between reporting date and auditor’s report means that even items such as provisions/estimates can be substantiated
Scope of work on forecasts is limited as forecasts are based on assumptions about the future and as such are subject to uncertainty

Question 11

Your firm acts as auditor to Columbus Ltd, a retail car dealer.

During the course of your audit for the year ended 30 June 20X5, you discover that the company’s sales manager, helped by the accounts clerk, has deliberately falsified details of the value of vehicles
sold in order to increase his monthly bonus payments.

Set out your responsibilities in respect of the above matter and contrast these with the responsibilities of the management of Columbus

Answer 11

Auditor responsibilities

• No responsibility to prevent fraud •
• Responsibility to detect material misstatements in the financial statements whether due to fraud or error
• Must design audit procedures to obtain reasonable assurance that financial statements are free from material misstatement whether caused by fraud or error
• Must make report to relevant authority under money laundering regulations
• Must not tip-off sales manager or accounts clerk

Management responsibilities

• Responsible for preventing fraud
• Responsible for detecting fraud
• Must implement system of internal control suitable for the business and monitor such systems
• Responsible for safeguarding the assets of the company

Question 12

Your firm’s largest client is Count Ltd (Count) a non-listed company. The statutory audit fee amounts to £468,000 per annum.

In addition, your firm provides tax services to Count worth £179,000 per annum. Your firm’s total fee income for the current year is estimated at £6,200,000 including all the fees from Count described above.

Outline the ethical issues and state how your firm should address these issues

Answer 12

Fee income from Count amounts to 10.44% of firm’s total fee income •
This is above 10% ‘review’ limit in ES S4 for non-listed client •
But under 15% limit •
Self-interest threat – firms objectivity may be impaired if fear losing major client •
Self-review threat for tax work if numbers impact financial statements •

How address

Disclose fee % to ethics partner and those charged with governance at Count •
Internal independent quality control review by partner not connected with audit •
If likely to exceed 10% on regular basis should arrange external quality review •
Separate teams for audit and tax to counter self-review threat •
Consider resignation from tax engagement

Question 13

Your firm is the external auditor of Kerry Ltd (Kerry) for the year ended 31 May 20X9. Following a due diligence investigation by your firm, Kerry acquired in January 20X9 the trade and assets of Blue ltd from the liquidator.

These assets are included in Kerry’s statement of financial position at 31 May 20X9.

Identify and explain the principal threat to your firm’s objectivity in respect of the audit of the financial statements of Kerry for the year ended 31 May 20X9 and state the safeguards that should be applied

Answer 13

Self-review •
Audit team may be reluctant to identify impairments •
Audit team may rely too heavily on colleagues’ work •

Safeguards

• Members of the audit team should not have been involved in the due diligence investigation
• Independent partner or quality control review

Question 14

Explain why an external auditor of a company should be objective and independent

Answer 14

• Issues arising in the preparation of financial statements involve the use of judgement •
• The auditor therefore needs to be unbiased in forming the audit opinion •
• Directors may make biased or inappropriate judgements
• The auditor needs to adopt rigorous and robust approach to identify such bias or inappropriate judgement
• The audit opinion should be based only on the available audit evidence and no other factors
• Independence increases the likelihood that an auditor will be objective •
• A lack of independence may reduce public confidence in the auditor’s objective view •
• Which would reduce the credibility and reliability of reports and opinions issued by auditors
• Objectivity and independence are required by Ethical Standard S1 and the Companies Act

Question 15

Your firm has been the external auditor of Moose Ltd (Moose) for a number of years.

Adam Flayman has been the engagement partner for four years. Moose is in the process of becoming a listed company and its directors have requested that Adam Flayman continue as the engagement partner once the company is listed.

