In: Accounting
You are an audit supervisor of Samyantwi &
Associate and you are planning the audit of Franko
Company, a listed company, for the year ending 31st March 2017. The
company manufactures
computer components and forecast profit before tax is GHS33.6m and
total assets are GHS79.3m.
Franko Company distributes its products through wholesalers as well
as via its own website. The
website was upgraded during the year at a cost of GHS1.1m.
Additionally, the company entered
into a transaction in February to purchase a new warehouse which
will cost GHS3.2m. Franko
Company’s legal advisers are working to ensure that the legal
process will be completed by the
year end. The company issued GHS5m of irredeemable preference
shares to finance the warehouse
purchase.
The company has launched several new products this year and all but
one of these new launches
have been successful. Feedback on product Luge, launched four
months ago, has been mixed, and
the company has just received notice from one of their customers,
Adanko Company, of intended
legal action. They are alleging the product sold to them was
faulty, resulting in a significant loss
of information and an ongoing detrimental impact on profits. As a
precaution, sales of the Luge
product have been halted and a product recall has been initiated
for any Luge products sold in the
last four months.
The finance director is keen to announce the company’s financial
results to the stock market earlier
than the previous year and in order to facilitate this, he has
asked if the audit could be completed
in a shorter timescale. In addition, the company intends to propose
a final dividend once the
financial statements are finalized.
Franko Company’s finance director has informed the audit engagement
partner that one of the
company’s non-executive directors (NEDs) has just resigned, and he
has enquired if the partners
at Samyantwi & Associates can help Franko Company in recruiting
a new NED. Specifically he
has requested the Engagement Quality Control Reviewer, who was
until last year the Audit
Engagement Partner of Franko Company, to assist the company in this
recruitment. Samyantwi &
Associates also provides taxation services for Franko Company in
the form of tax return
preparation along with some tax planning advice. The Finance
Director has recommended to the
audit committee of Franko Company that this year’s audit fee should
be based on the company’s
profit before tax. At today’s date, 20% of last year’s audit fee is
still outstanding and was due to
be paid three months ago.
Required:
i. Identify and explain TEN ethical threats which may affect the
independence of
Samyantwi & Associates audit of Franko Company; and
ii. For each threat, suggest a safeguard to reduce the risk to an
acceptable level
Prepare your answer using two columns headed Ethical threat and
Possible Safeguard
respectively
1. Risk: Franco Co’s Non-executive director has resigned, and their directors have requested the partners of Samyantwi & Associates to assist them in recruiting a new director. A Non-Executive Director has an important part to play in looking after the audit process and the audit firm. So this request can be a self-interest threat as an audit firm cannot take part in the recruitment of the board of directors.
Safeguard: Samyantwi & Associate can assist by advising the management regarding the qualification suitable for the role and review the list of candidates but they cannot make a decision in the recruitment.
2. Risk: The finance director who is eager to publish the financial results for Franco Co has requested the audit firm to complete the audit in a shorter span of time. This may result in an intimidation threat as they may be put under pressure to complete the audit quickly and result in missing out on key procedures of and this could affect the objectivity and quality of the audit performed.
Safeguard: Engagement partner can discuss with the finance director to commence the audit a little earlier than the original time so that there is no pressure within the audit team to complete the audit. If they do no agree, the partner shall inform them politely that the team will undertake the audit in consideration of all standards and quality control measures and so the chances of completing the audit in a shorter span of time is unlikely.
3. Risk: The audit firm currently provides taxation services, audit engagement, and possibly services related to the recruitment of the members of the board of directors. There is a potential intimidation threat as a large portion of the income of the Samyantwi & Associates is now coming from Franco and Co.
Safeguard: Audit firm should assess whether the total fees received from Franco and Co. would be more than 15% of gross income from practice for two consecutive years. If yes, then it should be discussed whether recruitment and taxation services should be undertaken or not.
4. Risk: Twenty percent of the previous year’s audit fee is currently pending for payment and was due three months ago. This could be a self-interest threat if the fees continue to remain unpaid, as Samyantwi & Associate may feel the pressure to agree to certain accounting adjustments which may not be as per the rules and regulations.
Safeguard: Samyantwi & Associates should discuss with the management the reasons why the audit fee is still overdue. They can come to an agreement where the payment of fees can have a new structure by making sure the entire fees are paid before the audit is completed.
5. Risk: It was mentioned that the audit fee is based on the profit before tax of Franko Co. This type of fee could indicate a contingent fee. Contingent fees could result in a self-interest threat. If the audit fee is based on profit, the engagement team may be pressurized to ignore certain audit adjustments which could lead to a reduction in profit
Safeguard: The audit firm should not accept contingent fees and must communicate to the management at Franco and Co.
6. Risk: It was mentioned that the website had been upgraded. So there are chances that the data on the website is not updated and could be exposed to security risks.
Safeguard: Samwantwi & Co should review the website thoroughly to check if any activity is pending to be implemented in relation to the upgrade.
7. Risk: Franco and Co have halted the sales of the new product and a recall has been initiated. This could result in malpractices such as altering the books of account
Safeguard: The audit firm should review the sales and pricing thoroughly to avoid material misstatements in the financial statements.
8. Risk: Franco and Co. have entered into an agreement to purchase a new warehouse but the legal procedures will be completed only by the end of the year. There is a threat of initiating business in the warehouse without completing all the legal formalities.
Safeguard: The audit firm should discuss with the management regarding the purchase of the warehouse and verify all the documents related to the purchase.
9. Risk: There is a risk of inadequate disclosure in the books of accounts while issuing preference shares to finance the purchase of the warehouse.
Safeguard: Auditor should ensure that the categorization of the issue of shares is done correctly to avoid any misstatements.
10. Risk: The engagement quality control reviewer (EQCR) of Franko and Co was their audit engagement partner until last year. There could be a familiarity threat involved in it.
Safeguard: Franco and Co. are a listed company and hence the previous engagement partner should not be conducting the audit for at least two consecutive years. Another EQCR shall be appointed.