LSBM207: Auditing in Context

Table of Contents
Task 1: Sanders Brothers ........................................................................................................... 2

(a) Describe what actions auditors can take to minimise the threat of removal by the directors.

.................................................................................................................................................... 2

(b) Explain how an audit committee can provide additional safeguards to audit independence

in such a situation....................................................................................................................... 3

Task 2: Somerset Co .................................................................................................................. 4

(a) With reference to the above information, analyse the differences between the interim audit

and the final audit....................................................................................................................... 4

(b) Discuss the level of assurance provided by an audit and review engagement. .................... 5

Task 3: Smith Phones................................................................................................................. 6

(a) Define the types of audit risk and evaluate audit risks related to Smith Phones. ................. 6

(b) Discuss whether your firm should accept or decline the audit and provide legitimate

reasons for coming to any decision. ........................................................................................... 7

References .................................................................................................................................. 8
Task 1: Sanders Brothers

(a) Describe what actions auditors can take to minimise the threat of removal by the
directors.

Keeping in view the situation that is being faced by Ernest Jones, it can be considered that the

auditor Ernest Jones has an intimidation threat to his independence. The intimidation threat

can be defined as a threat that occurs when an auditor is intimidated by the directors or

management of the firm to an extent that they become deterred from acting in an objective

manner (Ojo, 2014; Nasution & Östermark, 2012). However, in this case, as the audit file of

Sanders Brothers suggests an opinion of the qualified audit, the Ernest Jones is willing to

issue the qualified opinion but he is certain and intimidated that if he would issue the

qualified opinion, the Sanders Brothers’ directors will appoint any other firm as the auditors.

In addition to this, the company contributes 10 per cent to the total revenues of the audit firm.

Therefore, due to these reasons, Ernest Jones is facing difficulty in issuing a qualified

opinion.

Hence, in order to mitigate the threat of the removal by the company’s directors, Ernest Jones

can issue a qualified opinion by putting in place the safeguards. Ernest Jones can mitigate the

risk of being removed from the directors by putting in the safeguards which are specific to the

particular item of the work. In this regard, Ernest Jones can discuss the issue regarding

qualified opinion with the other people of Sanders Brothers who are dealing with and are

accountable for the company’s governance issues. Ernest Jones can discuss the issue with the

board of directors and audit committee of the company which has already recommended a

need for a qualified opinion (Chia-Ah & Karlsson, 2010). Therefore, if Ernest Jones will take

these actions in order to mitigate his risk of removal through the help of safeguard, the audit

committee, as well as senior non-executive directors of Sanders Brothers, will further discuss
this issue with the directors of the company who may later allow Ernest Jones to issue the

qualified opinion of the audit.

(b) Explain how an audit committee can provide additional safeguards to audit
independence in such a situation.

The audit committee is the key operating committee of the board of directors of the company

which is in charge of overseeing financial disclosure and reporting (Council, 2012).

Considering the case of Sanders Brothers, as the audit committee of the company has already

recommended a qualified opinion of the audit and as it tends to maintain interaction with the

controller as well as chief financial officer (CFO) of Sanders Brothers, it can initiate a special

kind of investigation in regards to determine that the accounting practices of the company are

problematic.

The audit committee would be first contacted and informed by Ernest Jones. Later, it will

contact the Sanders Brothers controller and the chief financial officer and will inform them

regarding the need for a qualified opinion of the audit and the reaction of the board of

directors of the company that they will appoint another audit firm. In this way, the audit

committee will be providing additional safeguards to the audit independence to Ernest jones

because when the controller, as well as chief financial officer of Sanders Brothers, will be

aware of the whole situation in regards to the need of qualified opinion of the audit, they will

be acting as a support and defense of Ernest Jones.

There will be higher chances that the controller and the chief financial officer of Sanders

Brothers will allow the Ernest Jones to carry on with issuing the qualified opinion in regards

to the material debt owed to the Sanders Brothers. However, the chances will be higher

because the controller and the chief financial officer of the company will be in favour of the

issuance of the qualified opinion of an audit. After all, otherwise in the worst-case scenario,
they will be held accountable. Therefore, the controller, as well as chief financial controller

of the firm, will be aimed at mitigating the risk of any kind of mishap (Alqatamin, 2018).

Task 2: Somerset Co

(a) With reference to the above information, analyse the differences between the interim
audit and the final audit.

In a general context, the interim audit tends to involve a work of preliminary audit which is

carried out prior to the end of the fiscal year of the client. The tasks related to the interim

audit are carried out for the purpose of compressing the period required for completing the

final audit (National Audit Office, 2010). On the other hand, the final audit is such an audit

that is carried out after the ending of the fiscal year of the client or when the preparation of

the final accounts is being done. The final audit is completed within one constant session.

Therefore, the major difference between the interim audit and the final audit is that the

interim audit can be carried out on the monthly as well as a quarterly basis while on the other

hand the final audit can only be carried out on the annual basis.

Keeping in view the case of Somerset Co, it can be considered that it is not necessary that the

situation which the company was found to be facing during the period in which the interim

audit was carried out would be same as the situation which is being faced by the company

during the period when the final audit is being carried out.

However, the company was found to be facing a liquidity issue when the interim audit was

conducted due to the available facility of the bank overdraft. This kind of information can

benefit the Somerset Co as it can be aware of the situation which may cause any kind of loss

to the company in advance and this gives the company a chance of mitigating of risk of loss

before it occurs. On the other hand, the final audit does not tend to provide the company with

such kind of a chance because it is a complete audit of the whole year. In other words, the
interim audit was a warning for Somerset Co and the final audit is the final result of the

company about which the company is unable to fix anything (Kueppers & Sullivan, 2010).