Discuss the ethical issues arising and any safeguards that your firm should adopt in respect of the directors’ request

Answer 15

There is an issue of long association with Moose Ltd •
Which may lead to a familiarity threat •
The audit partner may be too trusting of the client or the client’s representations •
Ethical Standard S3 guideline for rotation of unlisted company engagement partners is 10 years
For listed companies the engagement partner must not act for more than five years •
Where the entity becomes listed the length of time the partner has already acted must be taken into account
If the partner has served four years or more they may continue for no more than two years once listed
Adam Flayman has served for four years and therefore may continue for a maximum of two years
If Adam continues for two further years after listing safeguards will be required •
Such as independent partner review of the audit work •
Should communicate the maximum number of years to the client •
Document reasons for allowing Adam to continue •
Self-interest threat may arise if fear losing client by failing to meet the directors’ request •
Seek advice from ethics partner

Question 16

Describe the role of the ethics partner within an external audit firm

Answer 16

Responsible for adequacy of firms policies and procedures regarding integrity, objectivity and independence
Responsible for firm’s compliance with the FRC Ethical Standard •
Responsible for effectiveness of communication on ethical matters to partners and staff •
Provides ethical guidance and advice to individual partners and teams •
Gives consideration to whether policies and procedures are properly covered in training •
Provides guidance where difficult and objective judgement needs to be made or a consistent position reached
Assesses implications of any breach of the FRC Ethical Standard •
Determines whether any safeguards can be put in place or whether there is a need to resign from engagement

Question 17

During the external audit of Kipper Ltd (Kipper), an employee of the company informed the audit senior that the managing director of Kipper had instructed the employee not to record a transaction in the accounting records as it had nothing to do with Kipper’s business.

The transaction involved a cash deposit which was paid into the company’s bank account and a week later the same amount was paid by Kipper, via direct transfer, into a bank account in the name of David Hake, a friend of the managing director. The amount is not material in the context of any of the key figures in the financial statements.

State, with reasons, how the audit senior should deal with this matter

Answer 17

Report to firm’s Money Laundering Reporting Officer (MLRO) •
Without tipping off •
There is suspected money laundering •
Appears to be disguising/transferring proceeds •
No de minimis where money laundering concerned

Question 18

Explain the fundamental principle of professional competence and due care and provide two examples of how a firm of chartered accountants can identify whether its partners and staff are complying with this principle

Answer 18

Professional Competence:

• Maintain professional knowledge and skill at the level required to ensure that clients receive a professional service, based on current developments in practice, legislation and techniques
• Act diligently and in accordance with applicable technical and professional standards when providing professional services

Identify Compliance:
On the job supervision of junior staff •
Review of juniors’ and seniors’ work by manager •
Hot/internal quality control reviews •
Cold reviews/monitoring •
Staff appraisals •
Staff training

Question 19

During the external audit of Milk Ltd you discover that the directors have accounted for research costs inappropriately resulting in a material misstatement in Milk’s financial statements.

Your firm plans to issue a modified audit opinion if the misstatement is not corrected. During a conversation with your firm’s audit partner, Milk’s managing director, Hazel Blue, indicated that it is the directors’ intention to seek the removal of your firm as external auditors if your firm issues a modified audit opinion in respect of this matter.

Explain the actions that your firm should consider taking in response to the conversation between Hazel Blue and your firm’s audit partner

Answer 19

Discuss the issue with the directors and request that they amend the financial statements as the issue may be avoided if the directors understand the problem of incorrect accounting treatment.

Reconsider other areas of the audit or undertake an independent internal quality review as the intimidation threat may have impaired objectivity on other aspects of the audit work.

Seek legal advice or advice from the ethics partner in order to ensure that the firm’s exposure to any risk is limited.

Consider resignation as the directors’ actions represent an intimidation threat and breakdown of trust as well as raising doubts about management’s integrity.

Question 20

Your firm has received notice from Pisces plc (Pisces), a listed company, that it will not be re-
appointed as external auditor when its term of office expires as the audit committee of Pisces
has recommended the appointment of another firm

Set out the rights and responsibilities of your firm, including those under the Companies Act
2006, relating to the change in appointment.

Answer 20

Rights
Outgoing auditors may:
make written representations and request directors to circulate to members •
attend and speak at general meeting •

Responsible
Prepare a statement of circumstances: •
specifying reasons for ceasing to hold office –
to be deposited at Pisces’ registered office and copy to be sent to Registrar of Companies
As Pisces is listed, there is no option to state there are no circumstances •
Obtain permission from client to reply to prospective auditor’s communication •
Return promptly all books and records of the company •
Maintain client confidentiality after ceasing to act •
Maintain anti-money laundering identification records •

Question 21

Your firm has been approached by Snipe Ltd to accept appointment as external auditor for the year ending 30 June 20X6.

