QUESTIONS AND ANSWERS

TUTORIAL 1 -PROFESSIONAL CODES OF ETHICS AND CONDUCT

Review Questions

MCQ
The following scenario relates to questions 1–5

You are an audit manager at Horti & Co and you are considering a number of ethical
issues which have arisen on some of the firm’s long-standing audit clients.

Tree Co
Horti & Co is planning its external audit of Tree Co. Yesterday, the audit engagement
partner, Charlie Thrower, discovered that a significant fee for information security
services, which were provided to Tree Co by Horti & Co, is overdue. Charlie hopes to be
able to resolve the dispute amicably and has confirmed that he will discuss the matter
with the finance director, Percy Marsh, at the weekend, as they are both attending a party
to celebrate the engagement of Charlie’s daughter and Percy’s son.

Bush Co
Horti & Co is the external auditor of Bush Co and also provides other non-audit services
to the company. While performing the audit for the year ended 31 October 20X8, the
audit engagement partner was taken ill and took an indefinite leave of absence from the
firm. The ethics partner has identified the following potential replacements and is keen
that independence is maintained to the highest level:
 Brian Smith who is also the partner in charge of the tax services provided to Bush
Co

 Monty Nod who was the audit engagement partner for the ten years ended 31
October 20X7

 Cassie Dixon who introduced Bush Co as a client when she joined the firm as an
audit partner five years ago

 Pete Russo who is also the partner in charge of the payroll services provided to
Bush Co

Plant Co
Plant Co is a large private company, with a financial year to 30 June, and has been an
audit client of Horti & Co for several years. Alan Marshlow, a partner of Horti & Co, has
acted as the engagement quality control reviewer (EQCR) on the last two audits to the
year ended 30 June 20X8. At a recent meeting, he advised that he can no longer be
EQCR on the engagement as he is considering accepting appointment as a non-executive

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director and will sit on the audit committee of Plant Co. The board of directors has also
asked Horti & Co if they would be able to provide internal audit services to the company.

Weed Co
Weed Co, a listed company, is one of Horti & Co’s largest clients. Last year the fee for
audit and other services was $1·2m and this year it is expected to be $1·3m which
represents 16·6% and 18·1% of Horti & Co’s total income respectively.

Q1 Which of the following statements correctly explains the possible threats to Horti &
Co’s independence and recommends an appropriate safeguard in relation to their audit of
Tree Co?
(1) An intimidation threat exists due to the overdue fee and Tree Co should be advised
that all fees must be paid prior to the auditor’s report being signed
(2) A self-review threat exists due to the nature of the non-audit work which has been
performed and an engagement quality control review should be carried out
(3) A self-interest threat exists due to the relationship between Charlie and Percy and
Charlie should be removed as audit partner

A 1, 2 and 3 B 1 and 2 only C 2 only D 3 only

Q2 Taking into account the concern of the ethics partner, which of the partners identified
as potential replacements should take over the audit of Bush Co for the year ended 31
October 20X8?
A Brian Smith B Monty Nod C Cassie Dixon D Pete Russo

Q3 Which of the following correctly identifies the threats to Horti & Co’s independence
and proposes an appropriate course of action for the firm if Alan Marshlow accepts
appointment as a non-executive director of Plant Co?

Threats Course of action

A Self-interest and familiarity Can continue with appropriate safeguards
B Self-interest and self-review Must resign as auditor
C Self-review and familiarity Must resign as auditor
D Familiarity only Can continue with appropriate safeguards

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Q4 You are separately considering Plant Co’s request to provide internal audit services
and the remit of these services if they are accepted. Which of the following would result
in Horti & Co assuming a management responsibility in relation to the internal audit
services?

(1) Taking responsibility for designing and maintaining internal control systems
(2) Determining which recommendations should take priority and be implemented
(3) Determining the reliance which can be placed on the work of internal audit for the
external audit
(4) Setting the scope of the internal audit work to be carried out

A 1 and 3 B 2, 3 and 4 C 1, 2 and 4 D 3 and 4 only

Q5 Which of the following actions should Horti & Co take to maintain their objectivity in
relation to the level of fee income from Weed Co?
(1) The level of fee income should be communicated to those charged with governance
(2) Separate teams should be used for the audit and non-audit work
(3) Request payment of the current year’s audit fee in advance of any work being
performed (4) Request a pre-issuance review be conducted by an external accountant

A 1 and 4 only B 3 and 4 only C 2 and 3 only D 1, 2, 3 and 4

1 D In line with ACCA’s Code of Ethics and Conduct, a self-interest threat would arise
due to the personal relationship between the audit engagement partner and finance
director. A self-interest threat, not intimidation threat, would arise as a result of the
overdue fee and due to the nature of the non-audit work, it is unlikely that a self-review
threat would arise.

2 C In order to maintain independence, Cassie Dixon would be the most appropriate

replacement as audit engagement partner as she has no ongoing relationship with Bush
Co. Appointing any of the other potential replacements would give rise to self-review or
familiarity threats to independence.

3 B If Alan Marshlow accepts the position as a non-executive director for Plant Co, self-
interest and self-review threats are created which are so significant that no safeguards can
be implemented. Further as per ACCA’s Code of Ethics and Conduct, no partner of the
firm should serve as a director of an audit client and as such, Horti & Co would need to
resign as auditor.

4 C Assuming a management responsibility is when the auditor is involved in leading or

directing the company or making decisions which are the remit of management.
Designing and maintaining internal controls, determining which recommendations to

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implement and setting the scope of work are all decisions which should be taken by
management.

5 A Weed Co is a listed company and the fees received by Horti & Co from the company
have exceeded 15% of the firm’s total fees for two years. As per ACCA’s Code of Ethics
and Conduct, this should be disclosed to those charged with governance and an
appropriate safeguard should be implemented. In this case, it would be appropriate to
have a pre-issuance review carried out prior to issuing the audit opinion for the current
year.

Q6. The Code of Ethics for Professional Accountants Section 400 of MIA by laws
suggests that independence in assurance services (Audit & Reviews engagement) is
required because:

A) It assures through knowledge of the audit client’s industry.

B) It is in the public interest.
C) It reduces threats to financial safeguards.
D) It assures client firm competence.

Q7. The need for public confidence in the quality of service of the profession is

A) The underlying reason for a code of professional conduct for any

profession accountant
B) Achieved by provisions of the Sarbanes-Oxley Act of 2002 which allow audit
firms to provide all the non-audit services for audit clients
C) Achieved through the compliance CA firm internal policies
D) Achieved through Sarbanes-Oxley Act s 203 which requires which employees
of an accounting firm to rotate off the engagement every ten years

Q8. Ownership of 5000 shares of an audit client and ownership by an auditor of a small
part of a joint venture in which a secretary at the audit client also owns shares are
examples of:
A) Lack of independence in fact.
B) Lack of independence in appearance
C) Substance over form.
D) Violation of International Standards on Auditing (ISAs).

Q9. You need to refuse an audit engagement if:

A) Your client insists that you should be given a commission on the increase
in share price as soon as the financial statement are issued.
B) Your client asks you to join the members of the staff at their conference in
Cairns, all expenses paid, just like other senior staff.

