Question

Grove Clark is a ten-partner accountancy firm. It has been approached by five potential audit clients and the partners are considering the independence and ethical risks associated with taking on these audits.

Client A is a company in the financial services industry. Grove Clark have no experience in this industry but they would like to build up some expertise in this industry. The chief financial officer of Client A used to be a Grove Clark partner.

Client B has been recommended to Grove Clark by Client H. Clients B and H are both in the manufacturing industry and have worked together on several large contracts. If Grove Clark accept Client B, Company H expect a discount on its next audit as commission for making the recommendation.

Client C is a new company with ambitious plans for growth and stock market listing. Whilst Client C is currently exempt from statutory audit, the directors wish an audit to be conducted to make it easier to negotiate lending arrangements with its bank. A meeting with the bank has been scheduled for three months after the year-end and the directors insist that the audited financial statements with an unmodified report be available before the meeting.

Client D is a start-up company owned and managed by a couple of scientist/inventors who have discovered a way of converting insects into food fit for human consumption. They need to be associated with a reputable accounting firm in order to approach large corporations for the finance needed to develop their scheme and as a result they are happy to pay a higher fee.

Client E is a medium-sized I.T. company which has developed a new app for downloading music from the internet. The CFO resents having to pay an audit fee and suggests instead that the audit fee could be taken either as new shares issued by Client E or by the firm agreeing to accept 5% of the profits generated by the new app.

Required

: a) For each potential client highlight any independence or ethics risks the partners should consider and why. In addition, suggest safeguards that could be considered to mitigate the relevant risks.

b) Explain what is meant by ‘professional scepticism’ and how it is relevant to the conduct of an audit of financial statements.

Answer 1

SOLUTION (A)-

1. Client A
Threats: management participation threat and familiarity Threat. In this case, due to an employment relationship, independence will be broken.
Safeguards:
Built by profession, legislation and regulation: If this engagement is to be taken within a year of employment, the engagement should be evaluated by a qualified professional to conclude whether the engagement team members can keep the suitable level of skepticism when assessing the representations and performance of the former firm member.
Executed by firm: Training and education of workers concerning ethical requirements, a governance composition within the firm.
2. Client B
1) Threats: Undue Influence Threat and Self Interest Threat. Independence may be broken here, as the firm might experience revenue losses due to the discount or loose its old as well as potential clients in this circumstance.
2) Safeguards:
· Executed by Firm: At the inception of the engagement itself, the terms of fees and discounts should be admitted upon ethically.
· Designed by profession, legislation and regulation: Specific type of Financial relationships are banned by the regulation.
3. Client C
1) Threats: Undue Influence Threat. The client is symbolizing that a particular type of opinion should be given, irrespective of what was actually concluded.
2) Safeguards:
· Executed by firm: acceptance and continuation methods that are intended to limit association with clients that pose a threat that is not at an agreeable level to the member's compliance with the laws.
· Created by profession, legislation and regulation: Professional resources, such as hotlines, education and training.
4. Client D
1) Threats: None can be distinguished from the given knowledge.
5. Client E:
Threats: Familiarity Threat and Self interest threat. In this case, fees being dependent on the share price of the client or the profits of the client, damages the independence completely.
Safeguards: Formulated by profession, legislation and regulation: Acceptance of fees in such form may be banned under the relevant statutes and regulations. Financial relationships like owning shares and profit sharing is prevented.
Created by firm: Discussion of independence matters by audit committee, procedures of the firm and engagement contract with the client.

SOLUTION (B)-

Professional skepticism is being fully self-aware of the environment, or you can say being suspicious to the situations which may symbolize potential misstatement due to error or fraud, and a crucial assessment of audit evidence.
Professional skepticism has perpetually been practiced to examine the reliability of the information through investigating questions, crucial assessment of evidence, and being attentive to red flags and differences.

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