In the auditor’s report on the financial statements for the year ended 30 June 20X5, the previous auditor issued a qualified opinion, due to disagreement over the accounting policy for inventory valuation.

This matter was cited by the previous auditor in response to your firm’s letter requesting information that might influence your firm’s decision as to whether to accept the engagement. In addition, the previous auditor stated that the audit fees due for the year ended 30 June 20X5 remain unpaid.

Identify and explain the ethical issues arising from the above and identify any actions your firm should take in respect of this matter before deciding whether it should accept the appointment as external auditor.

Answer 21

Ethical Issues:

• The previous auditors appear not to have been reappointed due to giving a qualified opinion and the directors may now be opinion shopping
• This raises doubts over management’s integrity and suggests a possible intimidation threat which may result in the firm issuing an inappropriate audit opinion
• Failure to pay fees could be further indication of an intimidation threat and also leads to self-interest threat if the firm fears non-payment of its own fees
• However, these issues do not preclude acceptance

Actions:

• Review the prior year financial statements and auditor’s report to establish the accounting policy for inventory valuation and ascertain the basis for the qualification
• Consider whether firm agrees with basis for qualification •
• If the firm agrees, discuss with management whether they intend to change the accounting policy
• Ascertain from management the reason for the overdue fees in respect of prior year audit •
• Consult firm’s ethics partner •
• Decline appointment if any suggestion that non-payment of previous auditor’s fees was linked to the qualification
• Carry out a background check on management

Question 22

Explain why external audit firms are required to monitor the length of time that audit engagement partners serve as members of the engagement team for each audit

Answer 22

Audit firm is required, by Ethical Standard S3 (ES S3), to establish procedures and policies because a long association with the audit engagement may create threats to an auditor’s objectivity and independence resulting from:
Self-interest •
Self-review •
Familiarity •
ES S3 sets out a mandatory requirement for the audit of listed companies where the engagement partner must be rotated every five years.
ES S3 also recommends that engagement partners for audits of non-listed companies be rotated every 10 years, however this requirement is not compulsory.

A firm may need to:
apply safeguards to reduce any threats to an acceptable level; or •
resign from the audit if appropriate safeguards cannot be applied.

Question 23

(Your firm, which has 25 offices throughout the UK, is planning to open a new UK office in the town of Milton Keynes.

The managing director of Robinia plc Robinia), a property company with numerous properties throughout the UK, has suggested that your firm leases one of Robinia’s vacant properties in Milton Keynes at the market rate.

Your firm is the external auditor of Robinia.

State with reasons, whether it is appropriate for your firm to lease this property from Robinia

Answer 23

Business relationships are permitted under ES S2 as long as the arrangement is:
- in the ordinary course of business •
- on an arm’s length basis •
- not material to either party •
Leasing properties is in the ordinary course of business for both parties
Market rate implies arm’s length basis
As both parties are large, transaction is unlikely to be material to either
Robinia has numerous properties and firm has 25 other offices therefore appropriate to accept

Question 24

Your firm has informed its external audit client, Lion Ltd (Lion), that it will not be seeking reappointment at the end of its term of office because of a disagreement with Lion’s directors over the treatment of an accounting item. Charn LLP (Charn), a firm of auditors, has recently written to your firm requesting information that might influence its decision to accept
appointment as external auditor of Lion.

State your firm’s responsibilities in relation to Charn’s request, as set out in the ICAEW Code of
Ethics

Answer 24

Firm’s responsibilities:
Obtain authority from the company to discuss Lion’s affairs with the new auditor •
Answer promptly the request for information •
Record in writing any discussions with Charn •
Confirm to Charn that there are matters about which they ought to be aware •
Explaining these matters meaningfully (honestly and unambiguously) •
This should include an explanation of the differences of opinion between the firm and Lion regarding the accounting treatment
If Lion refuses to grant the firm permission to discuss the client’s affairs, the firm should report that fact to Charn

Question 25

During the course of the external audit of Wood Ltd (Wood), the audit junior identified a payment in the cash book, described as ‘commission’, for which there was no supporting documentation.

On enquiry of the management of Wood, the audit junior was informed that the payment was made to a government official in another country to facilitate the progress of a contract Wood was undertaking in that country.