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 C) Your client’s audit fee constitutes about 10% of the total income of the office
in Melbourne.
D) Your consulting firm has been appointed to perform the client’s friends’
internal audit function.

Q10 The board of Fir Co has asked if Sycamore & Co can take on some additional work
and have asked if the following additional non-audit services can be provided:
(1) Routine maintenance of payroll records
(2) Assistance with the selection of a new financial controller including the checking of
references
(3) Tax services whereby Sycamore & Co would liaise with the tax authority on Fir Co’s
behalf

Ignoring the potential effect on total fee levels, which of the following options correctly
identifies the threats to independence from providing the above non-audit services?
Self-review Self-interest Advocacy
A2 1 3
B1 3 2
C1 2 3
D3 1 2

Q10 C As per the ACCA Code of Ethics and Conduct/MIA By laws, the following
threats would be created from carrying out the non-audit services requested by Fir Co:
Payroll – Self-review as the auditor will also be involved in auditing the figures included
in the financial statements in relation to wages and salaries.
Recruitment – Self-interest as the auditor would be involved in selecting an officer of the
company who has significant influence over the financial statements.
Tax – Advocacy as the auditor may be perceived to be representing and promoting Fir
Co’s interest in liaising with the tax authority.

Short Essay questions

1. Explain the meaning of independence of mind and independence of appearance as

provided in the MIA By-Laws (On Professional Ethics, Conduct and Practice).

Answer:
Independence in mind is the state of mind that permits the expression of a
conclusion without being affected by influences that compromise professional
judgment, thereby allowing an individual to act with integrity, and exercise
objectivity and professional skepticism.

Independence in appearance refers to the avoidance of facts and circumstances that

are so significant that a reasonable and informed third party, would be likely to

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 conclude, weighing all the specific facts and circumstances, that a firm’s, or a
member of the audit team’s, integrity, objectivity or professional skepticism has been
compromised.

2. Although many countries adopted mandatory audit firm rotation, MIA By-Laws only
adopted mandatory audit partner rotation. Discuss the pros and cons of mandatory
audit firm rotation.

Answer:
The case for mandatory firm rotation may seem very seductive when considered
superficially. However, when one considers the many implications and looks at
global trends, audit firm rotation creates more problems than it solves. These include:

Pros (Advantage)
Proponents of firm rotation base their argument on the perceived closeness of the
relationship between auditor and client management. This, together with the
commercial pressure to retain this long-term relationship, may impede the
independence of the auditor, at a minimum it impacts the perception of
independence. Mandatory audit firm rotation would be seen to overcome these
issues.

Cons: (Disadvantages)
 The loss of “corporate memory” of a client, reducing audit effectiveness.
Effective audits require a deep understanding of not just the industry environment
but also the client, more so today given the level of complexity in most
businesses. Indeed, in the USA in over 400 cases it was been determined that
business failures occurred almost three times as often when the auditor was
performing the audit for the first or second year.

 Increased costs of doing business. The need to go through audit proposal

processes regularly distracts both senior client and audit resources away from the
real task of their business. In addition, audit staff are continually being trained in
the complexities of the business.

 Impact of rotation on the audit profession. The competitive nature of audit

appointments in Italy where rotation has been compulsory has resulted in fee
reductions of around 40%. While for some this may seem a positive
development, increasingly there is a concern this negatively impacts upon the
quality of the audit.

 In addition to the diversion of management attention from audit to constant re-

proposals, and lower costs, there is the uncertainty for audit partners’ career
pathing. Indeed, in some cases audit partners have been known to follow their
clients!

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  Rotation may conceal auditor issues. Currently, an auditor having concerns at a
client will resign or does not see re-appointment. This is a strong signal to the
market. With compulsory rotation, the relationship terminates naturally and may
conceal real concerns.

 Global concerns regarding the practicalities of rotation. If different countries

adopt different practices, including different time frames for rotation, this
will further complicate and compromise the quality of the audit and other
practicalities, including scope of service conflicts of interest.

 Rotation restricts freedom of choice. Firms may fall into a routine whereby they
“rotate” clients and will be less inclined to make an investment in their clients,
knowing they will be relinquishing these investments. This is particularly
appropriate in the latter years of the appointment.

3. Why is it important that professional accountants should participate in continuing

professional development (CPD) programmes?

Answer:
Participation in continuing professional development (CPD) programmes is
essential for every profession because the environment the professionals are now
operating is rapidly changing. Rapid changes in legislation, accounting
standards, developments in technology and increased public expectations continue
to place increasing demands on the work of the accountants and on the profession.
To ensure that the professionals maintain their technical knowledge and
competency at a satisfactory level, and to assist accountants to respond to new
technological developments and expanding responsibilities, participation in CPD
programmes is necessary.

4. Why contingent fees paid to auditors will impair independence?

Answer:
Contingent fees mean no fee charged unless a specified finding or result is obtained
(or fee is otherwise contingent upon an outcome). If an auditor is paid fees on a
contingency basis, then their interest becomes too closely aligned to that of the
client. They will both want the same thing to occur (i.e. the thing the fee is contingent
on) and the risk is that the accountant will act in the interest so the client to ensure
that it happens. This creates self interest threat. It is forbidden under the MIA By-
Laws as it will impair auditors’ independence.

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Scenario Questions

Question 1
Aventec International Bhd, a listed company, manufacturers and wholesales a wide
variety of products including fashion clothes and audio-video equipment. The company is
audited by Voon & Associate, a Public Accounting Firm, and the audit manager is Danny
Ho. The following matters have arisen during the audit of the group’s financial
statements for the year ended 30 June, 2021 which is nearing completion:

(1) During the annual physical count of fashion clothes at the company’s principal
warehouse, the audit staff attending the count were invited to purchase any items
of clothing or equipment at 30% of their recommended retail prices.

(2) The chief executive of Aventec International Bhd, Dato Ang, owns a private jet.
Dato Ang invoices the company, on a monthly basis, for that proportion of the
operating costs which reflects business use. One of these invoices shows that
Danny Ho was flown to Florida in September 2020 and flown back two weeks
later. Neither Aventec nor Voon & Associate have any offices or associates in
Florida.

Required
Discuss the ethical issues raised and the actions which might be taken by the
auditor in relation to these matters.

Answer

Scenario (1) Offer of goods

At the inventory count, the auditors attending were invited to purchase inventory at 30% of
RRP, that is, at a 70% discount.
MIA BY LAW -S 420
• R420.3 A firm, network firm or an audit team member shall not accept gifts and
hospitality from an audit client, unless the value is trivial and inconsequential.
• 420.3 A1 Where a firm, network firm or audit team member is offering or
accepting an inducement to or from an audit client, the requirements and
application material set out in Section 340 apply and non-compliance with these
requirements might create threats to independence.
420.3 A2 The requirements set out in Section 340 relating to offering or accepting
inducements do not allow a firm, network firm or audit team member to accept gifts and
hospitality where the intent is to improperly influence behavior even if the value is trivial
and inconsequential.

