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- 10 Marks
Question
You have been recently promoted as the Ethics Partner in Famous Chartered Accountants, a licensed audit firm. At your first visit to the Managing Partner, he informs you of an appointment by Phobia Foods Ltd (PFL), and gives you a file to go through. You open the file and find a copy of an e-mail from the Managing Director of PFL, extracts which read as follows:
From: Managing Director, Phobia Foods Ltd.
To: Managing Partner, Famous Chartered Accountants
Subject: Evaluation of Business Expansion Plan and Associated Items
Congratulations on your offer of appointment as auditor cum advisor of our company. As discussed in our earlier meeting, Phobia Foods Ltd (PFL) would like to open three more outlets, two in Sunyani and one in Sogakope. The necessary financing will be obtained through a new bank loan and the rescheduling of the payments of the existing loan, which is technically in default.
Your appointment and fees
Your audit fee will be GH¢16,000 for the year ended 30 June 2018.Your fee for evaluation of our expansion plan and advisory services in relation to obtaining a bank loan will be GH¢9,000. For advisory services and business efficiency and strategic decisions, your fee will be GH¢3,400 per month for the next two years.
Shareholders and key management issues
Five founding directors, each with equal shares, incorporated PFL which commenced trading in 2009. I still maintain my original 20% holding.
Audit and accounts 2016-2018
Ofosu-Mensah & Associates., a firm of licensed auditors audited the accounts for the years ended 30 June 2016 to 30 June 2018 inclusive. The audit of PFL for the year ended 30 June 2018 was signed off on 16 November 2018 with an unqualified opinion, notwithstanding that qualified opinions had been published on the previous two years’ accounts. The shareholders of PFL approved your firm’s appointment at the annual general meeting held on 15 April 2019 for the year ended 30 June 2019.
The funds raised by the new bank loan will be used for expansion of the business. Your firm is also expected to advise the company on the application for the new bank loan and the rescheduling of repayments of the existing loan in default.
Yours sincerely,
Managing Director.
Required:
Evaluate FIVE (5) risk considerations and issues for Famous Chartered Accountants that should be identified prior to accepting this engagement. (10 marks)
Answer
The risks to be considered in relation to accepting this particular client are as follows:
- The client appears more focused on our role as business advisors than auditors. The managing director refers to us as “auditor cum advisor”. The risk here is that the client does not appreciate the nature of assurance services and sees them as a mere extension of our advisory roles. This could lead to confusion and even conflict later.
- The client’s financial position appears precarious. Although I do not yet have access to very detailed financial information about the client, there is a suggestion of a loan being, in the client’s own words, “technically in default”. Clients whose financial position is unsound present a much greater risk for several reasons. One reason is that their management teams tend to be under pressure rendering them more susceptible to unethical conduct or even outright fraud. Another reason is that accounting practices are more often pursued through the courts when clients have failed financially.
- A third point concerning this appointment is that the fees appear to have been fixed by the client in advance. A fee of GH¢16,000 has been agreed as the audit fee. It seems imprudent to have fixed such a fee in advance of really understanding the client or fully appreciating what is involved with the audit. This is an ethical risk because personnel performing the audit may feed under psychological pressure to reduce the time spent on the audit commensurate with the fee.
- Also, a fee has been agreed in relation to our advice and support in relation to the client’s application for some sort of “roll-over” of the bank financing. This would appear to create an advocacy threat to our independence. There is also an offer on a rolling fee of GH¢3,400 per month for general business, strategic and financial advice. It is commendable that this income will be received monthly by the practice but we need to be assured that we have the resources to invest in this on a continuous basis. It also gives rise to a familiarity threat so we will need to ensure the existence of robust information and communication barriers (so-called “Chinese Walls”) between the audit team and others working for the client.
- It would appear that there were difficulties with audits in two of the three previous years. It appears that the audit reports for the years ended 30 June 2016 and 2017 were both subject to qualification. Although the 2017 report was not so qualified, the fact that there were difficulties in two of the three previous years is still a cause of concern. At this point, there appears to be insufficient detail of what lead to the qualifications but there must be a risk that these issues are still relevant notwithstanding the unmodified report in the year to 30 June 2018.
(5 points well explained @ 2 marks each = 10 marks)
- Tags: Audit Risk, Auditor Independence, Client Engagement, Ethical Issues, Risk Consideration
- Level: Level 3
- Uploader: Joseph