State, with reasons, the action to be taken by the audit junior.

Answer 25

Actions: Report to firm’s MLRO/senior member of the engagement team

Reasons:

• Bribery of a foreign government official/inducement
• Is a criminal offence/illegal
• Under Bribery Act
• Also required to be reported under POCA
• Benefiting from criminal conduct

Question 26

During your firm’s external audit of Long Ltd (Long), a chemical manufacturer, you were told by an employee of Long that the company frequently fails to provide its factory workers with the legally required protective clothing when working with hazardous chemicals.

Requirement
Explain why this information should be considered by your firm during the external audit

Answer 26

Firm required, by ISA (UK) 250A Consideration of Laws and Regulations in an Audit of Financial Statements, to consider non-compliance with laws and regulations

Failure to provide protective clothing may breach health and safety regulations and may indicate a lack of management integrity

There may be an impact on the financial statements due to:
Fines for non-compliance with regulations •
Provisions/contingent liabilities arising from legal claims if employees suffer injuries •
Going concern issues if authorities close factory/suspend licence •
Breaching law and regulations to save costs may be considered money laundering

Question 27

Your firm has received a request for information from Blonde LLP, a firm of auditors, in respect of its prospective external audit client Auburn Ltd (Auburn). Auburn is currently audited by your firm but, after discovering that Auburn’s manufacturing process includes unethical labour practices in its overseas supply chain, your firm decided not to seek reappointment.

Requirement
State, with reasons, the actions that your firm should take with respect to the request for information from Blonde LLP.

Answer 27

Request written authority from Auburn to respond to Blonde
Firm is bound by confidentiality until permission is received •
If request is refused inform Blonde
Blonde can evaluate impact on decision as to whether to accept appointment •
Once authority is received should respond in writing as quickly as possible
Allow Blonde to make a decision in the time available •
Set out reasons in response as to why firm is not seeking reappointment
So Blonde is in possession of all the facts before deciding to accept

Question 28

While reviewing the post year-end purchase invoices of Builda Ltd (Builda), a construction company, the audit senior discovered an invoice for two designer watches costing £5,000 each.

On enquiry, the audit senior was informed that the watches were given, by the directors of Builda, to the managing director of Deluxe Developments Ltd (DD) and his wife. DD is a property development company to which Builda regularly submits tenders for construction projects.

Requirement
State, with reasons, the action to be taken by the audit senior.

Answer 28

Actions to be taken: 
Report to firm’s MLRO/senior member of engagement team/ethics partner •
Bribery/inducement •
Is a criminal offence •
Under Bribery Act 2010 •
Excessive in value •
Also required to be reported under Proceeds of Crime Act •
Benefiting from criminal conduct •
Must not tip off client

Question 29

The FRC stated recently that its reviews of audits would give particular consideration as to whether appropriate professional scepticism has been applied in specific areas. Two of these areas are asset impairments and related parties.

Requirement
State what is meant by professional scepticism and explain why it is fundamental to the audit of
asset impairments and related parties.

Answer 29

Professional scepticism is an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.

Asset impairments

Involve estimates/assumptions/judgements about the future/discount factors/subject to uncertainty
Assets more vulnerable to impairment in current economic climate •
Management may be reluctant to write down assets •

Related parties

Related party transactions may be used as vehicle for fraud •
Management may be reluctant to disclose/deliberately conceal •
Evidence not readily available/reliant on management to disclose

Question 30

Mullet LLP (Mullet) is the external auditor of Bream plc (Bream), which is a listed company. The directors of Bream have requested that Mullet undertakes an engagement to revalue a class of the company’s assets which amount to 12% of total assets.

Requirement
Explain why Mullet should refuse this request.

Answer 30

• Not permitted by Ethical Standard S5
• Material to financial statements as greater than 2% of total assets •
• Self-review threat too great/no adequate safeguards •
• May rely too heavily on valuations in subsequent audit
• May be reluctant to identify a misstatement in the valuation
• Management threat as may involve subjective judgement/making assumptions

Question 31

Grover Ltd (Grover) has headquarters in London and is an external audit client of Tyler LLP (Tyler), an ICAEW firm of chartered accountants. Tyler has received a telephone call from the City of London Police requesting that the firm discloses information about transactions undertaken by Grover in order to help the Police with their enquiries.