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Value Trivial & Inconsequential?
It is possible that this offer does approximate to offers made to staff at Aventec
International Bhd, as clothes commonly retail at prices with a substantial mark up on cost.
It would not be unreasonable for a clothes retailer to give staff a ‘cost’ benefit. The auditor
should determine whether such a benefit is made available to staff. If it is not made to staff
it should not be accepted by the auditor. The ethical threat most likely to be relevant here
is self-interest, although enjoying a discount that client staff may also introduce to a
familiarity threat.

‘trivial’ should be considered both in terms of materiality to the auditor and the company.
The offer is not material to Avetec International Bhd, for whom clothes retail is only one
division. However, the offer of unlimited fashion at a 70% discount is extremely likely to
be material to junior audit staff (who is most likely to be allocated to the inventory count).

Timing
It would be inappropriate to take up the offer at the inventory count because this would
constitute movement of inventory during the count, which would be wrong.

Also, the junior staff members should not accept such goods without having discussed the
matter with the audit partner (it is assumed in this answer that this is the first time such an
offer has been made).

Lastly, if mistakes were to be made on the inventory count, the audit might be open to
charges of negligence if it appeared its staff members indulged in a shopping trip when
they should have been auditing.

Action to be taken
The staff members should not have taken up the offer at the inventory count.
The audit partner should discuss the matter with management, ascertain whether a similar
benefit is offered to staff and decide whether he feels it is appropriate for his staff to take
up the offer. It may be inappropriate as Aventec International Bhd might become
perceived to be a ‘reward’ job by audit staff. Alternatively, it might be appropriate of the
audit partner to impose a financial limit to the benefits their staff could accept.

Scenario (2) Hospitality

An invoice to the company for business use of the Chief Executive’s jet shows that the
audit manager was flown to Florida and back for a stay of two weeks.

Issues
(a) If the invoice was ostensibly for ‘business use’, what was the business? (Neither
the client nor the auditor have offices in Florida.)
(b) If the invoice was not for business, the Chief Executive is wrong to invoice it to the
company. Is this a common practice?
(c) If it was for business, the cost of the auditor’s flight should not have been charged

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 directly to the company, but the audit firm, who could then have recharged it. Was
Darius Harken working for the weeks in question, or is it recorded as holiday in the
audit firm’s records?
(d) Does the invoice actually represent a significant example of hospitality being
accepted by the audit manager?
(e) Did the audit manager travel alone, with family, or even with the Chief Executive?
Does this indicate that the audit manager has a close personal relationship with the
Chief Executive?

Hospitality/close personal relationship

It is possible that points (d) and (e) above may be indicated by the invoice.
In terms of accepting hospitality, MIA’s guidance (s420 value trivial & inconsequential) is
the same as was discussed above in relation to accepting goods. It is unlikely that paying
for an auditor’s flight would be considered “trivial”, because it would be traditional for the
audit firm simply to recharge the cost of a business trip. Taking steps such as these would
help to reduce the suggestion that something inappropriate has occurred, if the trip was
genuinely business related.

If the trip was a pleasure trip (a) it should not have been charged to the company, which
raises several auditing issues in its own right and (b) it does not come within the issue of
trivial & inconsequential. Ethical threats of self-interest and familiarity are evidently
possible

In terms of close business or personal relationships, MIA’s guidance states that these
might adversely affect, or appear to, the objectivity of the auditor. It seems likely that in
this instance, if the Chief Executive and the audit manager have been on holiday together,
or at least a business ‘jolly’, then as a minimum, objectivity will appear to be threatened.

Action to be taken
(a) The audit firm should check their personnel records and see whether Danny Ho
was working or holidaying at the relevant time.
(b) If the trip was business related, the audit partner should check why the cost has
been invoiced to the company by the Chief Executive and not by the audit firm.
(c) If the trip was personal, then the audit manager appears to have threatened the
objectivity of the audit, and indeed, given that the trip appears to have been taken
around the time the prior year audit was taking place, that audit is also adversely
affected.
(d) The prior year audit files should be subjected to a cold review and the audit
manager should be replaced on this year’s audit, which should also be subject to a
quality control review.
(e) All invoices rendered to the company in respect of the jet should be scrutinized by
the audit team, for further evidence of personal expenses being charged to the
company.

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Question 2
Answer
(a) Confidentiality
Confidentiality is an implied term of an auditor’s contract with the client. It is also a
requirement of the MIA By-Law (refer S 114) and IFAC (the Code of Ethics for
Professional Accountants).

Confidentiality is essential to the auditor-client relationship because in order to form an

opinion, the auditor must work closely with those who have prepared the financial
statements and have their trust. If this is lacking, the client will not be open with the
auditor fearing that matters may be reported to competitors, other third parties or
regulatory authorities.

The duty of confidentiality owed by the auditor is not absolute. There are
circumstances in which auditors have a right or duty to disclose matters to third parties
without the client’s knowledge or consent. Duties are mainly legal duties to report
matters of national security such as any suspicions of money laundering, drug
trafficking or terrorist offences. A right to report matters also exists in these
circumstances but the duty to report is more important. An auditor may also disclose
matters to defend himself in disciplinary proceedings.

It is not uncommon for regulatory authorities such as the tax authorities or the police to
ask ‘informally’ for details of confidential matters. Only when the persons requesting
the information have obtained the appropriate statutory or other authorities to demand
such information should the request be granted.

Auditors are under no general duty to report illegal acts to the authorities; however, it
is not appropriate for an auditor to continue a relationship with a client that engages in
such activities, not least because the auditor may be implicated in the crime.

(b) Blake Seven Sdn Bhd

Auditors should avoid conflicts of interest where possible. One example of a conflict
of interest is where two parties in dispute both request advice from the same firm.
There is no absolute rule that says that a firm cannot act for both parties in these
circumstances but there have to be stringent controls to ensure that the interest of one
client do not adversely affect the interests of another, and of course permission of both
parties is required, which may not be forthcoming. This is can be difficult with small
firms because there are often insufficient staff to have two different ‘teams’ acting on
behalf of the parties.

Request - remuneratian package

Some information on directors’ remuneration packages may be available by inspection
of the financial statements filed with the authorities, although this information will be
historical rather than current. There may also be requirements for companies to make
details of service contracts available for inspection by members of companies, such as
Rosella, although these often constitute a very incomplete picture of the total

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 remuneration package.

It is clear that as existing auditor and advisor to Blake Seven Sdn Bhd, it would be
inappropriate to disclose any such information to Rosella, or even to help her find the
information that is available on the public record, without the permission of Blake
Seven Sdn Bhd which is unlikely to be forthcoming.

Personal advisor
It would only be possible to act as personal advisor to Rosella if the remaining
directors of Blake Seven Sdn Bhd agreed (which seem unlikely) because the current
‘negotiations’ may well turn into a dispute over the valuation of the shareholding. The
existing company might well wish to understate profits and assets in order to reduce
the valuation, and Rosella may wish to see the amounts increased. It may be possible
to act as personal tax advisor) although there are likely to be tax implications to the
buy-out.

