Question

Sharon Gallagher, Josh Thomas, and Jo Wadley work for the audit firm W&S Partners. Sharon is an audit manager, Josh is an audit senior, and Jo is an audit partner. They meet to discuss the results of a survey of other offices of W&S Partners, as well as their own office. The survey was directed toward determining if W&S Partners had any independence problems with respect to a new prospective client, Cloud 9 Inc. Based on the survey, they learn the following:

Jo Wadley and David Collier (Cloud 9's CFO) both serve on the board of directors of the local chapter of Special Olympics.

A tax senior in another office has a sister that consults with Cloud 9 on shoe design. Cloud 9 is her largest client.

Fifteen employees of W&S Partners, ranging from partners to entry-level staff, own shares in retailers that sell Cloud 9 shoes.

A survey shows that 23% of professional staff working for W&S Partners have purchased Cloud 9 shoes in the past.

Required Evaluate each of the items above and their impact on the independence of W&S Partners with respect to Cloud 9. If relevant, list any additional actions you might take before making your independence recommendation to Jo Wadley.

1. Review the Code of Professional Conduct (ET 1.200) and PCAOB standard ET 101).
2. Determine if the firm member is a “covered member.”
3. If either source specifically defines the situation as a threat, so state. Identify the source as AICPA ET 1.2xx.xxx or PCAOB ET 101 xxx (where xxx identifies the specific paragraph). Also document whether the standard states the threat can (or can’t) be reduced to an acceptable level through application of safeguards.
4. Identify potential safeguards, if applicable. Safeguards may include not assigning the firm member to the audit.
5. State whether the threat is at an acceptable level (after applying safeguards, if applicable).

Answer 1

(a) Prepare a document that explains the impact, if any, of each piece of relevant information on your client acceptance decision for Cloud 9 Pty Ltd.

Issues (sections refer to APES 110):

• The relationship between David Collier and P.S. Nethercott is described as distant (i.e., not Close Family). Section 290 discusses familiarity threats which can occur because of a close relationship, such as a member of the assurance team having an immediate family member or close family member who is a director or officer of the assurance client, or an employee in a position to exert direct and significant influence over the subject matter of the assurance engagement. In this case, P.S. Nethercott is not on the assurance team (and is not likely to be), and although the relationship is with a person in a position to be involved in the subject matter of the audit, the relationship is distant. There would be no threat to independence.
• The potential consulting fees are twice the size of the audit fee, creating a significant business relationship between the audit firm and the client, and potentially an undue dependence on the fees from this client (relative to total fees from all clients). According to s. 290a self-interest threat to the auditor’s independence could arise from this relationship. In general, firms would limit the size of non-assurance service fees relative to the size of assurance fees for any one client, through either limiting the amount of non-assurance services provided or refusing to perform both for the same client. In addition, it is possible that a self-review threat could arise if the IT installation was relevant to the financial data that would be the subject matter of the audit in future periods. The non-assurance service (IT installation) in itself should also give risk to consideration of the threats to independence. The matter is discussed in detail in ss. 290.201 – 290.206. In general, the self-review threat is likely to be too significant to allow both services to be provided by the same firm, except if the audit client clearly takes all management decisions with respect to the installation of the IT project, and non-assurance and assurance staff at the audit firm are kept separate.

• Purchases of products in the normal course of business and on an arm’s-length basis, such as shoes from stores, is acceptable and is not an independence threat (s. 290.120).
• Members of the IT department at the audit firm could be involved in the audit. As such, their financial interests need to be considered. In this case, the shareholdings are in retailers that sell the audit client’s products, and the shareholdings are material and have been disclosed to the audit firm. The shareholdings are not in the audit client, and the relationship does not allow the members of the IT department to influence management decisions at either the retailers or the audit client. There is no independence threat to the audit of Cloud 9.
• This point does not relate to independence issues. In this case, the newspaper article suggests that the management of Cloud 9 Inc., the parent firm of the audit client, is engaged in illegal and/or unethical behavior. The auditor is required to consider client integrity in the client acceptance decision (ASQC1). In addition, s. 210 of APES 110 requires the auditor to consider any threats to the fundamental principles. Such a threat could occur if the prospective client is dishonest or involved in illegal activities. The management of Cloud 9 Inc. has denied the allegations and invited international human rights groups to visit their factories. Cloud 9 Inc. is not the prospective client of W&S Partners, so it could be argued that the auditors are not concerned with this issue. However, a lack of integrity at the parent company could indicate a lack of integrity at the local level, and/or create other issues for the auditors related to dealings between the companies. The auditors could raise the issue with Cloud 9 Pty Ltd management, and if still concerned, also visit the factories.

(b) List and explain any additional actions you would take before making your client acceptance recommendation to the partner, Jo Wadley, in this case.

Other issues to be considered in making the client acceptance decision include:

• Other issues relating to client integrity, such as reasons for the audit switch, client attitudes to risk, internal controls, accounting standards, full access to information, and payment of fees.
• Obtaining permission from the client to communicate with the previous auditor, third parties such as bankers and lawyers, and client personnel
• Review press
• Any potential threats to other fundamental principles, such as professional competence and due care through lack of auditor expertise in the client industry or insufficient audit staff

(c) Assume the decision is made to accept Cloud 9 as a client. Prepare the client engagement letter.

Prepare client engagement letter as per example in ASA 210