Auditing and assurance revision question and answer

Auditing and Assurance Revision Questions and Answers

a) The objectivity of the external auditor may be threatened or appear to be threatened where:

(i) There is undue dependence on any audit client or group of clients;
(ii) The firm, its partners or staff have any financial interest in an audit client;
(iii) There are family or other close personal or business relationships between the firm, its partners or staff and the audit client;
(iv) The firm provides other services to audit clients.

(a) For each of the four examples given above, explain why the objectivity of the external auditor may be threatened, or appear to be threatened, and why the threat is important.
(10 marks)

(b) Flowers Anytime sells flowers wholesale. Customers telephone the company and their orders are taken clerks who take details of the flowers to be delivered, the address to which they are to be delivered, and account details of the customer. The clerks input these details into the company‘s computer system (whilst the order is being taken), which is integrated with the company‘s inventory control system. The company‘s standard credit terms are payment one month from the order (all orders are dispatched within 48 hours) and most customers pay bank transfer. An accounts receivable ledger is maintained and statements are sent to customers once a month.

Credit limits are set the credit controller according to a standard formula and are automatically applied the computer system, as are the prices of flowers.

Describe and explain the purpose of the internal controls you might expect to see in the sales system at Flowers Anytime over the:

(i) Receipt, processing and recording of orders. (6 marks)
(ii) Collection of cash. (4 marks)
(Total: 20 marks)

a) Why external auditor objectivity may be, or appear to be, threatened

(i) Undue dependence

If the auditor depends, or relies on a particular client or group of connected clients because the firm takes a large part of its fee income from the client, the auditor may be less likely to challenge accounting policies or disclosures proposed the client, for fear of upsetting them. This typically happens when the firm is small, but the client is large.
Where the firm feels that an audit qualification may be necessary, it may be reluctant to issue it for fear of losing the client and the fee income. This applies regardless of whether the fee income is audit fee income or income for other work.
The issue is important because if the auditor does not issue a qualified audit report where appropriate, the firm may be sued for negligence. Where a large client is involved, the firm‘s professional indemnity insurance may not cover the claim.

(ii) Financial interest

Where a partner or member of staff in a firm (or the firm itself) holds shares in a client, they have an interest in the client‘s performance. If the client performs well, the value of the shares may rise. A qualified audit report is not usually associated with good performance and the firm may therefore be reluctant to issue one where appropriate. This is important for the reasons noted above.
Even if there is no question of a qualified audit report, there may be a temptation to help the client present the results in the best possible light, instead of presenting a balanced view.
There is also a financial interest where partners, staff or the firm make loans to, or guarantee the borrowings of the client or vice versa. Significantly overdue fees of amounts that are significant to either auditor or client are akin to loans.

(iii) Family or other close personal or business relationships

Where there are family or other close personal or business relationships between client and audit firm, the individuals concerned may try to influence the firm in its dealings with the client in order to protect the family or personal relationship, or the mutual business interest.

If, for example, an audit partner is married to the finance director of a client, it is less likely that the client will receive a qualified audit report than it would be if the relationship did not exist. This is important in any case but more so where the effect of a qualified (or modified) audit report is likely to result in, say, withdrawal or non-renewal of banking facilities which might result in the business ceasing to be a going concern. If the firm does not issue a modified audit report in such circumstances, the firm may be exposed to claims of negligence the bank.

If there are close business relationships between client and auditor, both parties have an interest in each other‘s performance and there is therefore a double pressure to present the results in the best possible light and not to issue a qualified audit report.

(iv) Other services

Many audit firms provide their audit clients with services other than audit services. It is very common for to provide their very small audit clients with accountancy services, for example.

Other services that can be provided include tax, management consulting, IT and human resources advice. Some firms not only provide consulting advice, but also perform IT and other functions for some of their clients.

There are two threats to objectivity where other services are provided. Firstly, the firm may find that it is reporting on a system that the firm itself has set up or advised on, or reporting on information that the firm itself has prepared. This means that it is reporting on its own work and it may be difficult to be objective in such circumstances. Secondly, the fee income from other services may well exceed the fee income from the audit and the client may pressure the firm to give an unqualified audit report threatening to take the other services to another firm if a qualified report is given.

(b) Internal controls

(i) Receipt, processing and recording

 All orders taken should be recorded on a pre-numbered multi-part document generated the computer. One part might be a copy for the customer, one might form the invoice, one might be for the dispatch department and one might be retained for accounts receivable ledger purposes.

 Manual or computer systems should perform checks on the completeness of the sequence of pre-numbered documents at various stages. Any documents unaccounted for should be traced and investigated.

 The computer system should apply the credit limits set the credit controller and the system should reject any orders that exceed customer credit limits at the point at which the order is taken, so that the customer can be advised. Any override of credit limits should be authorised the credit controller.

 From time to time, there should be an independent check to ensure that the credit limits within the system are being properly calculated and properly applied to individual transactions. Similar considerations apply to prices maintained within the system. The computer system should also reject any order for which there are no flowers available so that orders cannot be taken for flowers that cannot be delivered.

 All invoices should be posted to the sales day book, the accounts receivable ledger and the accounts receivable control account automatically the system and the accounts receivable ledger and the accounts receivable control account should be reconciled each month in order for sales and receivables records to be kept up to date.

 There should be controls in place to deal with credit notes and other discrepancies involving the price, type or quality of flowers delivered in order to maintain the accuracy of records and customer goodwill.

(ii) Collection of cash

 At the end of each period, the system should produce a list of overdue receivables. There should be procedures for chasing these customers and for putting a ‗stop‘ on accounts where amounts are significant in order to control bad debts;

 When bank transfers are received from customers, they should be input into the system and matched with individual transactions and controls should ensure that the correct amounts are allocated to the correct customers and transactions.

 An exception report should be produced for any unallocated bank transfers. Exceptions should be promptly investigated. This will ensure that receivables information is accurate and up to date and that customers are not chased for amounts that have been paid

 Bank reconciliation should be performed on a monthly basis in order to ensure that the company‘s cash records are complete, accurate and up to date.

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