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Auditing and Assurance

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Threats to auditors independence

Situation 1

Self-interest threat

It emerges when for instance, the auditor has just one client who account for significant
proportion in their business (Alkafaji, 2017). CJ as the auditor their independence will be
threatened since they will be forced to want to provide the qualified audit opinion which may
cause a problem with LHT because they are worried on losing business with LHT Company.
LHT is the most prominent client for CJ. If CJ adhere to this it will be violating the ASA
200.14/ISA 200 that need the auditors to comply with relevant ethical requirements and will have
to face penalties from Australian Taxation Office (ATO) and ASIC ( Australian Securities and
Investment Commission) for failing to comply with audit independence if found (Freebairn,
2016).

Advising threat

The threat occurs when an auditor also offers financial advices for their client (Tepalagul & Lin,
2014). It will be difficult for CJ to have independence audit when they are provide financial
advice to LHT as proposed by the CEO Chris states that Geoff offer advices on investment and
even facilitate promotion to investors. The CEO noted that the board will find it difficult to
continue business with CJ if Geoff declines to offer such assistance, indicating that this will
undermine the CJ conducting an independent audit.

Situation 2

Relationships threat

They are broad and cover anything which engages the auditor knowing trustees, accountant or
members on the personal level (McKinnon, 2013). When one has a business or close family
relationship with the trustee it will be difficult to attain independence in auditing the LHT
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Corporation. According to the case the CEO and board members want to create a close
relationship with Geoff that may deem to undermine his audit independence by providing him
with a 14-day holiday package. It can result into loose of auditing practicing license if noticed by
ATO and ASIC or having to pay penalties by violating ACT guidelines (Freebairn, 2016).

Ex-staff and the partners threat

It occurs when an employee or partner leaves to start their business and perform audits for their
earlier employer (McKinnon, 2013). For instance Annette has been appointed in the team to
conduct audit report for LHT was a temporary tax consultant and accountant in LHT. It may
undermine his independence for close relation with the firm. Also, it may interfere with her
compliance to independence rules and guidelines due to her close relation with the business.
Thus, affecting the code of ethics in auditing as stated in APES 110,s 100.5 that provide specific
guidelines on independence needs for audit.

a) The safeguards to the threats identified

If any of the threats occur, it may not necessarily denote that an auditor cannot finish the audit.
Safeguards should be put in place to eradicate the threat and the safeguards should be recorded in
the audit report (Johari, Mohd-Sanusi, & Chong, 2017). In doing so, CJ will be able to
understand that a single situation can give rise to over one threat and every threat should be
addressed.

Auditors acknowledge that ethics codes are fundamental in good accounting. Once CJ auditors
understands that considering independence they could have the potential to achieve
independence in accordance with ethical codes as indicated by APES 110 for professional
accountants. It helps them in documentation of independence threats (Freebairn, 2016). These
include: identifying the threat, analysis the significance of the threat such as self interest threat
how it is going to implicate CJs working independence and presentation of audit report for LHT.
Considering safeguards CJ may put in place to resolve the threat. The auditors in CJ audit firm
such as Geoff may apply safeguards to eradicate the threats such as propelling them to do
contrary to APES 110 code of Ethics for professional accountants that are issued through APESB
(Accounting Professional and Ethical Standards Board). It states that members are anticipated to
conform to the spirit and letter of rules.
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For example in the case of Chris stating that if Geoff does not provide the requested business
assistance they may opt not to engage in any business with CJ again. They should document such
remarks as they pose a threat to their independence (Wan Ismail & Kamarudin, 2016). The ASA
200 and ASA 102.5 require that auditors such as Geoff should comply with the appropriate
ethical requirements when carrying out auditing tasks. For example in situation of multiple
referrals threat Geoff can have the external reviewer look at specific files in the SMSF
(Freebairn, 2016). The external reviewer can also create possibility for partners and ex-staff to
safely operate with former staffs. It can build a great opportunity for staff like Annette to worker
well in this circumstance. It will be a positive since they understand the business and have good
working association, however it is ensuring that independence has been wholly considered and
the appropriate safeguards are well placed in the order (Blay & Geiger, 2012). But since each
circumstance is unique, the code states that auditors should apply their professional judgment to
get if the safeguards are suitable to the case at hand. In some incidences, the nature of a threat
can be so significant which even the safeguard can be called in to question by the regulators
(Blay & Geiger, 2012). When Geoff of CJ after determining the significance of a threat and
creating the safeguards, if the solution cannot be achieved independence, Geoff not contended
then he could require resigning or declining for the engagement. The CJ auditors could solicit for
the views of all the interested parties, nevertheless establish independence standards basing on
the judgment of board members on how to best attain the auditor independence goal.

a) Business risk

It refers to the risk emanating from significant circumstances, events, conditions inactions or
actions which might affect the ability of entity to attain its objectives and implement their
strategies or creating an inappropriate strategies and objectives (Wan Ismail & Kamarudin,
2016). For the case of MSL equipment purchase and spare parts the business faces risk of slow
cash flows and there is the business risk associated with the liquidity of MSL operations. The
business risk can arise from MSL purchasing equipment and spare parts may include:

