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You are an audit manager in McKay & Co, a firm of Chartered Certified Accountants. You are preparing the engagement letter for the audit of...

You are an audit manager in McKay & Co, a firm of Chartered Certified Accountants. You are preparing the engagement letter for the audit of Ancients; a public limited liability company, for the year ending 30 June 2006.Ancients has grown rapidly over the past few years, and is now one of your firm’s most important clients. Ancients has been an audit client for eight years and McKay & Co has provided audit, taxation and management consultancy advice during this time. The client has been satisfied with the services provided, although the taxation fee for the period to 31 December 2005 remains unpaid. Audit personnel available for this year’s audit are most of the staff from last year, including Mr. Grace, an audit partner and Mr. Jones, an audit senior. Mr. Grace has been the audit partner since Ancients became an audit client. You are aware that Allyson Grace, the daughter of Mr. Grace, has recently been appointed the financial director at Ancients. To celebrate her new appointment, Allyson has suggested taking all of the audit staff out to an expensive restaurant prior to the start of the audit work for this year.

Required:
Identify and explain the risks to independence arising in carrying out your audit of Ancients for the
year ending 30 June 2006, and suggest ways of mitigating each of the risks you identify.

Answers

Wilfred
Independence risks
Audit partner – time in office
Mr. Grace has been the audit partner of Ancients for eight years. His objectivity for the audit
may be threatened by the ongoing close relationship with the client. In other words, he may
be too friendly with the directors of Ancients. This means he may not be willing or able to
take difficult decisions such as issuing a modified audit report for fear of prejudicing his
friendship with the directors. Rotating the audit partner would remove this threat.

Unpaid taxation fees
Ancients has not paid the taxation fees for work that took place nearly six months ago. The
non-payment of fees can be a threat to objectivity similar to that of an unpaid loan. In effect,
McKay is providing Ancients with an interest free loan. The audit partner in McKay may not
wish to issue a modified report for fear that the client leaves and the ‘loan’ is not repaid. The
unpaid fee must be discussed with the directors in Ancients and reasons for non-payment
obtained. McKay may wish to delay starting the audit work for this year until the fee is paid
to remove the potential independence problem. If the fee is not paid at all then McKay may
decline to carry out the audit.

Fee income
No details are provided regarding fee income obtained from Ancients. However, the company
is growing rapidly and McKay does provide other services besides audit. As a limited liability
company, McKay should ensure that no more than 10% of its recurring practice income
(including auditing, accountancy and other work combined) is derived from this client.
Obtaining more than 10% could indicate undue financial reliance on one client, and impair
objectivity regarding the audit report (again fear of issuing a modified report and losing the
fee income from the audit client). If the 10% limit is close, McKay may have to limit other
services provided so that independence is not impaired. An annual review will be required
on clients where the fee is between 5 and 10% to ensure that the fee income rules will not
be breached.

Allyson Grace
Allyson Grace is not deemed to be connected to Mr. Grace because she is presumably over the age of 18. If she was still a minor, then there would be a connection and it would be inappropriate for Mr. Grace to be the audit partner as he could in theory influence Allyson’s decisions. However, there may still appear to be an independence problem as Mr. Grace may not be objective in making audit decisions. He may not wish to annoy his daughter by having to qualify the financial statements. Appointing another audit partner would remove the perceived independence problem.

Meal
The offer of a meal by Allyson may appear to be a threat to independence; having received
an expensive meal, the audit staff may be favorably disposed towards Ancients and be less
inclined to investigate potential errors. Audit staff are allowed to receive modest benefits on
commercial terms; whether there is a benefit depends on how expensive the meal is. To
ensure no independence issues it would appear that the invitation should be declined. One
possible option would be for Mr. Grace and Allyson to pay personally as a purely social event
even though this may be unlikely. However, this does not remove the implied independence
issue.
Wilfykil answered the question on April 12, 2019 at 08:42

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