Question

Bling-Bling Jewellery Company Limited (“BB”) has been engaging in selling jewellery. It keeps a substantial amount of gem stones as inventory. The gem stones are recognized as raw material in the financial statements, and the amount of the gem stones is considered as material for the financial statements. Lee, Wong & Partners (“Lee Wong”) is the auditor of BB for its financial statements for the year ended 31 December 2020. Michael Lau, the CFO of BB, understands that Lee Wong also provides valuation services. He proposes to the audit partner to invite Lee Wong to provide an independent valuation report of the gem stones and the valuation fee would be around 30% of the proposed audit fee for the year ended 31 December 2020. Meanwhile, the proposed audit fee for the year ended 31 December 2020 would be reduced by 20%. If the audit fee is not reduced, BB may engage another audit firm to be the auditor of the company instead.

Required:

(a) Identify the ethical issues faced by Lee Wong and propose appropriate safeguards to respond to each ethical issue.

After Lee Wong finishes the audit for BB’s financial statements for the year ended 31 December 2019, Michael invites the audit team for dinner as a token of appreciation. A box of six red wines is served during the dinner and two bottles are consumed. Michael gives the remaining four bottles to the audit team after the dinner.

Required:

(b) Explain whether the audit team can accept the wine left over at the dinner.

Subsequent to the financial year ended 31 December 2020, BB has opened an online shop to attract more customers. However, there have been many news reports that customers receive fake gem stones when they purchase from the online shop. They feel cheated and would take legal action against BB. Before the case has been put to the court, the CEO has transferred all the assets of BB to a company controlled by his relative.

Required:

(c) Determine the areas that Lee Wong would consider in assessing whether to continue the existing audit engagement with BB.

[Total for Question 2: 24 marks]

Answer 1

1. The ethical issue arising in the given scenario is that of the director proposing to give the auditor additional work in order for reduction in audit fees charged by him or else to hire another auditor. There are certain rules and regulations introduced to ensure that the auditor does not accept any other engagement other than those specifically permitted by the statue, so as to ensure that his independence stays intact.

Examples of safeguards introduced against such ethical issue -

a. Absolute Prohibition - for example, barring auditors from having any direct financial investment in any auditees

b. Permitting the activity or relationship but restricting its extent or form - for example, a restriction that auditors cannot have material indirect financial interests in auditees

c. Permitting the activity or relationship but requiring other policies or procedures that eliminate or mitigate the threat - for example, the mandatory replacement of an engagement partner after the partner has spent a certain period of time on a specific audit engagement to mitigate a familiarity threat, and

d. Permitting the activity or relationship but requiring the auditor to disclose information about it to the audited client’s management, audit committee, board, or others - for example, disclosure to an auditee’s audit committee of the nature of all services provided by the auditor to the auditee and the fees received for such services.

2. Accepting wine from dinner maybe a personal issue of the auditor as the invitation for the dinner was made in personal capacity and shall be accepted provided the auditor does not allow such scenario to have an impact on his independence.

3. Certain situations which may force the auditor to consider whether he should continue with the engagement, are as follows -

a) The auditee warrants a limitation on the scope of audit

b) The auditor suspects of fraudulent mangament activities or fraudulent management intentions

c) Lack of the auditee's intergrity to carry the responsibility as agreed upon

d) Auditor feels there is loss of indepence in the engagement

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