(c) Auditor to Blakes Heaven Sdn Bhd

There are potentially serious problems associated with becoming auditor to the new
company because it is both in competition with the existing client, and has a very
similar name. Blake Seven Sdn Bhd may well have a legal case against Rosella and the
new company for attempting to pass itself off as the existing company, and thereby
damage the existing company’s goodwill. The fact that Rosella has done this, together
with her request for information, which she should know is confidential (in relation to
remuneration), may cast doubt on her personal integrity which is a further reason not to
act for her.

Alternatively, if the information presented in the question is incomplete, it may be

possible to take the view that the firm would prefer to act as auditor and advisor to
Rosella and the new company, rather than to the existing company, particularly if the
terms of the engagement are attractive. There is no specific ‘rule’ which prohibits this
course of action, however, the requirement to behave with integrity in all professional
and business relationships suggests that this would not be an appropriate course of
action.

Question 3
For each of the following situations, discuss whether it creates a threat to
professional independence. What safeguards would you suggest?

a. Heng, a sole proprietor in in public practice, plans to establish a separate department

that will provide internal audit services to her audit clients

b. Salleh & Co. has been the auditors of JBC Bhd since the incorporation of the
company in 1988. The company is now listed on Bursa Malaysia for the past l0 years.
Mr Salleh has been the engagement partner for the audit of JBC Bhd.

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c. Safemore Mart has traditionally been presenting the members of the audit team with
New Year hampers. This year because of the good company performance, each audit
member is given a hamper worth RM 150.

Answer
a. Provision of internal audit services to audit clients may create self-review and self-
interest threats. Heng must ensure that the safeguards suggested in the code of
ethics are applied to reduce such threats to an acceptably low level. Under the by-
laws, provision of internal audit services to clients which are listed entities is
prohibited.

b. Association with an audit client for a long period of time is likely to give rise to
familiarity threat. For financial statement audit clients that are listed entities, the
IFAC Code stipulates that the engagement partner (EP) and the quality control
reviewer should be rotated after serving in either capacity for a pre-defined period. In
Malaysia after 2018, the MIA specified the period as not more than Seven years. In
addition, such a person rotating after the Seven year period should not participate in
the audit engagement until a further cooling off period of three years.(for period
2018 to 2023) after 2023 the cooling period is 5 years for EP and 3 years remain
unchanged for Quality control reviewer. (Refer to the MIA Guidelines)

c. Gifts and actions of hospitability from clients may create self interest or
intimidation threat to objectivity. Unless the value of gift and hospitability is clearly
insignificant, a professional accountant in public practice should not accept such gifts
or hospitality.

Refer to S420 of MIA By law

MIA BY LAW -S 420

• R420.3 A firm, network firm or an audit team member shall not accept gifts and
hospitality from an audit client, unless the value is trivial and inconsequential.
• 420.3 A1 Where a firm, network firm or audit team member is offering or
accepting an inducement to or from an audit client, the requirements and
application material set out in Section 340 apply and non-compliance with these
requirements might create threats to independence.
420.3 A2 The requirements set out in Section 340 relating to offering or accepting
inducements do not allow a firm, network firm or audit team member to accept gifts and
hospitality where the intent is to improperly influence behavior even if the value is trivial
and inconsequential

In this case, the audit team members should not accept the hamper.

Question 4

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You have been the auditor of MRC Trading Sdn Bhd for several years. During 2014, the
company opened a new branch in Shah Alam. In verifying the fixed assets additions for
the new branch, you discovered an error in the invoice for the installation of new fixtures.

Due to a clerical error, the supplier Sung carpentry Sdn Bhd, has sent an invoice for an
amount that reads RM137, 890.35 instead of the correct amount of RM173, 890.35. The
invoice was paid immediately and subsequent statement from Sung Carpentry showed
that the account. of MRC has been paid in full. Assume that the amount is material to the
financial statements MRC Trading for the year ended 31 December 2014.

Required:
a. What course of action would you take in this case?
b. Assuming that you are later appointed as the auditor of Sung Carpentry Sdn
Bhd, would you use your knowledge in the MRC audit to initiate a reopening of
MRC account?

Answer
a. The error represents an understatement of liability and fixed assets in the financial
statements of MRC Trading. The auditors should inform the client of the error and
advise the client to make the necessary adjustment. It is possible that Sung Carpentry
may discover the error later and request for the balance of the payment. If the client
does not agree to the adjustment, the auditor would have to consider the effect of the
error on the auditor’s report.

b. This situation involves the ethical issue of confidentiality and gives rise to an ethical
dilemma. The auditors should not disclose confidential client information without the
consent of the client. If the auditor discloses his knowledge about the invoicing error
obtained from MRC Trading in the audit of Sung Carpentry, he would be violating
the ethical rule of confidentiality. However, if he does not inform the client of the
previous billing error, the financial statements may not be fairly stated. The better
alternative would be to “detect” the error in invoicing by examining the client’s
billing system and determine how the error arises and advise the client accordingly.

Question 5
Each of the following situations involves a possible violation of the MlAs By Laws. For
each of the situations state whether it is a in violation
(a) Bohan Badarudin is an auditor, but not a partner with 3 years of professional
experience with Lee & Co. He owns 20 shares in an audit client of the firm, but
he does not take part in the audit of the client, and the amount of stock is not
material in relation to his total wealth.

(b). In preparing the personal tax returns for a client, Fiona Asan, an auditor, observed
that the deductions for contributions and interest were unusually large. When she
asked the client for backup information to support the deductions, she was told, 'Ask

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 me no questions, and I will tell you no lies." Asan completed the return on the basis
of the information acquired from the client.

(c). A non-audit client requests assistance of Jamil, an auditor' in the installation of a

local area network. Jamil had no experience in this type of work and no knowledge of
the client's computer system, so he obtained assistance from a computer consultant.
The consultant is not in the practice of public accounting, but Jamil is confident of his
professional skills. Because of the highly technical nature of the work, Jamil is not
able to review the consultant's work'

(d). Five small Alor Star CA firms have become involved in an information project
by taking Part in the inter-firm working paper review program Under the program,
each firm designates two Partners to review the audit files, including the tax returns
and the financial statements of another CA firm taking part in the programme. At the
end of each review the auditors who prepared the working papers and the reviewers
have a conference to discuss the strengths and weaknesses of the audit. They do not
obtain authorisation from the audit client before the review takes place

(e) Billah Arif, an auditor, set up a casualty and fire insurance agency to complement
his auditing and tax services. He does not use his own name on anything pertaining to
the insurance agency and has a highly competent manager, Francis Chong, who runs
it. Billah often requests Francis to review the adequacy of a client's insurance with
management if it seems underinsured. He believes that he provides a valuable service
to clients by informing them when they are underinsured.

