Question Tag: Self-Interest Threat

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  • 10 Marks

AAA – May 2016 – L3 – Q1b – Professional responsibility and liability | Rules of professional conduct

Identify and evaluate ethical threats in an audit engagement and recommend safeguards to mitigate these threats.

Dibidibi & Co., an audit and assurance firm, has been engaged as auditors for BCG Bank Ltd, a public limited liability company, for some time now. BCG Bank has sixty branches throughout the country and branches in Togo, Burkina Faso, and Cote d’Ivoire. The Bank is one of the banks in the country which can boast of large landed properties. Dibidibi & Co. receives about 20% of its income from this particular client. Before last year’s audit, the bank engaged the audit firm to value its Land and Buildings in all its branches and headquarters. This work was executed by the audit firm and a report has been issued to management. The report has been incorporated in this year’s financial statements to be audited soon. Dibidibi & Co. sees BCG Bank Ltd. as a very important client whose works are always executed with dispatch.

i) Identify and evaluate the significance of any threats to the Code of Ethics for Professional Accountants raised in the case. (4 marks)

ii) Recommend safeguards to eliminate the threats (mentioned in (i) above) or reduce them to an acceptable level. (6 marks)

i) Threats to the Code of Ethics for Professional Accountants:

  • Self-interest or Intimidation Threat: As the audit firm receives about 20% of its income from just one audit client, there is a self-interest or intimidation threat. The firm will be concerned about losing the client. The self-interest and intimidation threats are significant considering the nature and duration of the breach – that is the high percentage of income from a single client received for some time now; and the knowledge of the audit firm of such interest.
  • Self-review Threat: The valuation services provided by the audit firm raise a self-review threat. If an audit firm performs a valuation that will be included in financial statements audited by that firm, a self-review threat arises. This threat is significant as the valuation of Land and Buildings of all branches of the bank, including the head office, is material to the financial statement to be audited.

ii) Safeguards to Eliminate or Reduce the Threats:

  • For Self-interest or Intimidation Threats:
    • Reducing dependence on the client.
    • Implementing external quality control reviews.
    • Consulting a third party, such as a professional regulatory body or a professional accountant, on key audit judgments.
    • Conducting internal quality control reviews.
    • As the bank is a public interest entity and the firm’s total fees have been that high for two consecutive years, the Code of Ethics provides that the firm shall:
      • Disclose this to those charged with governance.
      • Conduct a review, either by an external professional accountant or by a regulatory body.
      • Since the total fees significantly exceed 15%, a pre-issuance review shall be required, i.e., a review before the audit opinion on the second year’s financial statements.
  • For Self-review Threat from the Valuation Services:
    • Conducting a second partner review.
    • Confirming that the client understands the valuation and the assumptions used.
    • Ensuring that the client acknowledges responsibility for the valuation.
    • Using separate personnel for the valuation and the audit.
  • 10 Marks

AAA – May 2020 – L3 – Q1a -Rules of professional conduct, Professional responsibility and liability

Discuss five ethical issues arising for auditors when performing an audit engagement.

You are an audit manager at Abdulai Afriyie & Co., a firm of Chartered Accountants. You are currently preparing the audit of Adoma Mining & Jewelleries Ltd for the year ended 28 February 2019. Adoma Mining & Jewelleries Ltd is a small Mining and Minerals Company which offers an extensive range of services that covers exploration, jewellery production, industrial applications, decommissioning and closure. You reviewed the previous years’ files for this client and noted the following:

i) The previous financial statements were prepared by the Consulting Division of Abdulai Afriyie & Co. and there is nothing in any of the files to suggest any particular difficulty with the assignment.

ii) In the course of the review of the files, it was observed there is a note explaining that on the completion of the assignment, each member of the consulting team with whom the client had come into contact, was given a gift of “presentation box” of the client’s Jewelleries. These presentation boxes contain samples of each of the different jewelleries produced by the client. These boxes are not available for sale but are sometimes given as gifts (for example, at Christmas) to loyal customers and others such as school principals who are seen to bring business to the client. Since this was a non-assurance assignment, the gifts were automatically and gratefully accepted.

iii) In early January 2019, the company received correspondence from the Ghana Revenue Authority (GRA) claiming that the company has failed to pay certain mineral royalties which are usually charged on the jewellery manufactured. Normally, these levies are automatically deducted when miners or mining companies sell minerals to dealers. In this case, all of the minerals extracted were used to make jewels and ornaments by the company itself; and so the company never considered the possibility that such royalties might apply to it. The Chief Executive Officer (CEO) of Adoma Mining & Jewelleries Ltd tells you that he has done some research into the issue. It is his view that an argument can be made that the royalties do not apply in this case. However, should they apply, the amounts outstanding could be material since a number of years of non-payment might be involved. The CEO is aware that Abdulai Afriyie & Co. has a lot of Jewelleries based clients and has asked if Abdulai Afriyie & Co. would handle this matter as a separate assignment in addition to the audit.

Required:
Discuss FIVE (5) ethical issues that may arise for Abdulai Afriyie & Co. in relation to the audit of Adoma Mining & Jewelleries Ltd. (10 marks)

The following may give rise to ethical issues for Abdulai Afriyie and Co:

  1. The preparation of accounts as well as auditing them.
  2. The request to deal with the failure to pay royalties and
  3. The offer of a gift from the client to members of the audit team.

