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- 10 Marks
Question
You are an audit manager with AA & Co. Chartered Accountants and Business Consultants. You have been assigned to the audit of Western Decors Ltd (WD), a long-established firm of event planning service in the city where your practice is located. The audit of the financial statements for the year ended 31 March 2019 is due to commence shortly. The audit firm is aware that the client has received a loan from the bank in April 2018 and that the bank will rely on the audited financial statements as part of the terms and conditions in the loan agreement.
The partner in charge of AA & Co. has just visited the client and made the following notes during his trip:
- The firm has a number of individual and corporate clients outside Accra and has invested heavily in recording and broadcasting equipment to allow some events to be broadcasted over the internet. This facility is now available at all events conducted in WD’s premises and is proving to be very popular. To date, no specific extra charge has been levied for this service but the Chief Executive Officer (CEO) of WD has asked us to prepare a report for him advising on whether it would be practical to charge separately for it; and, if so, the level at which the charge should be set.
- Unfortunately, WD’s main supplier of chairs went into liquidation during the year. The Partner said that they were fortunate to be able to find an alternative supplier with whom they entered into a three-year contract for the supply of chairs. At the time of signing the contract, WD considered the contract to be on very favourable terms. However, the supplier is based in Nigeria and the contract was denominated in Naira. Movements in the exchange rate now make the contract look far less attractive and the CEO has requested that we examine the contract to see if there is any way he can legally set it aside.
Required:
i) Critically evaluate any possible ethical issues arising from the client’s requests. (4 marks)
ii) Discuss whether the auditors may be liable to the bank in case the audit was negligently done. (6 marks)
Answer
i) Ethical Issues Arising from Client’s Requests:
- Independence Threat: Providing advisory services such as recommending pricing strategies for broadcasting services and reviewing contracts for legal viability could impair the auditor’s independence. This is particularly relevant since these services may create a self-review threat where the auditor might be perceived as reviewing their own work.
- Advocacy Threat: The request to provide a report on pricing for broadcasting services and the possibility of setting aside a contract denominated in Naira may create an advocacy threat, where the auditor might be seen as advocating for the client’s position rather than maintaining an objective stance.
- Competence: The audit firm must consider whether it has the necessary competence to provide legal advice on setting aside a contract. Legal expertise may be required, and the audit firm must ensure that it does not overstep its professional boundaries.
- Management Responsibility: The auditor should ensure that management, not the auditor, makes any final decisions regarding pricing or legal matters. The auditor can advise but should not assume management responsibilities.
ii) Auditor’s Liability to the Bank if the Audit was Negligently Done:
- Duty of Care: The auditor owes a duty of care to the bank, especially since it is known that the bank will rely on the audited financial statements as part of the loan agreement. This establishes proximity and reliance, making it foreseeable that the bank would suffer a loss if the audit is negligently performed.
- Breach of Duty: If the audit is performed negligently, for example, by failing to detect material misstatements or by not adhering to relevant auditing standards, the auditor would be in breach of this duty of care.
- Causation: The bank would need to prove that the auditor’s negligence directly caused its financial loss. If the bank relied on the audited financial statements to make lending decisions and those statements were materially misstated due to negligence, causation would likely be established.
- Financial Loss: The bank must demonstrate that it suffered a financial loss as a direct result of relying on the negligently audited financial statements. If these elements are proven, the auditor could be held liable for damages to the bank.
(6 marks)
- Tags: Advisory Services, Audit, Competence, Ethical Issues, Independence
- Level: Level 3
- Uploader: Joseph