Answer:
a. No violation. Johan Baharuddin is not a partner nor is he assigned to the
engagement team for the audit client.

b. S 111 & 112 of MIA By law Integrity and Objectivity. Violation. a member may
resolve doubt in favor of his or her client as long as there is reasonable support for his
or her position. In the example case, the client has provided no support for the
unusual deductions. Fiona Asan should have asked for supporting documents to clear
her doubt
.
c. S 113 (Professional competence and due care). Violation. S 113 states that a member
who accepts a professional engagement implies that he or she has the necessary
competence to complete the engagement according to professional standards. Jamil
has violated the rule since he does not have the expertise to review the work of the
consultant hired

d. S 114 on Confidential Client Information. Violation. The client should have been
notified that the review was to take place, and an attempt made to obtain the client's
permission for such review because the review was not a part of MIA practice review.
The firms violated S 114 by not obtaining consent from the client for the review.

15
e. S 112 (objectivity). Violation. Appearance of independence has been impaired by
Billah Arif’s agency’s financial dealing with his audit clients and participation in a
business, which impairs his objectivity. It is also a conflict of duties to recommend
his own firm to review the adequacy of the existing insurance coverage of existing
clients

Question 6
The finance director of Reiki Bhd informed the audit partner that the reason for
appointing WONG & Co as auditors was because they audit other mobile phone
companies, including Reiki’s main competitor. The finance director has asked how
WONG & Co keeps information obtained during the audit confidential.

Required: Explain the safeguards which your firm should implement to ensure that this
conflict of interest is properly managed.

Answers:
Conflicts of interest(s 112 Objectivity of MIA by law)
– Both Reiki and its competitor should be notified that Wong & Co would be acting as
auditors for each company and, if necessary, consent obtained.
– Advising one or both clients to seek additional independent advice.
– The use of separate engagement teams, with different engagement partners and team
members; once an employee has worked on one audit, such as Reiki , then they would be
prevented from being on the audit of the competitor for a period of time. This separation
of teams is known as building a ‘Chinese wall’.
– Procedures to prevent access to information, for example, strict physical separation of
both teams, confidential and secure data filing.
– Clear guidelines for members of each engagement team on issues of security and
confidentiality. These guidelines could be included within the audit engagement letters.
– Potentially the use of confidentiality agreements signed by employees and partners of
the firm. – Regular monitoring of the application of the above safeguards by a senior
individual in Wong & Co not involved in either audit

Question 7

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 You are an audit senior of Beech & Co and have been allocated to the audit of Willow
Wands Co (Willow), a listed company which has been an audit client for eight years and
specialises in manufacturing musical instruments. Bethan Oak was the audit engagement
partner for Willow and as she had completed seven years as the audit engagement
partner, she has recently been rotated off the audit engagement. The current audit partner,
Sandeep Pine, has suggested that in order to maintain a close relationship with Willow,
Bethan should undertake the role of independent review partner this year. In addition
Willow has requested that Bethan assist them by attending their audit committee
meetings, as a non-executive director has recently left the company. Willow has also
asked Sandeep and the other partners at Beech & Co to help them in recruiting a new
non-executive director.

The total fees received by Beech & Co for last year equated to 16% of the firm’s total fee
income. The current year’s audit fee has not yet been confirmed, but along with taxation
and other possible non-audit fees the total income from Willow this year could be greater
than for last year. Last year’s audit fee was being paid monthly by Willow but no
payments have been made for the last three months.

The audit manager for Willow has just announced that he is leaving Beech & Co to join
Willow as the financial controller.

Required:

Using the information above:

(i) Identify and explain FIVE ethical threats which may affect the independence of
Beech & Co’s audit of Willow Wands Co; and
(ii) For each threat explain how it might be reduced to an acceptable level.

Answer
Ethical threats
Bethan Oak was the audit engagement partner of
Willow Wands Co (Willow) for the last seven
years and has recently rotated off the audit. It has
been proposed that she should now become the
independent review partner. This represents a
familiarity threat as the partner will have been
associated with Willow for a long period of time
and so may not retain professional scepticism and
objectivity
Willow has requested the previous engagement
partner, Bethan Oak, attend audit committee
meetings as a non-executive director of Willow
has recently left. This represents a self-interest
threat as the audit firm may be perceived as
performing the role of management by attending
these meetings and this threatens objectivity.
Managing the threats
As Willow is a listed company, then Bethan
Oak should not serve as the independent
review partner for a period of two years
(before 2018) After 2018 3 years cooling off as
per MIA by law.(After 2023 5 years cooling
off) An alternative review partner should be
appointed instead.
The firm should politely decline this request
from Willow, as it represents too great a threat
to independence.

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A non-executive director of Willow has recently
left and the management of Willow have asked
whether the partners of Beech & Co can assist
them in recruiting to fill this vacancy. This
represents a self-interest threat as the audit firm
cannot undertake the recruitment of senior
management of Willow, especially as non-
executive directors have a key responsibility in
appointing the audit firm.
The total fees received from Willow for last year
equated to 16% of the firm’s total income. The
fees for this year have not been finalised, but it is
anticipated that they could be greater than 16%.
There is a potential self-interest threat as the
total fees could represent a significant
proportion of Beech & Co’s income.
Last year’s audit fee was being paid monthly,
however, the last three months’ payments are
outstanding. A self-interest threat can arise if
the fees remain outstanding, as Beech & Co may
feel pressure to agree to certain accounting
adjustments in order to have the previous year and
this year’s audit fee paid. In addition, outstanding
fees could be perceived as a loan to a client which
is strictly prohibited.
Ethical threats
The audit manager of Willow is leaving Beech &
Co to become the financial controller at Willow.
This represents a self-interest and familiarity
threat as the audit manager is familiar with the
audit plan which is to be adopted at Willow and he
may also have commenced work on this year’s
audit.
Beech & Co is able to assist Willow in that
they can undertake roles such as reviewing a
shortlist of candidates. However, they must
ensure that they are not seen to undertake
management decisions and so must not make
the final decision on who is appointed
Beech & Co should assess whether audit and
non-audit fees would represent more than 15%
of gross practice income for two consecutive
years. If the recurring fees are likely to exceed
15% of annual practice income this year,
additional consideration should be given as to
whether the taxation and non-audit
assignments should be undertaken by the firm.
In addition, if the fees do exceed 15% then this
should be disclosed to those charged with
governance at Willow
Beech & Co should discuss with those charged
with governance the reasons why the last three
months’ payments have not been made. They
should agree a revised payment schedule
which will result in the fees being settled
before much more work is performed for the
current year audit.
Managing the threats
A new audit manager should be appointed to
Willow and any work already undertaken by
the previous manager should be independently
reviewed. In addition, it would be advisable to
modify the audit plan so that the manager
would not be overly familiar with the approach
to be adopted.

Question 8.
You are an audit manager of Pink Partners & Co (Pink) and are planning the audit of
Golden Finance Co (Golden), a banking institution which provides a range of financial
services including loans. Your firm has audited Golden for four years and the company’s
year end is 30 September 2015. At the end of August, Golden’s financial controller left
and the new replacement is not due to start until approximately two months after the year
end. The finance director, who is the sister-in-law of the audit engagement partner, has

18
asked if a member of the audit team can be seconded to Golden for three months to act as
the temporary financial controller. You are aware that a number of the audit team
members currently bank with Golden and two team members have significant loans
owing to the company. Pink’s taxation department also provides services to Golden. They
have been approached by Golden to represent them in negotiations to resolve some
outstanding issues with the taxation authorities, for which the fees quoted are substantial.
The finance director has informed the audit engagement partner that when the audit is
complete, she would like the whole team to attend an evening watching the national
football team play a match followed by a luxury meal.