These issues are addressed below: Accountants producing and then auditing the financial statements of companies is a near-universal practice in the case of private, unlisted entities. Similarly, conducting specific extra assignments on behalf of the client would not be unusual. However, these situations are not without ethical difficulties. In particular, the following threats arise:

Threat Discussion of threat in this case
Self-Interest threat Probably not excessively severe in this case but both points of the question will, if they are accepted, mean that extra revenue will be received from the client and thus we will need to be aware of any consequent impairment of our independence.
Self-Review threat In either of these cases we will inevitably (as a practice) be reviewing our own work and so there is a danger that we will not bring to bear on such a review the same degree of professional scepticism as we would in the case of the work of an outsider. In the case of the potential charge to royalties we may leave ourselves in the invidious position of feeling the need to insist on an accrual for a charge the existence or quantum of which we are, simultaneously, rigorously denying.
Familiarity threat Doing a lot of work for the client and having very frequent contact with them could lead us to lose or dilute our professional scepticism in relation to the client. In simple terms, we might become too trusting of the client because we know them very well. The use of different teams for different assignments would be an important safeguard.
Advocacy threat The assignment in point ii) of the question will, almost by definition, require us to “take the side of the client” and argue the client’s case. We are, therefore, advocating for the client and, for an auditor, that is fundamentally dangerous. The decision on whether to accept will depend on issues such as the materiality of the amounts potentially involved; the degree of disputatiousness likely to arise (in as much as that can be measured); and our ability, as a practice, to put safeguards in place.
Management threat In the case of both points i) and ii) there is a danger that we, as auditors, will take decisions that should properly be made by the client. For example, decisions about accounting policies should be made by the client. In the second case, the decision on how far to pursue action against the Ghana Revenue Authority on the levies issue should purely be one for the client. The difficulty arises because, if we accept the assignment, we will be advising the client, but we must ensure that the client comes to their own decision.

(5 points well explained @ 2 marks each = 10 marks)

  • 10 Marks

AAA – May 2019 – L3 – Q2a Professional Responsibility and Liability

Evaluate ethical threats affecting audit independence and recommend safeguards to eliminate or mitigate them.

Your audit firm, Adjaye-Gyamfi & Co. has just taken on a new client, Ablordey Ltd (Ablordey), a very successful health club that provides gym and fitness services. The company operates a chain of fitness centers with a wide range of workout equipment, solarium rooms, fitness sessions, nutritional planning, changing rooms, and locker facilities.

You have just been informed that your firm has received an invitation to tender for the audit of the company that owns Gyms Ltd., a major competitor of Ablordey. The Managing Director of Ablordey, Kusiwaa, is an old college friend of your audit manager, and it was through his connection that your firm was able to tender for its audit. You have been assigned as senior auditor for Ablordey.

On a recent visit to your office, Kusiwaa stated that she would like to extend an offer that all staff of Adjaye-Gyamfi & Co. would be eligible for a special membership rate, which is 50% of standard membership rates and entitles the member to 75% off special classes.

She proposed that you sit on the board of directors at Ablordey as a non-executive director. Additionally, she proposed that your firm confirm, as part of the audit, the figures on an insurance claim to be submitted in respect of damage caused by a burst water pipe. The pipe burst during a spell of cold weather in the main gym area prior to the year-end.

Required:

In the context of the above scenario: i) Evaluate FOUR (4) ethical threats (real or perceived) which may affect the independence of your firm’s audit of Ablordey; and (4 marks) ii) For each threat, recommend how it might be eliminated or mitigated to a satisfactory level. (6 marks)

i) Ethical threats

  1. Self-interest threat – Staff membership rates at Ablordey:
    Such a benefit could cause a self-interest threat to the audit, because the recipients may not want to lose their benefit, and therefore be biased in their audit work or not seek adjustments where there are material issues in the financial statements.
  2. Familiarity threat – Partner invited to sit on the board:
    If the partner were to sit on the board of directors, there is a risk that the partner could lose their audit objectivity as they may start identifying too closely with the company and its other directors. There is also a risk that the audit partner may start taking management responsibility at Ablordey Co.
  3. Advocacy threat – Assurance re insurance claim:
    Audit firms must always ensure that accepting other services does not impact on audit objectivity, whether due to the amount of fees relating to the service or as a result of the nature of the service itself.
  4. Conflict of interest – Competing audit engagement:
    Adjaye-Gyamfi & Co has been invited to tender for an audit which will involve Ablordey’s major competitor, Gyms Ltd. It can be appropriate for audit firms to audit competitors, but the clients involved might feel that there is a threat to client confidentiality and may prefer to seek other auditors in such a situation.

(4 points well explained @ 1 mark each = 4 marks)

ii) Management of threats

  1. Self-interest threat:
    Auditors are not allowed to accept such benefits unless their value is trivial and inconsequential. In this case, the value of a reduced membership of a spa is unlikely to be trivial and inconsequential to audit staff members, and therefore Adjaye-Gyamfi & Co should reject this offer.
  2. Familiarity threat:
    Auditors are prohibited by the Code of Ethics from acting as a director for their clients. You should explain this to the Managing Director and politely decline the invitation.
  3. Advocacy threat:
    The partners should discover more about the size and nature of this engagement to determine whether it will affect independence. In particular, they should determine whether such an engagement would put the firm in the position of advocating Ablordey’s position to the insurance firm, as this could cause an insurmountable barrier to independence. They should also monitor the level of fee income this would earn Adjaye-Gyamfi & Co from all work performed for Ablordey Co to ensure it does not cause a self-interest threat.
  4. Conflict of Interest:
    Adjaye-Gyamfi & Co should therefore disclose to Ablordey that they are in the process of tendering for the audit of a competitor. If either Ablordey Co or Gyms Ltd is unhappy with this situation, then Adjaye-Gyamfi & Co will need to decide which audit they want to secure. If Adjaye-Gyamfi & Co performs both audits, they must ensure that they use separate audit partners and teams and set up “Chinese walls” to maintain confidentiality.

(4 points well explained @ 1.5 marks each = 6 marks)

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