Table of Contents
- Part A …………………………………………………………………………………3
- Part B: Importance of auditor’s independence in accordance with APES Code of Ethics for Professional Accountants …………………………………………7
- Introduction …………………………………………………………………7
- Instances of Auditor’s self-interest …………………………………………7
- Need for self-review …………………………………………………………8
- Decision’s influenced by Close Relations …………………………………9
- Auditor Independence ………………………………………………………..10
- Protecting Independence ………………………………………………..11
- Conclusion ………………………………………………………………..12
Auditing is an independent objective evaluation of the financial statements of an organization to check the compliance of an organization to the outlined assertions. Therefore, auditing involves carrying out substantive tests so that we can obtain sufficient and appropriate audit evidence. The auditor is required to give an opinion whether the organization’s financial statements show a true and fair view (Jubb, Topple, Schelluch, Rittenberg & Schwieger, 2008). The opinion may be favorable or unfavorable. If the opinion is unfavorable, we refer to it as a qualified report. A favorable report is referred to as an unqualified report. In our context, one of our clients has experienced a problem because some patients who used their product, aspirin have been hospitalized after ingesting poisoned products of this company.
Because of this, there are some asset accounts that have been affected. They include, inventory account, account receivable accounts and trademark account. The inventory accounts will be at risk because there are stocks that were held in the warehouse. Since recalling of this product will damage the image of this product and the company, purchases of aspirin will definitely go down. The stock in the warehouse of the finished products will lead to losses to the company. The sock of work in progress will also be affected. If the consumers of aspirin boycott from buying it, there may be eventual closure of this account. This will lead to incomplete records that may make the work of the auditor hard. It may be hard for the auditor to obtain sufficient evidence to show whether the account showed a true and fair view of the company at the time of closure of that account. This may lead to inherent risk that involves misstatement of the inventory account such that the controls in place will not detect the error. There may also be detection risk if the evidence is distorted such that substantive tests of the auditor will not detect the misstatement.
Another asset account that may be at risk is the accounts receivable accounts. Accounts receivable account is recorded the amounts that are due from the customers. Therefore, when the product is recalled, the amounts that are due from the customers may not be received. This is due to the decline in sales of the aspirin. In addition, the company cannot follow every client because they already have a wrong impression about the company and therefore the company may end up loosing some of these customers. The happening of this activity may make the product unpopular in the market and hence end up experiencing low sales when aspirin is taken to the market. The auditor will not be in a position of getting sufficient and appropriate audit evidence as the information may have been distorted by the management to improve the image of the company. This will increase chances of making a wrong opinion. This type of risk is referred to as detection risk. It is the type of risk that the auditor will give a wrong opinion despite doing substantive testing. The tests done by the auditor do not detect this error. The final account that will be at risk is the trademark account. The trademark of a product is the name of a product that is used by a company to identify its products in the market. When the aspirin products were recalled, the trademark account will be affected because this will make the product unpopular in the market. People identify a product with its name and therefore aspirin will be associated with the harm that it caused to the patients that used it. This will risk the product and unless the name is changed, it may be end up being an extinct product in the market. Therefore, when the consumers have the impression that aspirin is harmful to their health, they will not consume it. This risk can be countered by changing the name of the product. However, this will be expensive because it requires intensive advertising. In addition to this risk, the products of the company may be seen as counterfeit products and therefore the company should develop strategies that will improve the perception of the consumers.
As an auditor, I will concentrate on valuation and allocation when auditing the inventory account. This is an auditing assertion that ensures that the accounts of assets are properly valued and recorded. This is important because the value of the stock in the warehouse has to be revalued to reflect the correct figure. The accounts have to reflect the correct figure of the stock because of any sock that may have been returned by debtors because of lack of market. The values should be correctly apportioned and allocated to the correct accounts. This assertion is important because it will help me to analyze the amounts that have been presented by the management so that we can know whether the amount is accurate. Auditing of these accounts will help me to know whether they show a true and fair view of the state of the account. As the auditor of this company, I would carry out substantive tests on this account to know whether there was any stock returned by the customers. I will check whether there is evidence of any goods returned note. An equivalent assessment is made with the delivery notes offered to the purchasers at the point of sale of the commodity. In addition, the auditor should check whether there was some unexplained increase in the level of stocks. This is meant to help us to know whether there is some fraud committed. This will reduce chances of additional stocks being added in the name of having been returned by the debtors. This substantive test will help me to know the credibility of the accounts.
