Q. No.

SR and Associates are the statutory auditor of ABC Ltd. Audit of the company is pending for F.Y 2021-
22 and 2022-23 due to a dispute between auditor and company with respect to certain proposed
remarks by the auditor in the audit report for F.Y. 2021-22. The company removed the auditor on
02.05.2023 in shareholders meeting complying with all legal formalities. SR and Associates after
coming to know about the removal, intimated the Registrar of Companies (ROC) through letter
highlighting the points of dispute including non-existence of fixed assets, bogus creditors etc. ABC
Ltd complained to ICAN against SR and Associates for their above letter to ROC. Comment with
reference to the Nepal Chartered Accountants Act, and Schedules thereto.

Answer: Nepal Chartered Accountants Act states that a chartered accountant in practice shall be
deemed to be guilty of professional misconduct, if he discloses information acquired in the course
of his professional engagement to any person other than his client so engaging him, without the
consent of his client or otherwise than as required by any law for the time being in force.

An accountant, in public practice, has access to a great deal of information of his client which is of
a highly confidential character. It is important for the work of an accountant and for maintaining the
dignity and status of the profession that he should treat such information as having been provided to
him, only to facilitate the performance of his professional duties for which his services have been
engaged. The Code of Ethics further clarifies that such a duty continues even after completion of the
assignment.

In the given situation, SR & Associates complained to the Registrar of Companies (ROC) through
letter highlighting the points of dispute including non-existence of fixed assets, bogus creditors, etc.
after coming to know about the removal. SR & Associates made voluntary disclosure of the
information acquired during the professional engagement without the consent of the client and
without there being any requirement in law to disclose the same.

Q. No. 2

You are an audit manager in Wimble & Co, a large audit firm which specializes in providing audit and
accountancy services to manufacturing companies. Murray Co has asked your firm to accept
appointment as external auditor. Murray Co manufactures sports equipment. Your firm also audits
Barker Co, another manufacturer of sports equipment, and therefore your firm is confident it has the
experience to carry out the audit.

You have been asked to take on the role of audit manager for Murray Co, should your firm accept the
engagement. You own a small number of shares in Murray Co, as you used to be an employee of the
company. Don Henman, who has been the engagement partner for Barker Co for twelve years, will
take the role of engagement partner for Murray Co. The audit senior will be Tim Andrews, as his sister
is the financial controller at Murray Co and therefore he knows the business well.

Your firm recently purchased some bibs, footballs and other equipment from Murray Co for the firm's
annual football tournament. Murray Co has offered to provide this equipment free of charge to the
firm if they accept the role as auditor
Murray Co would also like your firm to provide taxation and accounting services. Specifically, the
company would like you to prepare the financial statements and represent the company in a dispute
with the taxation authorities.

The fees for last year's audit of Barker Co have not yet been paid, and you have been asked by Don
Henman to look into the matter.

Required

✓ Describe the steps Wimble & Co should take to manage the conflict of interest arising from
performing the audit of Murray Co and Barker Co.
✓ Explain SIX ethical threats which may affect the independence of Wimble & Co in respect of the
audit of Murray Co or Barker Co, and for each threat identify ways in which the threat might be
reduced

Answer

a) Conflict of interest
✓ Wimble & Co must inform both clients of the conflict and obtain their consent to act.
✓ Separate teams and engagement partners must be used for each audit.
✓ Procedures should be in place to prevent access to information e.g., using teams from
different offices.
✓ The audit teams should sign confidentiality agreements.
✓ An independent review partner should be assigned to ensure the safeguards have been
effective

b)

Ethical Threat Possible Safeguards

Financial interest The audit manager must dispose of the shares
✓ The audit manager owns shares in Murray immediately.
Co
✓ This creates a self-interest threat: the audit
manager may be reluctant to identify
misstatements or modify the audit opinion
for fear of damaging the value of their
shareholding
✓ Previous employment with the client The audit manager should not be assigned to
✓ The audit manager used to work for Murray the audit of Murray Co if they would be auditing
Co accounting records they had prepared whilst
✓ This creates a self-review threat employed at the client.
If employment with the client was recent, the
audit manager may be auditing work for which
they were responsible when working for Murray
Co. They may not identify errors in their own
work, or if they are identified, they may not be
brought to the client's attention.
In addition, a familiarity threat may arise as the
audit manager is likely to have friendships with
previous colleagues which could result in the
audit manager not applying sufficient
professional skepticism and trusting the client
too much.
Gifts and hospitality The firm should evaluate the gift offered and
✓ Murray Co has offered free equipment unless trivial and inconsequential, the audit
to the auditor. team must not accept the equipment
✓ Accepting gifts or hospitality from an If the offer of free equipment is considered to be
audit client may create self-interest and an inducement to accept the engagement, the
familiarity threats offer should be declined, even if considered
✓ The auditor may feel indebted to the trivial and inconsequential
client or the offer may be seen to be a
bribe from the client for a clean audit
opinion.
Long association ✓ Rotate the senior personnel.
The engagement partner for Barker Co has been ✓ Independent review of the senior
in place for twelve years. personnel's work.
✓ Independent quality review of the
Familiarity and self-interest threats are created engagement.
by using the same senior personnel on an
assurance engagement for a long period of
time. The audit partner may be too trusting of
the client and may lack professional
skepticism.
Personal relationship Tim Andrews should not be on the audit team
The audit senior's sister is the financial for Murray Co.
controller at Murray Co and is therefore in a
position to exert significant influence over the
financial statements.

