You are an audit manager with Kwabotwe & Co, a firm of Chartered Accountants. You have been assigned to handle the firm’s quality control in the first quarter. In your first meeting, you invited staff to raise matters from their experience relating to their compliance with IFAC’s code of ethics. The following issues came up:
i) In its management letter to another audit client, Kwabotwe & Co warned the company that its computer system lacked essential controls. The company, subsequently decided to install a totally new system and Kwabotwe & Co’s management consultancy department was appointed to design the new system. (5 marks)
ii) Kwabotwe & Co was recently approached by a large company that was not, then, an audit client, for a second opinion with reference to the audit of the financial statements. The company was in dispute with its existing auditors who were proposing to issue a qualified audit opinion because of disagreement over inventory valuation. Kwabotwe & Co’s technical partner reviewed the evidence provided by the company and advised the company that its accounting treatment was in order. Shortly afterwards, Kwabotwe & Co was invited to accept nomination as auditors. The reply to the letter of enquiry to the existing auditors made it clear that the inventory valuation dispute was not as straightforward as the company had made it out to be. (5 marks)
Required:
Evaluate whether Kwabotwe & Co had complied with the IFAC’s Code of Ethics or had acted unprofessionally in any other way with respect to each of the above scenarios.
View Solution (i)
Advice on controls
- This raises a controversial area in auditor independence. While the reporting of control weaknesses discovered during the audit is a required procedure, advising on the development of new systems to overcome those weaknesses is seen by some critics as a possible threat to independence. There is both a general and a specific issue. The general issue is that audit firms generate revenues from clients for both audit and non-audit work.
- However, contracts for non-audit work are given by management. In performing the audit, the auditors may be reluctant to disagree with management for fear of losing non-audit contracts.
- The specific issue is that known as self-review. Since the firm designed the new internal control system, there is a presumption, when evaluating control effectiveness at the next audit, that there will be no weaknesses in the system.
- While providing non-audit services by auditors is not prohibited, the firm should ensure that they should not exceed the overall fee limit of 15% from any one client.
- However, they do stress that, in advising the client, the audit firm must not make executive decisions. The implementation of advice is the responsibility of management over which the auditor has no control. At the next audit the auditor must check that the system has been properly put into operation and that it is being operated effectively.
View Solution (ii)
Advice to non-audit clients
- Although Kwabotwe & Co are not threatening their own independence their action is in breach of professional rules. By offering advice they are prejudicing the independence of the auditors of the company they are advising. This practice is sometimes referred to as ‘opinion shopping’ and is carried out by companies in order to exert pressure on their existing auditors.
- When invited to provide such advice, professional rules require Kwabotwe & Co to communicate directly with the company’s auditors to ensure that their advice is based on all available facts relevant to the judgement.
- Kwabotwe & Co are under an ethical responsibility to decline to be nominated as auditors and to write to the company retracting the advice previously given in the light of further information.