AA Seminar 4 - Question - External audits, objectivity and independence PDF

Preview

Summary

External audits, objectivity and independence...

Description

Auditing and Assurance - Seminar 4

Task:

Read the scenarios below and then attempt the questions that follow. You should be prepared to discuss your points with your classmates in your seminar.

Source:

Adapted from ICAEW Audit & Assurance Question Bank (2018)

Jewel plc, Lake Ltd & Carnival Ltd Described below are situations which have arisen in respect of three unrelated external audit clients of Toco LLP. The year end in each case is 28 February 20X3.

Jewel plc (Jewel) Jewel is a listed company. Jewel appointed a new finance director and financial controller on 18 February 20X3 as the previous finance director and financial controller left the company in December 20X2. The directors of Jewel have requested that the prior year engagement partner, Linda Marcel, continues as engagement partner for the current year audit in order to safeguard the quality of the audit in light of the recent appointments. Linda has been the engagement partner for the previous seven years.

Lake Ltd (Lake) Lake has recently decided to outsource its internal audit function and has requested that Toco LLP accepts the engagement for an annual fee of £768,000. The directors believe that Toco LLP will be able to provide a costeffective service due to its cumulative knowledge of Lake's business gained through its provision of the external audit. Current services supplied by Toco LLP to Lake are the external audit and tax compliance work with annual fee incomes of £865,000 and £219,000 respectively. Toco LLP's total annual fee income, excluding the proposed internal audit services for Lake, is £17.1 million.

Carnival Ltd (Carnival) The financial controller at Carnival has been on long-term sick leave and the finance director has asked Toco LLP for help with finalising the accounting information in preparation for the year-end audit. He is particularly concerned about preparing estimates for the trade receivables allowance and year-end warranty provision as none of his accounting staff has the appropriate experience. He has requested that a member of staff at Toco LLP be seconded to Carnival to help with preparing the accounting information, including the specific estimates mentioned.

Required 1.

Explain why objectivity and independence are important principles in the context of an external audit engagement. Outline how ethical codes/standards can promote independence and objectivity in the conduct of an external audit. a. The expectation of those directly affected, particularly the members of the firm. The audit should be able to provide objective assurance on the truth and fairness of the financial statements that the directors can never provide. b. Audits of firms are in the public interest as firms are public entities, governed by rules requiring the disclosure of information which should be done objectively.

It makes sense for private sector firms to carry out audits as different audit firms specialises in different industry sectors. Audits are long and costly procedures

2.

In the UK, ethical standards promote independence and objectivity by requiring firms to implement safeguards. A safeguard is ‘an action of measure that eliminates a threat, or reduces it to an acceptable level’. Some of the areas which the safeguards target to try to achieve objectivity and independence are;  Self interest threat o Auditors are prohibited from holding various firms of financial interest in the audited body  Familiarity o Audit partners are prohibited from acting as audit partner for more than 7 years  Self review o A firm cannot provide a listed audit client with accounting and bookkeeping services The ethical standards are set by the Financial Reporting Council (FRC) 3.

For each of the three situations outlined above, explain the threats to the objectivity and independence of Toco LLP and list the safeguards available to mitigate these threats.

Jewel: Familiarity threat as Linda has been the engagement partner for 7 years. If she has been the engagement partner for too long they become too familiar, both on a personal level (making friends with employees) and on a professional level (getting to know the logistics of the firm). This could make her drop her guard and not be able to act objectively. Safeguards: engagement partner must not act for a period of more than 7 cumulative years for a particular client for listed audit clients. There are no safeguards against this. There has to be a cool off period of 5 years before they can re-enact as engagement partner Lake: Self review as they already carry out external audit and tax work The fees charged cannot exceed 15% of the firms income Carnival: self review, preparing accounting records and financial statements. The firm should be doing the accounting/reports and not the auditors....