As the audit firm receives about 20% of its income from just one audit client, there is a self-interest or intimidation threat. This is because the firm will be concerned about losing the client.

The self-interest and intimidation threats are significant considering the nature and duration of the breach – that is the high percentage of income from a single client received for some time now; and the knowledge of the audit firm of such interest.

Secondly, the valuation services provided by the audit firm. If an audit firm performs a valuation which will be included in financial statements audited by that firm, a self-review threat arises. This threat is significant as the valuation of Land and Buildings of all branches of the bank including the head office is material to the financial statement to be audited.

• Reducing the dependence on the client
• Implementing external quality control reviews; or
• Consulting a third party, such as a professional regulatory body or a professional accountant, on key audit judgments.
• Internal quality control reviews.

As the bank is a public interest entity and the firm’s total fees has been that high for two consecutive years, the Code of Ethics provides that the firm shall:

• Disclose this to those charged with governance;
• Conduct a review, either by an external professional accountant or by a regulatory body.

Since the total fees significantly exceed 15%, a pre-issuance review shall be required. That is a review before the audit opinion on the second year’s financial statements.
The safeguards for the self-review threat from the valuation services will include:

• Second partner review
• Confirming that the client understands the valuation and the assumptions used
• Ensuring that the client acknowledges responsibility for the valuation
• Using separate personnel for the valuation and the audit.

• Physical observation of the flooding by the Senior Partners on their visit to the factory.
• Tip-off from residents of the area, likely.
• Investigation by a regulatory organisation or government department such as the Environmental Protection Agency (EPA).
• Payment of fines or penalties, if any.
• Adverse media comments, likely.

The auditors should consider the following, when evaluating the possible effect on the financial statements for non-compliance with the law:

• Going Concern applicability
• The potential financial consequences, such as fines, damages, penalties, litigation, threat of expropriation of assets and enforced discontinuation of operations.
• Whether the potential financial consequences require disclosure like enforced discontinuation of operations.
• Whether the potential financial consequences are so serious as to call into question the fair presentation given by the financial statements, or otherwise make the financial statements misleading.
• Provisions to be made in the accounts and contingencies.

Pen Co.

Client acceptance procedures
As Pen, a relatively new client, is being investigated for tax fraud, it is possible that MM & Co. quality control and other procedures on acceptance of a client may not be as robust as would be ideal, and that they have accepted a client without obtaining sufficient knowledge and understanding.

In accepting a new client, MM & Co. should have completed the following.

• Obtained references about key personnel in the company and the company
• Obtained professional clearance from previous auditors
• Carried out procedures in line with MM & Co.’s anti-money laundering policies which should include detailed client identification procedures and customer due diligence

It is possible that MM & Co did not obtain appropriate references or obtained professional clearance. There is no reason why the client identification procedures would necessarily have raised any issues if Pen has previously had a clean record.

Concealed, previously undiscovered fraud?
Alternatively, given that under –declaring income is a fraud, it is possible that staff at Pen were under-declaring income and concealing the fact, and that both the old and the new auditors were unaware that it was going on. There is not necessarily any suggestion that negligent audits were carried out.

Confidentiality
MM & Co. has a duty of confidentiality to its client, and the partners and staff of MM & Co. must ensure that they do not breach their duty of confidentiality if asked questions by the tax authorities during the course of their investigation.
This may be complicated by the fact that Pen has been under declaring income, this may become an investigation into crime of money laundering, in which case MM& Co. may have legal duties of disclosure that are not subject to the duty of confidentiality and for which they have protection under qualified privilege.
Members are entitled to make disclosures to defend themselves and their professional reputation, and if the investigation includes members of the tax department of MM & Co. personally, they may need to make disclosures in their own interest.

Action to take
MM & Co. should take legal advice on disclosures that they are required to make and disclosures that they are not permitted to make before they make any disclosures to the tax authorities in the course of this investigation.

Scot family

Carrying out transactions on behalf of a client
Particularly in the light of the money laundering requirements incumbent on accountants and auditors, it is extremely ill-advised for auditors to carry out transactions on behalf of their clients, in case they inadvertently carry out the crime of money laundering.
In addition, being asked to carry out a transactions on behalf of a client might give rise to a suspicion of money laundering that the accountant was required to report to the appropriate authority.