Required:

Using the information above:

(i) Identify and explain FIVE ethical threats which may affect the independence of
Pink Partners & Co’s audit of Golden Finance Co; and
(ii) For each threat, explain how it might be reduced to an acceptable level.

Answer

Ethical Threats Managing these risks

The finance director is the sister-in-law of Although the family relationship is only
the audit engagement partner and hence there established by marriage, as it is a sister-in-law,
is a family relationship. There is a it would be advisable for the audit engagement
familiarity and self-interest threat as the partner to be removed and an alternative partner
audit partner and the finance director both appointed.
hold senior positions and therefore are in a
position to influence the outcome of the
audit. There is a concern that they may place
their family relationship above the needs of
the users of the financial statements.

Golden Finance Co’s (Golden) finance
director has asked if a member of the audit
team can be seconded to fill the role of
financial controller. A self-review risk arises
if the team member prepares records and
schedules which support the financial
statements and is then part of the audit team
responsible for auditing these.
Pink Partners & Co (Pink) should clarify
exactly which areas the seconded team member
would assist Golden on. Though it is likely that
as the financial controller, the team member
will be directly involved in dealing with items
related to the financial statements. As such, the
request from the finance director should be
politely declined, or the team member should be
removed from the audit of Golden.

Two members of the audit team have The terms of the loans should be reviewed to
significant loans owing to the company. ascertain whether they are in any way
Golden is a banking institution and hence the preferential. If not, no further action is required.
provision of a loan is within the normal However, if the terms are preferential then

19
 course of business. However, if either of the either the terms should be amended or these two
loans has any preferential terms, such as members should be removed from the audit
rates or repayment periods, then this would team.
represent a self-interest threat.

Golden has requested that Pink’s taxation Due to the likelihood of these issues having a
department represents them in negotiations material impact on the financial statements and
to resolve some outstanding issues with the the advocacy threat, it is advisable that the firm
taxation authorities. There is a potential politely declines this request.
advocacy threat where the firm may
promote an opinion on behalf of Golden,
such that the independence of the firm is
compromised. In addition, the outcome of
these issues may have a material impact on
the financial statements, resulting in a self-
review threat.

The taxation fees being quoted to Golden are
substantial. There is a potential self-interest
threat as the total fees could represent a
significant proportion of Pink’s income and
the firm could become overly reliant on
Golden.
Pink should assess whether audit, non-audit and
total taxation fees would represent a significant
proportion of recurring fee income. If the
recurring fees are likely to be significant,
additional consideration should be given as to
whether the taxation and/or non-audit
assignments should be undertaken by the firm.

The finance director has invited the whole As it is unlikely the football tickets and luxury
team to attend an evening out watching the meal for the whole team has an insignificant
national football team play a match followed value, then this offer should be politely
by a luxury meal. This represents a self- declined.
interest and familiarity or intimidation
threat as the acceptance of goods and
services, unless insignificant in value, is not
permitted.

Question 9
You are an audit manager in Chester & Co, and you are reviewing two situations which
have recently arisen with respect to potential and existing audit clients of your firm.

Stratford co
The audit of Stratford Co’s financial statements for the year ended 30 November 2020 will
commence shortly. You are aware that the company is in financial difficulties. Stratford
Co’s managing director, Colin Charlecote, has requested that the audit engagement partner
accompanies him to a meeting with the bank where a new loan will be discussed, and the
draft financial statements reviewed. Colin has hinted that if the partner does not

20
accompany him to the meeting, he will put the audit out to tender. In addition, an invoice
relating to interim audit work performed in August 2020 has not yet been paid.

Banburry Co
Banbury Co is a listed entity, and its audit committee has asked Chester & Co to perform
an actuarial valuation on the company’s defined benefit pension plan. One of the audit
partners is a qualified actuary and has the necessary skills and expertise to perform the
service. Banbury Co has a year ending 28 February 2021, and the audit planning is due to
commence next week. Its financial statements for the year ended 28 February 2020, in
respect of which the audit report was unmodified, included total assets of RM35 million
and a pension liability of RM 105,000.

Required:
Identify and discuss the ethical and other professional issues raised, and recommend
any actions that should be taken in respect of:
(a) Stratford Co;
(b) Banbury Co.

Answer
(a) Stratford Co The request to attend a meeting with the company’s bank can give rise to
an advocacy threat to objectivity. IESBA’s Code defines an advocacy threat as the
threat that a professional accountant will promote a client’s or employer’s position to
the point that the professional accountant’s objectivity is compromised. In this case,
the managing director may want the audit engagement partner to support a view that
Stratford Co will be able to continue as a going concern and that the loan ultimately
will be repaid. This means that the audit partner is promoting the client which leads to
the creation of an advocacy threat.

In addition, from a legal perspective, the audit firm must be careful not to create the
impression that they are in any way guaranteeing the future existence of the company
or providing assurance on the draft financial statements. In legal terms, attending the
meeting and promoting the interests of the client could create legal ‘proximity’, which
increases the risk of legal action against the auditor in the event of Stratford Co
defaulting on any loan provided by the bank. It may be possible for a partner other than
the audit engagement partner to attend the meeting with the bank, which would be a
form of safeguard against the ethical threat. Chester & Co’s partner responsible for
ethics should consider the severity of the threat and whether this, or another safeguard,
could reduce the threat to an acceptable level.

There is also an intimidation threat to objectivity caused by the managing director’s

hint at putting the audit out to tender. IESBA’s Code states that an audit firm being
threatened with dismissal from a client engagement represents an intimidation threat.
The managing director’s actions should also lead to questions over his integrity, and
the audit firm may wish to consider resigning from the audit if the threat becomes too
severe. Overdue audit fees are a self-interest threat, according to IESBA’s Code, which
states that a self-interest threat may be created if fees due from an audit client remain

21
unpaid for a long time, especially if a significant part is not paid before the issue of the
audit report for the following year.

The audit firm should determine the amount of fee that is unpaid, and whether it
could be perceived to be a loan made to the client. It may be a relatively insignificant
amount, and it may not be long overdue as it relates to work performed less than four
months ago, in which case the threat to objectivity is not significant.