In reference to accounts receivable account, the key assertion that I will employ is existence and valuation. This will help me to identify whether the accounts of debtors still exist or they returned the goods that were sold to them. This is an important assertion that helps us to know whether assets and liabilities exist. It also helps us to know whether the assets are recorded in their correct values. In our context, we will want to know whether the accounts of debtors have changed after the recalling of aspirin. If there are any changes that have occurred because of this, we will want to know whether they have been recorded correctly. This is the primary role of the auditor, as he/she makes sure that the accounts represent an accurate description of the status. To identify all this, I will carry out substantive tests to get the appropriate evidence. This will involve examining all the incoming credit notes. This will assist me to get evidence of any returns that have been made by the debtors and the value of the returned goods. It will also help me to know whether the debtors returned all the goods that were due from them. It may also involve checking whether there is evidence of goods returned notes. This will be used to compare with what we have in our accounts. This will help to show the state of the accounts. Finally, valuation and allocation assertion will help me to identify costs the company is incurring because of the unpopularity that the trademark aspirin receives. The loss of customers will be a cost to the company and it should be correctly valued so that it can be allocated appropriately. In reference to the trademark account, substantive evidence involves getting evidence of why the trademark has lead to losses to the company. I will evaluate the number of patients that were affected by aspirin and the level of publicity that was done to alert the public. As a professional accountant, I will be able to estimate the level of loss that should be allocated to trademark account. This will help me to give my audit opinion.
Recalling of aspirin will not only affect assets only but it will also affect expenses. Such expenses include legal expenses. Legal expenses account will be at because poisoning in medicine may be related with negligence. The patients may take legal actions against the company. This will lead to increase in the legal expenses of the company. The company will be liable for the damage that is caused on the patients. This will treated as negligence because the manufacturer owes the patient a duty of care. In auditing the accounts of the company in reference to the legal expenses, I would use the completeness assertion. This assertion will ensure that all the disclosures that should have been made are made. Completeness will be represented by the process of ascertaining that due process has been adhered to. Substantive tests will help me to identify the validity of the figures shown on the legal expenses account. These substantive tests involve tracing the receipts that have been made to cater for this legal suit. These payments have been made to the lawyers. In addition, I will examine the documentations that have been made in relation to this legal suit. This will help me to gather information that will help me to make the audit opinion.
Question part B: Importance of auditor’s independence in accordance with APES Code of Ethics for Professional Accountants
Independence of the auditor is a fundamental principle that is mandatory to all members of this profession. Failure to comply may lead to actions against the offender by the professional body. The concept of independence is based on the idea that the auditor is supposed to give an objective opinion that is not influenced by any external force. Section 100 of APES code of ethics for professional accountants gives some principles that guide accountants to practice independently. These principles includes integrity, objectivity, professional competence and due care, confidentiality and professional behavior (Gay, 2006). These principles will ensure that the accountant does not behave unprofessionally by being influenced by external forces in the opinion that he gives in his report. Corporations Act contains the auditor’s independence declaration in section 307c.
Instances of Auditor’s self-interest
The auditor should avoid any chances of being influenced by self-interest in the firm, self-review threats where a past decision requires to be rechecked by the member that made that decision. The auditor may also be faced with an advocacy threats where a previous wrong decision made will influence the decisions that are made in future. In addition, familiarity reasons may influence the decision of the auditor because of a close friend or relative, who he may become sympathetic to and therefore they influence his decision. Finally, independence can be influenced through intimidation, which may be direct or indirect (Ketz, 2006). The client may withhold some audit evidence that is very vital which if not considered in the decision making of the auditor may lead to a totally different opinion. Therefore, auditor independence is very vital in giving a valid audit opinion. Some of the reasons that may influence auditor’s independence are explained below.
Practical examples of the factors influencing independence of the auditor include self-interest such as financial interest in a client. This is wrong because the code of ethics prohibits any financial relationship between an accountant and his client (Parker, 1994). An auditor should not have any business relations with the client. An auditor should not give a loan to the client or receive the same from the client. This will definitely affect the independence of the auditor. Finally, an auditor should not accept any extra pay other than the usual remuneration in exchange for a favorable opinion. In addition, the auditor should be careful when the client demonstrates high level of hospitality or when he is given gifts by the client. This is referred to as opinion shopping. Auditor should identify the clients who are opinion shopping in advance and should accept their engagements at all.
Need for self-review
Self-review occurs when a significant error is discovered during re-evaluation of the work that the auditor had previously done. It may also occur when the auditor provides both auditing and accountancy services. Therefore, the auditor may be evaluating the performance of a financial system that he has designed. The opinion will be obviously biased because he cannot qualify his work. In addition, if the auditor was previously a director or an officer of the client, the decision of the auditor will be partial because he was there when designing some of these accounting systems and therefore it is hard for him to qualify these accounts because he was involved in their design.
Advocacy pressure occurs in instances where the auditor is required to audit the financial statements of a listed company and therefore promotes the shares of that company (Jubb et al., 2008). The auditor is not acting independent of his client. In addition, when an auditor acts like an advocate on behalf of an assurance client with disputes with the third party. This compromises the duty of the auditor. He should be impartial when carrying out his duties.
