Question

Review the threats to independence, and then review the safeguard to counteract the threats to independence. Now compare this to Conflicts of Interest and their safeguards.

***Please make the answer easy and simple. Thank you!

Answer 1

In the auditing profession, there are five major threats that may compromise an auditor’s independence. Before an audit engagement, it is crucial that each member of the audit team review the five threats to independence. If an auditor is exposed to a certain threat, he or she should either develop safeguards to reduce the threat to an acceptable level or resign from the audit engagement.

1. Self-Interest Threat

A self-interest threat exists if the auditor holds a direct or indirect financial interest in the company or depends on the client for a major fee that is outstanding.

Example

The audit team is preparing to conduct its 2020 audit for ABC Company. However, the audit team has not received its audit fees from ABC Company for its 2019 audit.

Issue

The audit team might be tempted to issue a favorable report so that the company is able to secure a loan to settle the fees outstanding for their 2019 audit.

2. Self-Review Threat

A self-review threat exists if the auditor is auditing his own work or work that is done by others in the same firm.

Example

The auditor prepares the financial statementsfor ABC Company while also serving as the auditor for ABC Company.

Issue

By having the auditor review his or her own work, the auditor cannot be expected to form an unbiased opinion on the financial statements.

3. Advocacy Threat

An advocacy threat exists if the auditor is involved in promoting the client, to the point where their objectivity is potentially compromised.

Example

The auditor is assisting in selling ABC Company while also serving as the auditor for the company.

Issue

The auditor may issue a favorable report to increase the sale price of ABC Company.

4. Familiarity Threat

A familiarity threat exists if the auditor is too personally close to or familiar with employees, officers, or directors of the client company.

Example

ABC Company has been audited by the same auditor for over 10 years and the auditor regularly plays golf with the CEO and CFO of ABC Company.

Issue

The auditor may have become too familiar with the client and, thus, lack objectivity in their work.

5. Intimidation Threat

An intimidation threat exists if the auditor is intimidated by management or its directors to the point that they are deterred from acting objectively.

Example

ABC Company is unhappy with the conclusion of the audit report and threatens to switch auditors next year. ABC Company is the biggest client of the auditor.

Issue

The auditor’s independence may be compromised, as ABC Company is their biggest client and they, quite naturally, do not want to lose such a client. Therefore, the auditor may issue a report that appeases ABC Company

Safeguard that may eliminate or reduce such threats to anacceptable level fall into two broad categories:

1.Safeguards created by the profession, legislation orregulation; and

2.Safeguards in the work environment

Examples of safeguards created by the profession, legislation orregulation:

–Educational, training and experience requirements for entry into theprofession.

–Continuing professional development requirements.–Corporate governance regulations.

–Professional standards

.–Professional or regulatory monitoring and disciplinary procedures.

–External review by a legally empowered third party of the reports,returns, communications .

Examples of safeguards in the work environment foraccountants inpractice:

–The firm’s leadership stressing compliance with fundamental principles

–Policies and procedures to manage reliance on revenue from a singleclient

–Rotating senior assurance team personnel

–Using different teams for non-assurance work

–Prohibiting individuals who are not team members from influencingthe outcome of the engagement

–Policies and procedures encouraging staff to communicate to seniormanagement of any ethical compliance issue that concerns them

–Advising staff of independence requirements in relation to specific clients