(b) Discuss the level of assurance provided by an audit and review engagement.

There is a difference between the level of the assurance that is provided by the audit and the

level of assurance that is provided by the review engagement. Generally, an audit tends to

provide a reasonable level of assurance in regards to the company’s financial statements

being free from the material misstatement and conforming to the GAAP. It is required by the

Securities and Exchange Commission for the public firms to have an audit on an annual basis.

The only financial statements that are audited are the type of reports that are permitted to

consist of express opinion regarding whether the company’s financial statements are

presented fairly and are conforming to the GAAP. The auditors are required to perform the

procedures of search and verification. Additionally, the auditors tend to review the systems of

internal control, tailor the programs of audit for the potential risks of the material

misstatement as well as report on the control weaknesses when the audit report is delivered.

The review engagement tends to provide limited assurance in regards to the statements being

free from the misstatement and conforming to the GAAP. The reviewers apply the analytical

procedures for identifying the unusual trends or items within the financial statements. The

reviewed statements tend to include a statement of the cash flows and footnote disclosures

(Davis, 2012).

The reason why the bank asked the external auditors to do the confirmation of the rationality

of the cash flow forecast provided by the company in order to avail bank loan is that the level

of the assurance that is provided by the audit is higher than the level of assurance which is

provided by the review engagement.

Task 3: Smith Phones

(a) Define the types of audit risk and evaluate audit risks related to Smith Phones.

Audit risk is such a risk that the auditor will be unable to detect the fraud or errors during

examining the client’s financial statement. The auditors can raise the number of procedures of

the audit for the purpose of reducing the level of the risk of audit. Declining the risk of an

audit to the modest level is the major part of the functions of the audit as the users of the

financial statements are depending on the assurances of the auditors while they review the

company’s financial statement. There are three major kinds of risks, namely: detection risk,

control risk and inherent risk. Each of the risks is discussed as below:

 Detection risk: it is the kind of risk that the used procedures of the audit are not

capable enough to detect the material misstatement.

 Control risk: it is the kind of risk that the potential material misstatements will not be

prevented or detected by the control systems used by the client.

 Inherent risk: it is the kind of risk that the financial statements of the client are

susceptible to the material misstatements. This kind of risk cannot be identified by the

financial officers or internal auditors of the firm.

Considering the case of Smith Phones, as the company is aimed at expanding its systems

involving capital expenditure for building new stations of transmission requiring extra

borrowings, it is vulnerable to the audit risks. The Smith Phones can face the detection risk

when the procedure of the audit which the firm will use, will not be capable of detecting the

material misstatement within the financial statements of the firm. Moreover, it can face the

control risk by not being capable of detecting or preventing the material misstatements with

the control systems it will be using. In addition to this, the Smith Phones can face the inherent

risk by making its financial statements susceptible to the material misstatements and the
internal auditors of the firm will be unable to identify the risks (Agee, B., ; BSA SERVICES

LLC, 2012).

(b) Discuss whether your firm should accept or decline the audit and provide legitimate
reasons for coming to any decision.

The firm should decline the audit of the Smith Phones because the plans of the firm for the

future that its financial statements can be vulnerable to numerous risks as the firm can later

indulge in any kind of fraud by manipulating the financial statements in order to mislead the

shareholders. The legitimate reason is that as the firm has planned to issue initial public

offerings into the future, it can fraudulently inflate the equity by omitting the debt

intentionally from its balance sheet. However, as the accounting equations suggest Total

assets = liabilities + equity, the firm can decrease its debt in order to show higher equity

fraudulently.

In addition to this, the firm can conduct errors while accounting for the debt which can occur

when the service payments of the debt are misclassified as the expenses in the place of

decline in the debt. Furthermore, if the accountant of the Smith Phones will not be aware of

the accounting rules, he can commit mistakes of presenting the long term debt of the firm as

current debt. Therefore, these mistakes can cause issues and several risks for the auditors due

to which it is suggested to the audit firm to not to opt for auditing the Smith Phones.
 References

Agee, B., ; BSA SERVICES LLC, 2012. Financial audit risk tracking systems and methods.

U.S. Patent Application.

Alqatamin, R.M.., 2018. Audit committee effectiveness and company performance: Evidence

from Jordan. Accounting and Finance Research, 7(2), p.48.

Chia-Ah, E. & Karlsson, J.., 2010. The impact of extended audit tenure on auditor

independence: Auditors perspective.

Council, F.R.., 2012. Guidance on audit committees. London: FRC. Available at: http://www.

frc. org. uk/getattachment/6ec23196-28ee-406e-8f56-89ab9d1dc06d/Guidance-on-Audit-

Committees-September-2012. aspx..

Davis, M.a.H.D.., 2012. An analysis of submissions on proposed regulations for audit and

assurance in New Zealand. Australian Accounting Review, 22(3), pp.303-16.

Kueppers, R.J. & Sullivan, K.B.., 2010. How and why an independent audit matters.

International Journal of disclosure and governance, 7(4), pp.286-93.

Nasution, D. & Östermark, R., 2012. The effect of client intimidation on auditor

independence in an audit conflict situation. In Nordic Accounting Conference 2012.

National Audit Office, 2010. Examination of the forecasts prepared by the interim Office for

Budget Responsibility for the emergency Budget 2010. The Stationery Office.

Ojo, M., 2014. AUDITS, AUDIT QUALITY AND SIGNALING MECHANISMS.