Actions to take
MM & Co. should stop carrying out transactions for client, however innocent they may have been in the past, so as to avoid any suspicion or any problem arising.

Politically exposed persons (PEPs)
Gino’s new position as a senior foreign government official makes him a politically exposed person (PEP). This increases the reputational risk for MM & Co. as there will be more publicity if something goes wrong.

Actions to take
The senior partner at MM & Co. should be alerted of the change in circumstances and judge whether the firm should continue to act as advisors for Gino and the Scot family given the increased risk. If the relationship continues, the firm should take reasonable measures to
establish the source of Gino’s wealth and conduct ongoing monitoring of MM & Co. relationship with Gino.
MM & Co. should also ensure that it has a risk management system in place to determine whether individuals are PEPs on acceptance or if circumstances change

In an initial audit engagement there are several factors which should be considered in addition to the planning procedures which are carried out for every audit. ISA 300 Planning an Audit of Financial Statements provides guidance in this area.

• ISA 300 suggests that unless prohibited by laws or regulation, arrangements should be made with the predecessor auditor, for example, to review their working papers. Therefore communication should be made with the previous auditor to request access to their working papers for the financial year ended 31 May 2014. The review of the previous year’s working papers would help us in planning the audit, for example, it may highlight matters pertinent to the audit of opening balances or an assessment of the appropriateness of HighTec Limited’s accounting policies.
• It will also be important to consider whether any previous years’ audit reports were modified, and if so, the reason for the modification.
• As part of the client acceptance process, we should request from previous auditors if there are any professional or other reasons why we cannot take up the audit of HighTec Limited.
• Any matters which were brought to our firm’s attention by the previous auditor should be considered for their potential impact on the audit strategy.
• There should also be consideration of the matters which were discussed with HighTec Limited’s management in connection with our appointment such as significant accounting policies which may impact on the planned audit strategy.
• Particular care should be taken in planning the audit procedures necessary to obtain sufficient appropriate audit evidence regarding opening balances, and procedures should be planned in accordance with ISA 510 Initial Audit Engagements – Opening Balances. For example, procedures should be performed to determine whether the opening balances reflect the application of appropriate accounting policies and determining whether the prior period’s closing balances have been correctly brought forward into the current period.
• With an initial audit engagement it is particularly important to develop an understanding of the business, including the legal and regulatory framework applicable to the company. This understanding must be fully documented and will help the audit team to perform effective analytical review procedures and to develop an appropriate audit strategy.
• Obtaining knowledge of the business will also help to identify whether it will be necessary to plan for the use of any experts.
• Our firm should have quality control procedures in place for use in the case of initial engagements, for example, the involvement of another partner or senior individual to review the overall audit strategy prior to commencing significant audit procedures.
• Given that this is a new audit client, that it is newly listed, when developing the audit strategy, consideration should be given to using an experienced audit team in order to reduce detection risk.

