Question

1. Under what general circumstances should an audit firm choose not to accept a high-risk engagement?

2. Do you believe auditors should have used confirmations in auditing accounts payable? Defend your answer. Briefly explain the differing audit objectives related to accounts receivable and accounts payable confirmation procedures and the key differences in how these procedures are applied.

Answer 1

Solution:-

1. Under what general circumstances should an audit firm choose not to accept a high-risk engagement:-

-High-risk audit clients provide a chance for auditors to hone their competencies, test procedures and likely bring in higher fees. The audit firm, however, also needs to consider the potential downside to taking on high-risk audit clients in terms of potential litigation, damage to a firm's reputation and the resulting loss of clients. In addition, audit firms (as with most professional service firms) have very high fixed costs, in the form of personnel, and need to cover those costs by keeping its teams active as much as possible.

-Many audit firms have "risk management" groups that will assess whether it is reasonable to take on a high-risk audit client. In addition, the decision to accept a high-risk client should be discussed at senior levels across the firm. In this example, the audit partner recommended that they drop the audit client despite having issued an unqualified audit opinion and his recommendation was overruled. So the procedures for accepting/retaining high-risk clients are not foolproof.

2. Do you believe auditors should have used confirmations in auditing accounts payable? Defend your answer. Briefly explain the differing audit objectives related to accounts receivable and accounts payable confirmation procedures and the key differences in how these procedures are applied:-

-Confirmation procedures are not generally required when auditing a client's accounts payable. In this case (a drug distributor), accounts payable represents a primary source of operating cash flow and is extremely important in an industry where operating margins can be less then 1%.

-Confirmation procedures look for evidence to support the existence, valuation and allocation (timing) when applied to accounts receivable. Confirmation procedures for accounts payable are generally less rigorous and focus primarily on whether the payables completely recognize the allocation.

-In this case, the auditor should have used confirmation procedures, however, they should have been more extensive than those typically used for accounts payable. The nature of the client's business suggests that its payables were concentrated to relatively few accounts and involved large amounts; therefore, the auditor should have been able to obtain externally-generated evidence tied to those payables. In addition, given the concerns raised in the client's previous audits, auditors should have sought multiple confirmations on payables (for example by fax, phone and mail).