Decision’s influenced by Close Relations
An auditor should not engage with a client who is his relative or a very close friend. This could be directors in the client’s management. He should not engage in a client with his relative or friend who is likely to influence his decision. In addition to this, he should not accept engagements from previous partners that he had worked with. Relatives and friends will influence the decision of the auditor because he will want to give a favorable opinion so that their employers can see them as performers. This is against the accounting profession (Bottomley, 2007).
An auditor’s decision can be influenced when he is threatened or intimidated by the directors of losing his job if he does not give an opinion that is favorable to them. A member of the accounting profession should not accept any engagement that he has knowledge that another auditor was dismissed because of acting objectively. Auditors should always practice professional courtesy (Marshall, 2007). This is where the incoming auditor seeks to know from the previous auditor why he left that client. If it was because of the client’s interference with the auditors work, the incoming auditor should refuse to accept that engagement. Finally, an auditor should not accept to reduce the work he is supposed to perform in order to reduce the fees being paid for the audit work. He should perform his work in accordance with the provisions of the relevant law and the professional body. This will ensure that the work performed is objective and the auditor maintains his integrity (Jubb et al., 2008).
When an auditor is said to be independent, it refers to independence from two points of view. These are independence of mind and independence of appearance. By independence of mind we mean that the auditor should be in a state of mind that allows him to give a conclusion without being affected by professional judgment and hence acting objectively. We also have independence in appearance. This may occur where significant, reasonable audit evidence has been omitted, and a reasonable person with all the details can see that objectivity and integrity of the auditor has been comprised (Lee, 1995). It is a basic need in the accounting profession because it helps to improve the confidence that people have in this profession.
When auditors make independent decisions without coercion or external pressure, people will be in a position to judge the opinion of the auditor. As evidenced above, independence of the auditor promotes objectivity and integrity in the profession. This results in an independent workforce that is not reliant on the company’s performance. Objectivity will improve the use of accounting services and this will definitely increase the client base. Integrity will also increase the confidence of the clients on the accounting professional. As we have seen, auditors need not to worry about loosing their clients because if they act objectively, it will automatically increase them. Integrity is another important trait that people should take note of. When the auditors maintain their integrity by not allowing to be easily influenced, it will also increase the integrity of the professional body. People can therefore depend on the work of the members of this professional body because they have built confidence to their clients
Independence of the auditors has other advantages. This is because when the correct opinion of a company is given, it will help the investors to make wise and informed decisions. This is usually recorded in instances when an organization has an initial public share offer. The auditor is required to produce an audit opinion about the going concern of a company and give an opinion as to whether the final accounts as per the director of the company show a true and fair view of the company (Parker, 1994). At the same time, an independent auditor yields results that are an accurate depiction of the company’s status. This ensures that the real going concern of a company is shown. Therefore, company’s real financial position will be shown.
There are measures that have been developed to prevent interference with the auditor’s independence. Such measures reduce possible threats that may arise to curb the independence of the auditor. Some of the measures include preventing professional staff from participating in audit. The reason for this is to ensure that they are totally independent from the management of their client. In addition, the auditor should always discuss issues concerning his independence with the management of the client before accepting the engagement (Nelson, 2006). He should also discuss his independence in relation providing non-assurance services to his client. This will help evaluate and identify whether such activities will interfere with his opinion. Concerning discussing his independence with the management, they can stipulate in the letter of engagement about activities by the client that will lead to the interference with the client’s independence and self-determination. This will also guarantee that the auditor always acts and performs his duties and responsibilities in an independent manner (Robertson & Davis, 1982).
In addition, the auditor should discuss with the client about possible consultation with an external auditor. This occurs where there is some doubt about the appropriate opinion. He can also consult on non-assurance activities that he may engage in that may lead to interference with the independence of the auditor. This allows the members of the assurance team to make rational decisions that are not biased at all. In addition, the member of the assurance team should engage an external member to provide assurance on the terms of engagement (University of Canberra, 2001). He can also provide assurance on whether the opinion given by the auditor is fair and shows the true and fair view as per the audit evidence obtained. The auditor should also make arrangements such that the personnel working in the non-assurance sector are not engaged in the provision of assurance services. The auditor should always get certification from the client of responsibility for the accounts that have been presented to him for analysis. This will ensure that the auditor deals with the correct information as per his requirements.
Finally, according to section 210 of APES 110 Code of Ethics the auditor should always disclose the manner in which the fees are charged to the management. He can report to the audit committee the nature of the fees charged. This important aspect will help reduce chances of intimidation by the client. In conclusion, we can say that the concept of independence is very fundamental to the auditors. It is contained in section 290 of the APES 110 Code of Ethics for Professional Accountants. This code requires identification of the threats that may face the independence of an auditor and the safeguards that can be employed to prevent interference with this independence (Jubb et al., 2008).
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