Question

You are Mark Ouse, an audit senior with the firm Pull, Lift, Tug & Co. You are planning the financial report audit of Nestree Ltd, a manufacturer of confectionery. The following issues have arisen.
Arthur Stick, the Finance Manager of Nestree, was ill for three months of the year and Eloise Lift, the engagement partner, received a request from Nestree to supply a member of staff on secondment until Arthur was well. Eloise was only too happy to help and Daisy Flute, a member of Pull, Lift, Tug & Co's audit staff was seconded to Nestree for three months. Nestree was happy with this arrangement and Eloise enjoyed the additional fees this created for the firm. As a result of Daisy's secondment and the knowledge she now has 153about Nestree, Eloise is suggesting that she will be a valuable member of the audit team for the current financial year's audit.
From the review of the draft financials that Mark has received, Nestree appears to take an optimistic approach to its valuation of development expenditure capitalised in intangible assets. Executive remuneration includes a profit-related bonus.
Staff of Nestree are entitled to visit the company shop where defective confectionery products or ‘seconds’ that do not make it past the company's quality control processes are available for purchase at a significant discount to normal retail prices. Nestree has in the past invited the audit team to enjoy this benefit while it is attending the company during its audit visit.
You are aware that Nestree's Finance Director, Barbara Polo, plays on the same softball team as Eloise Lift and recently spent a week with the team on a tour of Vanuatu.
Required
Explain the ethical threats above and identify how they might be avoided.

Answer 1

Ethical threats arise on account of wrong work being carried on with full knowledge of knowing that its wrong.

The independence of auditor is compromised on such occasions and independence threats may arise.

Ethical threats may be following :-

Self Review Threat - During three months of year, the audit firm supplied one of its employee and such employee was actively involved in the client work. Now sending the same person to audit will make it independence issue. The work done by same person is being reviewed by herself. This is an ethical threat to audit.

Self Interest threats - the client is one of the large clients of auditing firm. The revenue generated from one such client may force the audit firm to hide the frauds and this is what is self interest threat because there is always the fear of losing the client.

The company has an optimistic approach to its intangible asset which may lead to inflation of its assets. Careful study should be done by auditing firm as this may be a trick to inflate its assets.

It is a normal practice to provide profit related remuneration to employees but since one of the employees was also part part of client the same needs to be taken into consideration.

Profit related remuneration may cause inflation of sales in order to obtain remuneration.

The staff has rights to visit place where defective products are kept and also as a right to purchase the same at a discount. This is not ethically right because providijg defective products is paying with danger. This may cause harm to company and employees as well.

Just to save the money and cost, the company is providing such products at cheap cost to its own employees.

Even audit team is invited on occasions to visit these places. This again is not ethically correct as this may harm the independent of the auditors. The auditors always may have this thing in back of their kind which may cause errors from them.

No way, any form of bribery should be promoted because this is not ethically correct to bribe in order to get desired work done.

Again, the director is actively involved with audit team on vacation. Developing personal relations may cause errors and frauds to be left out by the team. Relationship threats and from of ethical threats where relations cause harm to audit work and independence is hampered.

Providing of employee by audit firm was also not ethically correct. Just to earn some extra bucks the firm compromised on its independence. Financial advisory and audit should be kept different. The place where financial obligation arises other then audit work, the firm is bound to get compromised.

Suggestions to remove these threats -

External reviewer - An external reviewer should be to review the work of audit team and this will help in avoiding any errors on part of audit team.

Avoiding personal relationships - any personal relationships with employees of company should be avoided. Also any form of bribery should be avoided.

Audit team - the audit team should be kept changing so that no comfort is developed and no person is known to client.

Audit team should not comprise of person who has done any accounting or any work related to client. This may case self review threat.

The client should not be provided with any services beyond auditing services to avoid clash of obligation. This would be helpful in long term for the company.

No vacation should be done along with directors as this is nothing but form of bribery.

The company should bear the cost of repairing the defective products or destroy them but should not provide the same as cheap cost to its employees. It may put them in danger.

The company should avoid all such ethical issues and discharge its duties correctly.

The financial should be kept properly and no inflation of assets or revenue should be done.

The company should avoid profit related remuneration as this may also force errors and company is ethically wrong as it is forcing to increase sales to pay remuneration.

Also, inflation of assets through intangible assets should be avoided by company.

All such ethical threats can be removed and avoided by various methods above.