• Rapid growth
  We were told that the company has seen rapid growth has occurred during the last few years. The growth could indicate a control risk, in that systems and personnel may struggle to keep pace with the volume of transactions which are being processed, leading to accounting errors being made. This is exacerbated by the lack of an internal audit department to provide assurance on systems and controls.
• Management bias
  The second audit risk identified relates to HighTec Limited becoming a listed entity during the year. This creates an inherent risk at the financial statement level and is caused by the potential for management bias. Management will want to show good results to the new shareholders of the company, in particular the institutional shareholders, and therefore there is an incentive for the overstatement of revenue and profit.
  There is a related risk of overstatement due to Ama Tawiah and her family members retaining a 30% equity interest in HighTec Limited, which is an incentive for inflated profit so that a high level of dividend can be paid.
  It appears that governance structures are not strong, for example, there are too few non-executive directors, and therefore Ama Tawiah is in a position to be able to dominate the board and to influence the preparation of the financial statements.
• This increases the risk of material misstatement due to management bias.
  There is also a risk that management lacks knowledge of the reporting requirements specific to listed entities, for example, in relation to the calculation and disclosure of earnings per share
• E-commerce
  With 30% of revenue generated through the company’s website, this represents a significant revenue stream, and the income generated through e-commerce is material to the financial statements. E-commerce gives rise to a number of different audit risks, including but not limited to the following:
  For the auditor, e-commerce can give rise to detection risk, largely due to the paperless nature of the transactions and the fact there is likely to be a limited audit trail, making it difficult to obtain audit evidence. For the same reason, control risk is increased, as it can be hard to maintain robust controls unless they are embedded into the software which records the transaction. The auditor may find it difficult to perform tests on the controls of the system unless audit software is used, as there will be few manual controls to evaluate.
• A risk also arises in terms of the recognition of sales revenue, in particular cut-off can be a problem where sales are made online as it can be difficult to determine the exact point at which the revenue recognition criteria of IAS 18 Revenue have been met. Hence, over or understatement of revenue is a potential risk to be considered when planning the audit.
• HighTec Limited also faces risks relating to the security of the system, for example, risks relating to unauthorised access to the system, and there is an increased risk of fraud. All of these risks mean that there is high audit risk in relation to the revenue generated from the company’s website.
• Franchise income
  The Franchise income which is deferred in the statement of financial position represents 13·4% of total assets and is therefore material.
  There is a risk that the accounting treatment is not appropriate, and there are two separate risks which need to be considered.
  First, it may be the case that the revenue from the sale of a Franchise should not be deferred at all. The revenue recognition criteria of IAS 18 need to be applied to the transaction, and if, for example, it were found that HighTec Limited has no continuing management involvement and that all risk and reward had been transferred to the buyer, then the revenue
  should be recognised immediately and not deferred. This would mean a significant understatement of revenue and profit.
  Second, if it is appropriate that the revenue is deferred, for example, if HighTec Limited does retain managerial involvement and has retained the risk and reward in relation to the Franchise arrangement, then the period over which the revenue is recognized could be inappropriate, resulting in over or understated revenue in the accounting period.
• Foreign exchange transactions
  HighTec Limited’s products sell in over 60 countries and the products are manufactured overseas, so the company is involved with foreign currency transactions which can be complex in nature. There is a risk that the requirements of IAS 21 the Effects of Changes in Foreign Exchange Rates have not been followed. For example, if transactions have not been retranslated to HighTec Limited’s GHS at the date of the transaction, then the amounts involved may be over or understated.
  There is also a risk that outstanding receivables and payables have not been retranslated at the year-end closing exchange rate, leading to over or understatement of assets and liabilities and unrecorded exchange gains or losses.

An injured party must prove ALL of the following three things in order to succeed in a claim for financial loss against an auditor for negligence:
– That the auditor owes a duty of care;
– That the duty of care has been breached;
– That financial loss has been suffered that was caused by the negligence.          (2 marks)

i) Looking at the strict interpretation of the first requirement, the auditor owes a duty of care only to the shareholders as a body and not to Boafo Bank Limited as an outsider.
The courts, however have accepted that if the Auditor, at the time of signing the report knew that someone, other than the shareholders as a body will rely on the report, then the duty of care extends to the person. The facts of this case show that at the time the auditor signed the Audit Report, he was aware that it was Financial Statements going to form the basis for preparing the projected financial information to be used to seek for the bank facility from Boafo Bank Limited. Paragraph 3 of preamble to question).
This means it is probable that a court will rule that requirement 1 above has been proved.        (2 marks)

ii) A breach of duty of care must be proved for a negligence claim against the audit firm to be successful. Duty of care generally means that the audit firm must perform the audit work to the required standard and that relevant legal and professional requirements and principles have been followed. For an audit firm, it is important to be able to demonstrate that ISAs have been adhered to. This is no evidence in the facts as given to enable us reach the conclusion that the duty of care has been breached or not. Looking at the fact that a loss of GHS4.3M was stated as a profit of GHS20.2M, a difference of GHS24.5M, if this error in the Income statement is confirmed, it is likely to be interpreted by a court to mean that the auditor did not perform the duties expected of him/her with all the skill, care and caution which a reasonably competent, careful and cautious auditor would use. What is reasonable skill, care and caution will depend on the particular circumstances of each case.