Requirements
State, with reasons, the actions to be taken by Tyler.

Answer 31

Ask the police for more information/request to be in writing •
Firm owes a duty of confidentiality to the client •
Do not disclose any information, unless there is a court order or other legal duty or there is a professional duty to disclose
Ask the client for permission to disclose •
If given, disclose the information to the police •

Consider whether:
money laundering is involved –
a report should be made to NCA –
Re-review the audit work in the areas about which the police have requested information •
Consider the implications for audit work/risk assessment/audit opinion •
Consider future involvement/reputational risk •
Seek legal advice or contact the ICAEW helpline

Question 32

Describe two procedures that an assurance firm should have in place to ensure that members of an audit team act with objectivity and independence.

Answer 32

• Rotation of engagement partners – partners of listed clients must be rotated every five years/partners of non-listed clients should be considered for rotation every 10 years
• ‘Fit and proper’/independence declarations – signed annually/at start of each audit •
• Formal process in place for partners/employees to report family/personal relationships, financial interests in audited entity or decision to join audited entity – adequately communicated to employees
• Training/development/appraisal processes – including employees’ understanding of how to identify threats to objectivity and independence and actions to take when threats identified
• Formal processes for considering appropriateness of appointment/reappointment – such as evaluation of client integrity, press/internet searches, obtaining references and discussion with directors/background checks
• Appointment of ethics partner – consulted on safeguards to ensure they are sufficient to address potential threats
• Requirement for engagement partners to be responsible for forming a conclusion on compliance with independence requirements for each engagement – includes identifying and evaluating circumstances/relationships that cause threats and taking action to eliminate them
• Engagement quality control reviewer – consider the adequacy of documentation of engagement partner’s consideration of auditors’ objectivity and independence
• Monitoring of compliance with firm’s policies and procedures – periodic review, on a test basis, of audit engagement partners’ documentation of consideration of objectivity and independence

Question 33

You are the manager responsible for the engagement to review the financial information of Riff Ltd (Riff) on behalf of an external audit client, Alto plc (Alto), a listed company.

Alto requested the review as it intends to acquire the share capital of Riff. The audit junior currently working with you on the review engagement told you that, yesterday, he purchased shares in Alto because he believes its share price will rise when the acquisition of Riff is announced.

He also told you that he has informed his parents about the acquisition and has advised them to purchase shares in Alto.

Requirement
Explain the ethical issues arising in this situation and state the actions you and your firm should take

Answer 33

Breach of the fundamental principles of confidentiality and professional behaviour due to:
Improper disclosure of information
Junior has given confidential information about the acquisition to his parents •
Improper use of information •
Junior has acted on the information for his own personal advantage/insider trading •
ICAEW Code of Ethics: professional accountant should not deal in shares of a company in which he/she has a professional association

Self-interest threat
Junior will want acquisition to take place to make a gain on the shares purchased •
Threat to professional competence and due care •
May not carry out work properly or fail to raise issues identified during review •
Could lead to inappropriate conclusion •

Actions
Remove junior from engagement team immediately •
Review/re-perform work of junior •
Notify engagement partner/ethics partner •
Disciplinary action/training of audit junior •
Obtain advice from ICAEW helpline

Question 34

You are the senior responsible for the external audit of Bass Ltd (Bass). During the audit, the managing director of Bass requested that you complete the audit work as quickly as possible.

As an incentive, he has offered you the company’s holiday villa for your personal use for no charge if you ensure the audit work is completed to his deadline.

Requirement
Explain the ethical issues arising in this situation.

Answer 34

Self-interest threat
Senior may comply with MD’s wishes to gain use of villa •
Use of villa likely to be considered excessive (not insignificant) •
Compromises objectivity/independence of senior

Offer may represent a bribe/inducement
Could lead to improper performance by senior/finishing work too quickly/audit quality compromised
Raises questions over management’s integrity •

Possible intimidation threat
If managing director exerts pressure on senior •
Lack of professional competence and due care •
Risk of unprofessional behaviour
Insufficient audit evidence may be obtained
Inappropriate opinion/material misstatement may not be detected

Question 35

Your firm sets its senior employees targets for generating fees from their external audit clients, including fees for non-audit services. One of the criteria for progression within the firm is achieving these targets.

