Question

You are a manager in Yiblam & Co, a firm of Chartered Certified Accountants, and you
have taken on the responsibility for providing support and guidance to new members of the
firm. Yiblam & Co has recently recruited a new audit junior, Ezekial Davies, who has come
across several issues in his first few months at the firm which he would like your guidance
on. Ezekiel's comments and questions are shown below:
a) I know that auditors are required to assess risks of material misstatement by developing
an understanding of the business risks of an audit client, but I am not clear on the
relationship between business risk and risk of material misstatement. Can you explain
the two types of risk, and how identifying business risk relates to risk of material
misstatement?
b) I worked on the interim audit of Crow Co, a manufacturing company which outsources
its payroll function. I know that for Crow Co payroll is material. How does the
outsourcing of payroll affect our audit planning?
c) Crow Co is tendering for an important contract to supply Hatfield Co. I know that
Hatfield Co is also an audit client of our firm, and I have heard that Crow Co's
management has requested our firm to provide advice on the tender it is preparing.
What matters should our firm consider in deciding whether to provide advice to Crow
Coon the tender?
d) I also worked on the audit of Campbell Co, where I heard the managing director, Ting
Campbell, discussing a potential new business opportunity with the audit engagement
partner. Campbell Co is an events organiser, and is planning to run a programme of
nationwide events for accountants, at which speakers will discuss technical updates to
financial reporting, tax and audit regulations. Ting proposed that our firm could invest
some cash in the business opportunity, supply the speakers, market the events to our
audit clients, and that any profit made would be shared between Yiblam & Co and
Campbell Co. What would be the implications of our firm considering this business
opportunity?
Required:
For each of the issues raised, respond to the audit junior, explaining the ethical and
professional matters arising from the audit junior's comments.

Answer 1

Solution:

a)

Risk of Material Misstatement: To understand the risk of material misstatement first you should know what material misstatement is. Material misstatement is related to the information present in the financial statement of a company. Material misstatement misguides the user of financial statement by providing incorrect financial data. Now Risk of material misstatement is the risk of loss due to material misstatement. Overall risk increases when suck material misstatements are frequent in a financial statement.

Business Risk: Simply defining business risk as the exposure of any business entity with the factors which may cause loss in the business. In journey of business there are many factors and situation which have ability to hamper the non-achievement of financial goals. Here are some examples stated to understand Business risk:

• Change in government policy
• Change in exchange rate.
• Customers preference changed
• Marketing cost changed, etc.

Identifying business risk related to risk of material misstatement can be done by assessing the effect of risk of material misstatement. Let us understand it by an example. Suppose a company’s financial statement having material misstatement in Revenue. Now decision of buying stock of this company can hamper the profitability goal as misstatement in its revenue may leads to fall in stock price.

b)

Outsourcing one or more function from third party is common in business environment. Even majority of companies working on this globe are using outsourcing services in different proportion. Commonly use outsourcing functions are IT services and Human Resources.

In Audit planning auditor need excess of some information from the both patent company and service company which payroll has been outsourced. This information are listed below:

• The nature of the services provided by the service company and the significance of those services to the audited company.
• Accounts and financial statements of transaction occurred and proposed between both parent and service company.
• Nature of relationship between both organizations.

The basic purpose of these information to auditor is to understand and identify any business risk associated with the risk of material misstatement in service company. Also auditor have better understanding of audited entities and thus he can point out measures to control such risks.

c)

Since Crow Co is our client and asking for advice in tendering our default perception may be that there is no issue to provide advice to Crow Co. But here the matter is Crow Co seeking advice in tendering for a contract to supply Hatfield Co which is also out client. From this point conflict between the interest of two audit clients arises from Ryder & Co offering advice to Crow Co on the tender being presented to Hatfield Co. As per the fundamental principles of the IESBA Code of Ethics, conflict of interest may create thread to confidentiality of information.

As Hatfield Co is our client, we have many internal business information of Hatfield Co. And Advice by our firm to Crow Co in tendering process may somehow provide unethical gain to Crow Co. The tender proposed by Hatfield will not get proper competition in market and Crow Co will get undue advantage over other suppliers in this situation.

In such situation Yiblam & Co should follow guidelines provided in IESBA Code in conflict of interest. Here are some solutions listed for dealing such scenario:

• The audit firm should inform both Crow Co and Hatfield Co. about the situation and get consent to proceed.
• Engage separate working team for both the clients.
• Proper guidelines should be provided to working team about security and confidentiality.
• Approved procedures should be followed to prevent access of information.

d)

The investment proposal to Yiblam & Co by Campbell Co is not just a business proposal, its also a proposal of foundation of new business relationship between two firms. Decision on proposal of investment of cash in business opportunity of Campbell Co can be done by reviewing risk associated in this proposal. This type of relationship is described in IESBA code of ethics. Following are risk which needs to assess before accepting proposal:

• The financial interest of our firm depends upon the success of the event planned by Campbell Co. Thus before investing cash, risk associated with success of event must be analyzed carefully.
• Due to this business relationship there may be chances of threat to current audit works with Campbell Co. Campbell may Threaten audit firm to fire from audit works if he will not participate more actively in event organization. So proper evaluation of roles and responsibility and terms & conditions of this proposal must be done.
• Some manpower of Yiblam & Co will get engage in this event. So if proposal get accepted, loss of audit work due to leave of manpower must be considered.
• Due to cash investment organisation financial position needs to be evaluated.