In this case, however, an error is material by all standards and will be proof that the auditor has acted negligently unless he can prove that the circumstance that caused this material error was beyond his/her control.
Requirement 2 appears to be likely to be proved.      (2 marks)

iii) Requirement 3 is easy to prove since the loan was given on the basis of the projected financial information based on the audited financial statements, it is likely that a court will not need any serious persuasion to agree with the Bank that its financial loss was caused by the negligence of the auditor. From this discussion, the Auditors must seek an out of court settlement to avoid the bad publicity and likely litigation costs since it is probable that they would be found to be professionally liable to the Bank and the Bank is likely to the Bank for negligence.         (1 mark)

Before accepting the engagement to review the company’s prospective financial information, there are several matters to be considered. A significant matter is whether it is ethically acceptable to perform the review. The review would constitute a non-assurance service provided to an audited entity, and IESBA’s Code of Ethics for Professional Accountants states that this may create self-interest, self-review and advocacy threats to independence. In this case, the advocacy threat may be deemed particularly significant as Hunt & Co could be perceived as promoting the client’s position to the bank. The review engagement should only be provided if safeguards can be used to reduce the threat to an acceptable level, which may include:

– Having a professional accountant who was not involved with the non-assurance service review the non-assurance work performed or otherwise advise as necessary.
– Discussing ethical issues with those charged with governance of the client.
– Using separate teams to work on the audit and on the review engagement.

As well as ethical matters, ISAE 3400 The Examination of Prospective Information requires that certain matters are considered before a review engagement is accepted. The firm must also consider the specific terms of the engagement. For example, the firm will need to clarify whether the bank has requested a review report to be issued, and what exact information will be included in the application to the bank. It is likely that more than just a forecast statement of profit or loss is required, for example, a forecast statement of cash flows and accompanying narrative, including key assumptions is likely to be required for a lending decision to be made.

ISAE 3400 also requires that consideration should be given to the intended use of the information, and whether it is for general or limited distribution. It seems in this case the review engagement and its report will be used solely in connection with raising bank finance, but this should be confirmed before accepting the engagement.
The period covered by the prospective financial information and the key assumptions used should also be considered. ISAE 3400 states that the auditor should not accept an engagement when the assumptions used are clearly unrealistic or when the auditor believes that the prospective financial information will be inappropriate for its intended use. For example, the assumption that the necessary capital expenditure can take place by September 2014 may be overly optimistic.
The firm should also consider whether there are staff available with appropriate skills and experience to perform the review engagement, and the deadline by which the work needs to be completed. If the work on the shops is scheduled to be completed by September 2014, presumably the cash will have to be provided very soon, meaning a tight deadline for the review engagement to be performed.

The report by an auditor on an examination of prospective financial information should contain the following:
(a) Title;
(b) Addressee;
(c) Identification of the prospective financial information;
(d) A reference to the ISAE or relevant national standards or practices applicable to the examination of prospective financial information;
e) A statement that management is responsible for the prospective financial information including the assumptions on which it is based;
f) When applicable, a reference to the purpose and/or restricted distribution of the prospective financial information;
g) A statement of negative assurance as to whether the assumptions provide a reasonable basis for the prospective financial information;
h) An opinion as to whether the prospective financial information is properly prepared on the basis of the assumptions and is presented in accordance with the relevant financial reporting framework;
i) Appropriate caveats concerning the achievability of the results indicated by the prospective financial information;
j) Date of the report which should be the date procedures have been completed;
k) Auditor’s address; and

l) Signature.
m) Such a report would

• State whether, based on the examination of the evidence supporting the assumptions, anything has come to the auditor’s attention which causes the auditor to believe that the assumptions do not provide a reasonable basis for the prospective financial information.
  e.g.
  Based on our examination of the evidence supporting the assumptions, nothing has come to our attention which causes us to believe that these assumptions do not provide a reasonable basis for the forecast.
• Express an opinion as to whether the prospective financial information is properly prepared on the basis of the assumptions and is presented in accordance with the relevant financial reporting
  framework.
  e.g.
  Further, in our opinion the forecast is properly prepared on the basis of the assumptions and is presented in accordance with International Financial Reporting Standards (IFRS)
• State that actual results are likely to be different from the prospective financial information since anticipated events frequently do not occur as expected and the variation could be material.