(b) Banbury Co Providing an actuarial valuation service is an example of providing

a non-assurance service. According to IESBA’s Code, the provision of such
services can create threats to objectivity of self-review and self-interest. The self-
review threat arises because the defined benefit pension plan on which Chester &
Co has been asked to provide a valuation service is included in the statement of
financial position, and the audit firm would need to audit the figure which has been
generated by a member of the firm. The self-interest threat arises from the fee
which would be paid to the firm. Chester & Co needs to evaluate the significance
of the threats and whether safeguards could be used to reduce the threats to an
acceptable level. In assessing the self-review threat the following factors should be
considered: – Whether the valuation will have a material effect on the financial
statements. – The extent of the client’s involvement in determining and approving
the valuation methodology and other significant matters of judgement. 19 – The
availability of established methodologies and professional guidelines. – For
valuations involving standard or established methodologies, the degree of
subjectivity inherent in the item. – The reliability and extent of the underlying data.
– The degree of dependence on future events of a nature that could create
significant volatility inherent in the amounts involved. – The extent and clarity of
the disclosures in the financial statements. A key matter to be considered is the
materiality of the pension plan to Banbury Co’s financial statements. Banbury Co
is a listed company, and therefore a public interest entity. The Code states that an
audit firm shall not provide valuation services to an audit client which is a public
interest entity if the valuations would have a material effect, separately or in the
aggregate, on the financial statements on which the firm will express an opinion.
Based on the 2012 financial statements, the pension liability at the year end
represented only 0·3% of total assets and was immaterial. Chester & Co should
consider whether there are any indications that the pension deficit may have
become more significant during the year, which may have caused the balance to
become material. In which case the audit firm should not provide the valuation
service to Banbury Co. An actuarial valuation involves significant subjectivity, for
example, in determining the appropriate discount rate, and in estimating key
variables to be used in the calculations. It is also unlikely that Banbury Co’s
management will possess sufficient knowledge and experience to have much
involvement, if any, in the valuation. However, it may be possible to use
safeguards to reduce the threats to an acceptable level. Examples of such
safeguards include: – Having a professional who was not involved in providing the
valuation service review the audit or valuation work performed; or – Making

22
 arrangements so that personnel providing such services do not participate in the
audit engagement.

Question 10-Self-Practice
Your audit firm, Chan & Co., has just taken on a new client, Maroon Sdn Bhd (Maroon),
a very successful indigenous health club that operates both a membership and pay as you
use system. Maroon, which commenced business in 2010, has faced competition for the
last two years from a nationwide health club, Celebrities Sdn Bhd, which operates a
members-only policy. You have just been advised that your firm has received an
invitation to tender for the audit of the company that owns Celebrities Sdn Bhd.

The Managing Director of Maroon, Dato Patrick, is an old college friend of your audit
manager and it was through this connection that your firm was able to tender for its audit.
You have been assigned as senior auditor for Maroon.

On a recent visit to your office, Dato Patrick stated that he would like to extend an offer
that all staff of Chan & Co. would be eligible for a special membership rate, which is
50% of standard membership rates and then entitles the member to 75% off spa services.

Dato Patrick also proposed that you sit on the board of directors at Maroon as a non-
executive director. Additionally, he proposed that your firm confirm, as part of the audit,
to submit and attend a meeting to present the figures on an insurance claim in respect of
damage caused by a burst water pipe to the insurance company. The pipe burst during a
spell of cold weather in the main gym area just prior to the year end.

Required:

(a) Evaluate FOUR (4) ethical threats (real or perceived) which may affect the
independence of your firms audit of Maroon.

(b) For each threat recommend how it might be eliminated or mitigated to a

satisfactory level.

Answers

(a) ETHICAL THREAT (b) SAFEGUARD/MITIGATION

Staff membership rates at Maroon -
self-interest threat
Such a benefit could cause a self-interest
threat to the audit, because the recipients
may not want to lose their benefit, and
therefore be biased in their audit work or
not seek adjustments where there are
material issues in the financial statements.
Auditors are not allowed to accept such
benefits unless their value is trivial and
inconsequential.
In this case, the value of a reduced
membership of gym facilities is unlikely
to be trivial and inconsequential to audit
staff members and therefore Chan & Co
should reject this offer.

Partner invited to sit on the board - Auditors are prohibited by the Code of

23
 familiarity threat
If the partner were to sit on the board of
directors, there is a risk that the partner
could lose their audit objectivity as they
may start identifying too closely with the
company and its other directors.
There is also a risk that the audit partner
may start taking management
responsibility at Maroon.
Assurance re insurance claim -
advocacy threat
Audit firms must always ensure that
accepting other services does not impact
on audit objectivity, whether due to the
amount
of fees relating to the service or as a result
of the nature of the service.
Conflict of interest
Chan & Co has been invited to tender for
an audit which will involve Maroon's
major competitor, Celebrities Sdn Bhd. It
can be appropriate for audit firms to audit
competitors, but the clients involved
might feel that there is a threat to client
confidentiality and may prefer to seek
other auditors in such a situation
Ethics from acting as a director for their
clients. You should explain this to the
Managing Director and politely decline
the invitation.
The partners should discover more about
the size and nature of this engagement to
determine whether it will affect
independence. In particular they should
determine whether such an engagement
would put the firm in the position of
advocating Maroon's position to the
insurance firm, as this could cause an
insurmountable barrier to independence.
They should also monitor the level of fee
income this would earn Chan & Co from
all work performed for Maroon to ensure
it does not cause a self-interest threat.
Chan & Co should therefore disclose to
Maroon that they are in the process of
tendering for the audit of a competitor. If
either Maroon or Celebrities Sdn Bhd is
unhappy with this situation then Chan &
Co will need to decide which audit they
want to secure. If Chan & Co performs
both audits, they must ensure that they use
separate audit partners and teams and set
up “Chinese walls” to maintain
confidentiality

Question 11-Self Practice

Situations below describe circumstances that could create threats to an auditor’s
independence:

(i) The partner in charge of the audit of financial statements holds a

significant amount of shares in his client company.

(ii) The audit firm produces an accounting software guide books while
the audit client provides the information technology expertise.

(iii) The spouse of a member of the assurance team works as the

Finance Manager with the audit client.

24
 (iv) Since the audit firm has the expertise in developing information
technology systems, the firm was asked to help in designing and
implementing an accounting information system for the client
company.

Required:

(i) Explain why the above situations might compromise the

auditor’s independence.

(ii) For each situation, identify TWO (2) safeguard measures

that could reduce the threat to an acceptable level.

Answers:
Reasons why the situations could create threats to auditor independence are:
(i) Direct financial interests in an audit client by the partner in charge
may create self interest threat.
Safeguards:
 Dispose of the direct financial interest prior to the individual
becoming a member of the assurance team;
 Remove the member of the assurance team from the assurance
engagement (if possible).

(ii) A close business relationship between the audit firm and the
assurance client or its management which involves a commercial or
common financial interest may create self-interest or intimidation
threats.
Safeguards:
 Terminate the business relationship;
 Reduce the magnitude of the relationship so that the financial
interest is immaterial and the relationship is clearly insignificant;
or
 Refuse to perform the assurance engagement.

(iii) Family and personal relationships between a member of the

assurance team and a director, an officer or certain employees,
depending on their role in management decisions, of the
assurance client, may create self-interest, familiarity or intimidation
threats.

Safeguards:
 Removing the individual from the assurance team;
 Where possible, structuring the responsibilities of the assurance
team so that the professional does not deal with matters that are
within the responsibility of the immediate family member; or

25
  Policies and procedures to empower staff to communicate to
senior levels within the firm any issue of independence and
objectivity that concerns them.
(
(iv) The provision of services by the audit firm to a financial statement
audit client that involve the design and implementation of
financial information technology systems that are used to
generate information forming part of a client’s financial
statements may create a self-review threat.