The treatment of revenue and capital expenditure business risk

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The risk here would be relating to the existence of the equipment and spare parts and property
plant, whether the revenue expenditure is being capitalized other than charging it as an expense
in the statement of income (Blay & Geiger, 2012). It may bring confusion as the auditor may fail
to determine the exact treatment of transaction carried out by MSL while purchasing their
equipment and distinguish them from the spare parts without proper documentation (Blay &
Geiger, 2012). It is because the business is operating in the high regularized sector and has
sophisticated network of associated businesses that could be misstated in the financial
statements. It poses a challenge in deciding the overhead allocation and analysis during planning
of the audit.

Inventory valuation business risk

They may occur for instance when there are some considerable aged inventory levels in the MSL
equipment and spare parts (Hossain, 2013). MSL Company may not have been keeping a proper
oversight through a competent audit committee of the financial factors of the company. The
corporation can even be lacking in an internal audit section that is the key control in the high
regulated environment such as purchasing of equipment and spare parts by MSL across China,
Europe and the US. It will create a difficult time for Crampton and Hasaad to plan for their audit.

b) Audit risk

The audit risk may be termed as a risk which the auditor explains an inappropriate opinion of the
audit when the statements of finances seem to be materially misstated. The audit risk may be the
risks function of detection risk and material misstatement (Weirich, Pearson, & Churyk, 2014).
The audit risk based on MSL case focus on two elements namely detection risk and material
misstatement. The material misstatement risk may be termed as the risks which a financial
statement is materially misstated before auditing. They involve two elements called control risk
and inherent risk.

The inherent risk may be an assertion susceptibility regarding the class of disclosure, account
balance or transaction to the misstatement which may be material, an individual or misstatements
aggregation before considering any associated controls (Weirich, Pearson, & Churyk, 2014). The
control risk may be seen as the risk which the misstatement that may emerge based on the
assertion regarding the class of disclosure, account balance or transaction and it may be material,
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individual or during misstatements aggregation that may not be corrected, detected or prevented
on the timely basis through an internal control entity.

In the case of MSL, the manufacturer gives its customers the two-year labor and spare parts
warranty from MSL. The customer is entitled to a free annual maintenance service during a
warranty time. However due to the companys application of subcontracted mechanics traveling
to the site of the customer in performance of maintenance services (Liu Xu, 2011). An audit risk
explanation may be due the contracted mechanics payment measurement since the service
performed in remote regions may not be accounted for, thus the amount required based on the
hourly rate may be costly and hard to account for by the auditor (Liu Xu, 2011). When the
auditor tries to reduce the performed service based on the lower end it may not detect the present
misstatement on the customers side, service maintenance performed or the company contracting
cost.

References
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Alkafaji, Y. A. (2017). Quality assurance review programs of auditing firms: an international

perspective. Managerial Auditing Journal, 22(7), 644-660.

doi:10.1108/02686900710772564

Blay, A. D., & Geiger, M. A. (2012). Auditor Fees and Auditor Independence: Evidence from

Going Concern Reporting Decisions*. Contemporary Accounting Research, 30(2), 579-

606. doi:10.1111/j.1911-3846.2012.01166.x

Freebairn, J. (2016). Taxation of Housing. Australian Economic Review, 49(3), 307-316.

doi:10.1111/1467-8462.12172

Hossain, S. (2013). Effect of Regulatory Changes on Auditor Independence and Audit Quality.

International Journal of Auditing, 17(3), 246-264. doi:10.1111/ijau.12002

Johari, R. J., Mohd-Sanusi, Z., & Chong, V. K. (2017). Effects of Auditors' Ethical Orientation

and Self-Interest Independence Threat on the Mediating Role of Moral Intensity and

Ethical Decision-Making Process. International Journal of Auditing, 21(1), 38-58.

doi:10.1111/ijau.12080

Liu Xu. (2011). Study of modern risk-oriented auditing platform modules. 2011 International

Conference on Business Management and Electronic Information.

doi:10.1109/icbmei.2011.5920387

McKinnon, J. (2013). Corporate disclosure regulation in Australia. Journal of International

Accounting, Auditing and Taxation, 2(1), 1-21. doi:10.1016/1061-9518(93)90012-i

Tepalagul, N., & Lin, L. (2014). Auditor Independence and Audit Quality: A Literature Review.

Journal of Accounting, Auditing & Finance, 30(1), 101-121.

doi:10.1177/0148558x14544505
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Wan Ismail, W. A., & Kamarudin, K. A. (2016). Family Firms and Audit Risks: The Role of

Audit Committee Financial Expertise. SSRN Electronic Journal.

doi:10.2139/ssrn.2049692

Weirich, T. R., Pearson, T. C., & Churyk, N. T. (2014). Accounting & auditing research: Tools &

strategies. Hoboken, NJ: J. Wiley & Sons.