Requirement
Identify and explain the threat to the objectivity of the senior employees and state, with reasons, whether or not these arrangements are appropriate.

Answer 35

Threat

Self-interest threat •
Incentive for progression within the firm. •
Explanation

Senior employees may push services not required by the client/exaggerate the benefits of non-audit services
Audit quality may suffer/errors may be overlooked/senior employees may be reluctant to raise contentious issues.

Is arrangement appropriate?

Not appropriate •
No safeguards possible •
For each audited entity, ES S4 states that the audit firm shall establish a policy to ensure that:
objectives of the members of the team do not include selling non-audit services criteria for evaluating performance or promotion of the members of the audit team do not include success in selling non-audit services
no specific element of remuneration of the members of the audit team is based on success in selling non-audit services.

Question 36

Your firm is the external auditor of Googly Ltd (Googly). The directors of Googly have requested that your firm helps in the preparation of its annual financial statements.

Requirement
Explain the threats to your firm’s objectivity arising from the above and describe the safeguards, if any, which should be put in place to mitigate those threats.

Answer 36

Explanation of threats to objectivity

Management threat •
Firm is expected to make decisions –
Firm becomes too closely aligned with the views and interests of management –
Self-review threat •
Results of a non-audit service are reflected in the amounts included or disclosed in the financial statements
- Such as calculations –
- Audit team reluctant to identify shortcomings in their colleague’s work or may place too much reliance on that work –

Safeguard
Refer to ethics partner •
Not prohibited in UK as company is not listed •
Limit the length of time for which help is provided •
Informed management in place •
Management makes all decisions requiring the exercise of judgement and –
Has prepared the underlying accounting records –
Firm does not initiate transactions or –
Make decisions –
Services provided are of a routine or mechanical nature –
Audit documentation demonstrates that management has made all decisions •
Responsibilities set out in engagement letter •
Staff member must have no involvement in the audit of the financial statements •
Independent partner review of: Audit work & Accounting services

Question 37

The ICAEW Code of Ethics identifies circumstances where an auditor is or may be required to disclose, to third parties, confidential information obtained during the course of an external audit.

Requirement
List, with examples, the circumstances in which the disclosure of confidential information, without the client’s permission, is or may be required.

Answer 37

Circumstances requiring the disclosure of confidential information by auditors:
- Required by law:
Legal proceedings
Suspected terrorist activities
Suspected money laundering to the NCA
Suspected bribery
- Permitted by law
- Professional right or duty to disclose, not prohibited by law:
Comply with quality review by ICAEW or professional regulator
Respond to enquiry or investigation by ICAEW or regulatory body
To protect professional interests in legal proceedings
Comply with technical standards and ethics requirements

Question 38

Coniston LLP (Coniston) has tendered for the external audit of Windermere plc. Coniston has proposed a fee below the market rate in the hope that the firm will subsequently be awarded more lucrative advisory work.

Requirement
Identify and explain the ethical issues posed by Coniston’s proposal.

Answer 38

Proposal represents ‘lowballing’ •
Not prohibited by the Code of Ethics •
ES Part B S4 states that the audit fee must not be influenced by the provision of other services
Threat to professional competence and due care •
Audit quality may be jeopardised –
Risk of audit failure/issuing an inappropriate audit opinion
Impaired scepticism

Self-interest threat •
Fear of not obtaining advisory work

If the advisory work is obtained there may be:
Self-review threat •
Over reliance on colleagues’ work during the external audit
Reluctance to identify firm’s errors to audited entity’s management

Management threat •
May be expected to make decisions
Too closely aligned with management

Question 39

Procedures to comply with firm’s policy prohibiting partners and staff from owning shares in client companies

Answer 39

Procedures to comply with firm’s policy prohibiting partners and staff from owning shares in client companies

• Firm to maintain an up-to-date list of all clients •
• Written confirmation by partners and staff of compliance with the firm’s policies on independence
• Annual or more frequent confirmations •
• New partners and staff required to provide confirmations on joining firm •
• Regular training for partners and staff on the firm’s policies and procedures on independence
• Monitoring of procedures •
• Disciplinary action for breaches •
• Procedures for prompt notification by partners and staff when shareholdings change •
  Eg, shares inherited •
  Eg, new client of the firm