Safeguards:
 The audit client acknowledges its responsibility for establishing
and monitoring a system of internal controls;
 The audit client designates a competent employee, preferably
within senior management, with the responsibility to make all
management decisions with respect to the design and
implementation of the hardware or software system;
 The audit client makes all management decisions with respect to
the design and implementation process;
 The audit client evaluates the adequacy and results of the design
and implementation of the system; and
 The audit client is responsible for the operation of the system
(hardware or software) and the data used or generated by the
system.

Question 12-Self Practice

Discuss whether the situations below may compromise the auditor’s independence and
identify safeguard measure that could reduce the threat to an acceptable level.
i) Sanny Cheong is the partner in-charge of the audit of Bedik Bhd holds a
significant amount of shares in the company.

ii) Amos & Co audit firm produces accounting software while IT Super Bhd which
is the audit client provides the information technology expertise.

iii) Getheta is the senior in-charge of RSP Bhd audit for financial year ended
December 2017. Getheta’s husband is working as a Finance Manager with RSP
Bhd since January 2017.

a) Threats and Safeguards

i) Self-interest threats - dispose of the direct financial interest prior to the individual
becoming a member of the assurance team

26
 ii). Self-interest threats - Terminate the business relationship - Reduced the
magnitude of the relationship so that the financial interest is immaterial and the
relationship is clearly insignificant

iii) Self-interest threats, familiarity or intimidation threats - Removing the individual

from the assurance team - Policies and procedures to empower staff to communicate
to senior levels within the firm any issue of independence and objectivity that
concerns them.

Note: Students need to elaborate on the suggested answers

Question 13
You are the audit manager at Tay & Co., and you are planning the audit of StarLight Bhd
(StarLight), which has been an audit client for three years and specialises in the manufacture
of portable swimming pool for kids. During the planning stage of the audit, you were
provided with the following information. StarLight’s employees are eligible to buy the
swimming pool with a 10% discount. In previous years, the audit team was provided with the
same discount just like the staff members. During the year, the financial controller of
StarLight was sick and therefore was not able to work. The company did not have any
substitute staff to fulfil this role and therefore a qualified Tay & Co audit manager was
seconded to the client for six months. The audit partner recommended that the senior audit
executive should work on the audit because they are familiar with the client. The fee income
derived from StarLight has increased tremendously by this engagement and along with the
audit and tax fees which made up 18% of the firm’s total fees. A review of the
correspondence shows that the partner and the director of finance have known each other
socially for a number of years and they were on vacation together last summer with their
families. As a result of this friendship, discussion between partner and the client has yet to be
made about last year's audit fee, of which 25% is still outstanding.

Required:
(i) Explain the ethical threats which may affect the independence of Tay & Co’s audit of
StarLight Bhd.

(ii) For each ethical threat identified above (i), explain how to avoid such a threat.

(iii) Describe the steps an audit firm should perform prior to accepting a new audit
engagement.

(i) Ethical Threat (ii) Managing Risk

The audit team has in previous years
been offered a staff discount of 10%
on purchasing luxury mobile phones.
This is a familiarity threat. It would
need to be confirmed if this discount
is to be offered to this year’s team as
well, as only goods of an
The audit firm should ascertain whether
the discount is to be offered to staff this
year. The discount should be reviewed
for significance and if the value of the
discount is significant, then the offer
should be declined.

27
insignificant value are allowed to be
accepted. A discount of 10% may not
appear If it is then the discount
should be reviewed for significance.
If it is deemed to be of significant
value then the offer of discount
should be declined.
The firm should clarify exactly what
An audit senior of Tay & Co has
areas the senior assisted the client on. If
been on secondment as the financial
he worked on areas not related to the
controller of StarLight and is
financial statements then he may be able
currently part of the audit team.
to remain in the audit team.
There is a self-review threat if the However, it is likely that he has worked
senior has prepared records or on some related schedules and therefore
schedules that support the year end he should be removed from the audit
financial statements and he then team to ensure that independence is not
audits these same documents. threatened.

The total fee income from StarLight
is 18% of the total fees for the audit
firm. If the fees for audit and
recurring work exceed 15%
then there is a self-interest threat.
The fees for StarLight include tax
and audit that are assumed to be
recurring, however the secondment
fees would not recur each year.
The partner and the finance director
know each other socially and have
holidayed together. Personal
relationships between the client and
members of the audit team can create
a familiarity or self-interest threat.
MIA BY LAW does not specifically
prohibit friendships between the
audit client and the team. However,
due to the senior positions held by
both parties then there is a risk that
independence may be perceived to
have been threatened.
Last year’s audit fee is still
outstanding. This amounts to 20% of
The firm should assess if the recurring
fees will exceed 15%. If this is the case
then it might need to consider whether
the appearance of independence will
still be met if the tax and audit work is
retained.
No further work should be accepted in
the current year from the client, and it
might be advisable to perform external
quality control reviews. It may also
become necessary to consider resigning
from either the tax or the audit
engagement.
The personal relationship should be
reviewed in line with Jones’s ethical
policies.
Consideration should be given to
rotating the partner off this engagement
and replacing with an alternative
partner.
Tay & Co should chase the outstanding
fees.

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 the total fee and is likely to be a
significant value.
A self-interest threat can arise if the
fees remain outstanding, as Tay &
Co may feel pressure to agree to
certain accounting adjustments in
order to have the previous year and
the current year fee paid. In addition
outstanding fees could be perceived
as a loan to a client, this is strictly
prohibited.
If they remain outstanding, the firm
should discuss with those charged with
governance the reasons for the
continued non-payment, and ideally
agree a payment schedule which will
result in the fees being settled before
much more work is performed for the
current year audit.

Question 14
Dex & Co., a public accounting firm, has been engaged as the external auditor for the
Britonia Bhd (Britonia), a listed entity established in 2010. Britonia has twenty branches
throughout West Malaysia. This company owns a significant value of landed properties
in Malaysia and Singapore

Dex & Co. receives about 20% of its income from this particular client. Recently,
Britonia engaged Dex & Co., to value its Land and Buildings in all its branches and
headquarter. The valuation work was completed and a report has been issued by Dex &
Co., to management of Britonia. The report has been incorporated in this year’s financial
statements to be audited soon always. Dex & Co. treats Britonia as a very important
client.

Required:

(i) Identify and evaluate the significance of any TWO (2) threats to
the professional ethics in relation to the situation.

(ii) Recommend TWO (2) safeguards to eliminate each of the threats

(mentioned in (i) above) or reduce them to an acceptable level.

(i)

2 potential threats
Fee
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. For the audit of
public interest entity and the firm’s total fees earned from a single client should not exceed
15% for two consecutive years.

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Valuation Services
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.

(ii)

Fee
The possible safeguards for the self-interest or intimidation threats include:
• 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.
• Disclose this to those in charge with governance;
• Conduct a review, either by an external professional accountant or by a regulatory
body
• Internal quality control reviews.

Valuation services
The safeguards for the self-review threat from the valuation services will include:
• Second partner review
• Ensuring that the client acknowledges responsibility for the valuation
• Using separate personnel for the valuation and the audit.

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