1. The Institute of Internal Auditors (IIA) recommends that the appointment of the Internal Auditor (IA) be done by the Board of Directors or the Audit Committee (in this case the Audit and Finance Sub-Committee of the District Assembly) acting for the Board and not by Executive Management (the DCE in this case)
2. Her Educational Qualification and level of experience appears in appropriate for the responsibility she is expected to shoulder. It appears the DCE wants someone he can easily manipulate in the position.
3. The fact that she comes from the same village as the DCE could support the point made in 2 above and suggest the position was not advertised to open it up to competition and this will make the IA believe she must return the favour done her by the DCE and she will not be able to report objectively.
4. The IIA recommends that the IA should report functionally to the Board Audit Committee and administratively to the Chief Executive, placing her both administratively and functionally under the District Finance Officer is inappropriate and hinder her independence in reporing on financial issues.
(2 marks for discussion of any of the issues to maximum of 5 marks)

The IA will discuss the following issues from the the IIA’s International Professional Practices Framework (IPPF).
The IIA’s definition of Internal Auditing and to explain the need for ensuring the independence of the IA even though the IA is an employee by making sure the appointment of the IA is done by the Board or its Audit Committee and the IA also reports functionally (by sending his/her Internal Audit reports) to the Audit Committee and not the DCE or District Finance Office (DFO).

• The IA should also discuss objectivity as a requirement for the IA to be free from any bias.
• The IA should discuss the need for the Internal Audit function to adopt an Internal Audit Charter that is consistent with the Definition of Internal Auditing, the Code of Ethics, and the International Standards for the Practice of Internal Auditing (the Standards) of the IIA that will define the purpose, authority, and responsibility of the Internal Audit activity.
• The Charter must be in compliance with the recommendation of the IIA and approved by the Board prior to its adoption.
• The IA will discuss briefly the Code of Ethics and the International Standards for the Practice of Internal Auditing (the Standards) recommended by the IIA and their importance to the IA.
• The Internal Audit function must adopt a version of the Code of Ethics recommended by the IIA that is appropriate for the entity
• All the reports of the IA must mention that the Internal Audit assignment was performed in compliance with the Standards and any significant non-compliance must be disclosed in the report.
• The IA should mention how she personally will ensure that the Internal Audit activity at the District Assembly (DA) functions to add value to the activities of the DA and;
• ensure it achieves its objectives in a more efficient, effective and economic (3 E’s) manner and that she will comply with the Code of Ethics that will be adopted and deal fairly with all stakeholders of the DA.

All activities an auditor performs will be either an assurance or a consulting assignment depending on the type of report that will be issued as a result of the assignment and whether or not the activity may be performed on the basis of a contingent fee (that is a fee based on the outcome or results of the assignment). The differences are:

(2 marks for each difference and 1 mark for showing presentation, table or other visual display of the differences, maximum 5 marks)

• An officer or employee of Government has wilfully or negligently omitted to collect or receive any public money due to the Government;
• Any public money was not duly accounted for and paid into the consolidated Fund or other designated public account;
• An appropriation was exceeded or was applied for a purpose or in a manner not authorised by law;
• An expenditure was not authorised or properly vouched for or certified;
• There has been a deficiency through fraud, default or mistake of any person;
• Applicable internal controls are inefficient or ineffective;
• Resources have not been used with due regard to economy, efficiency and effectiveness in relation to the results attained.
• In the public interest, the matter should be brought to the notice of Parliament.

An audit firm’s exposure to litigation claims can be reduced by a number of methods.
1) Client acceptance procedures
Firms should accept only those clients that carry a low enough risk of litigation for the firm to manage, given its resources. Screening procedures should be used to identify factors that create potential exposure, for instance, a new client with going concern problems is likely to carry more risk than one without such problems.
2) Performance of audit work
Firms should make sure that all audits are carried out with professional standards and best practice, adhering to the requirements of ISAs. It is crucial in particular that proper documentation is kept, as this will be useful in the event of litigation.
3) Quality control
Firms should implement quality control procedures in line with guidance contained within ISQC1 Quality Controls for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements and ISA 220 Quality Control for an Audit of Financial Statements. This includes both firm-wide procedures and those related to individual assignments.
4) Issue of appropriate disclaimers
There is a risk of a legal duty of care arising to a third party even if the auditor is unaware of this duty. Disclaimers may be used in an attempt to restrict the auditor’s duty of care to shareholders, but there is no guarantee that they will be effective in