Family and personal relationships between a

member of an assurance team and a director of
the client, or an employee of the client in a
position to exert significant influence over the
subject matter, may create familiarity, self-
interest or intimidation threats.

The audit senior may be too trusting of his sister

and not apply sufficient professional
skepticism
Representing the client Firms must not represent audit clients in such
Murray Co would like the audit firm to represent disputes. The request should be politely
the company in a dispute with the taxation declined.
authorities
 This would create advocacy and self-review
threats as the audit firm would be seen to be
taking sides with their client
Overdue fees ✓ Obtain full or partial payment from the
The fee for last year's audit of Barker Co has not client.
yet been paid. ✓ Do not perform any more work for the
client until the outstanding fees have been
Overdue fees create a self-interest threat where paid.
they remain unpaid for some time. The auditor ✓ The auditor’s report must not be issued
may be reluctant to raise issues with the client until payment has been received.
in case they refuse to pay.
In addition, overdue fees could be perceived to
be a loan. An audit firm must not enter into any
loan arrangement with a client.
Provision of other services ✓ The firm must only perform work of a
Murray Co would like the audit firm to prepare routine or mechanical nature.
the financial statements. ✓ Use staff who are not part of the audit team
Preparing the financial statements and then to prepare the financial statements.
auditing them creates a significant self-review ✓ Arrange an independent partner or senior
threat. If the auditor reviews work, they were staff member to review the work
responsible for, they may not identify errors performed.
they have made ✓ If an audit client is a listed or other public
interest entity, the firm must not provide
any accounting or bookkeeping services

Q. No. 3

Pavlova Publications (Pavlova) is a long-established publishing company. In the last two years, it has
made significant losses as a result of its investment in technology and in particular, the high-tech
environment of e-commerce. This investment and the company’s sound future prospects have led
to a good Stock Exchange rating since they are generally seen as leading edge in this field, with good
preliminary sales and strong feedback on the ease of use and marketability of their web site

Pavlova’s investments have been funded through use of their reserves built up over many years.
However, two weeks ago, Pavlova’s shares were suspended, having fallen by 90% on rumors that
reserves had been significantly overstated and that they were no longer financially viable. Your firm,
as the auditors, has come in for significant criticism and is being accused of negligence. Your firm is
also being threatened with legal action in relation to the lack of due care in preparation of the
accounts

Required

Explain the legal position of your firm, the requirements for due care and the steps and procedures
the firm could have taken to prevent such a situation occurring

Answer
The audit firm has statutory responsibilities under company law including a duty to report on whether
financial statements show a ‘true and fair view’ or ‘present fairly’ the financial position. If the firm is
shown to be negligent in this process, they could be subject to various types of action (civil and/or
criminal).

In the specific case of Pavlova, the problems relate to investments from reserves and the collapse
in share price resulting from the ‘rumors’ of a lack of reserves and lack of financial viability. The
suspension of the Pavlova shares allows time to investigate the true position and deal with fact
rather than rumor.

During the audit of Pavlova, the firm would have considered the going concern basis of the company
and would have examined the financial statements for material error. This would include
consideration of the level of reserves. Therefore, if there are substantiated problems, the firm would
have been expected to identify the situation. The audit process should have been carried out with a
due level of skill, care and diligence and with regard to the required professional standards. If the
firm can demonstrate that the audit was performed in accordance with professional standards, then
it will be difficult to demonstrate negligence. However, if the firm had any suspicions of problems
with the company’s financial position, it should have fully pursued this to establish the facts and, if
it has not done so, could be accused of negligence.
The question does not identify the possible source of legal action. There is a possibility of liability in
tort, under which a third party could sue the firm for damages. However, such a third party would
have to prove that:
✓ the auditors owe a duty of care to the third party
✓ that appropriate standards of care have been breached, and
✓ that the third party has suffered loss as a direct result of this breach of standards

A duty of care exists where the auditors knew (or reasonably should have foreseen at the time of
auditing the financial statements) that those financial statements might be relied on for that
particular purpose and that it would be reasonable for such reliance to be placed for that purpose.

To avoid successful allegations of negligence, there are a number of key mechanisms that the
auditors of Pavlova should have followed,
✓ Ensure that evidence is available to demonstrate that best practice procedures were being
followed, including effective quality control and supervision of work undertaken on the
client.
✓ Effective planning of assignments, including the assignment of staff with the appropriate
skills and training, as well as effective direction of resources during the assignment.
✓ The use of appropriate audit programmes and checklists to ensure appropriate focus and
effective documentation and capture of evidence
✓ Review of business and audit risks. This may have indicated a longer term viability problem,
with both the heavy investment in e-commerce and the reliance on reserves in making this
investment being important business risks that should have been managed.
✓ Regular technical training and updating of all staff and proper briefing.
✓ Supervision of audit work, including review of working papers.
✓ Monitoring of quality control procedures.
✓ Final review of the financial statements.
✓ Professional indemnity insurance would provide an insurance protection should the
company be faced with successful legal actions.
Questions No. 4
You are a manager in the audit department of Whilling and Abel. A potential new client, Truckers Co,
a haulage company, has approached your firm to perform the external audit in addition to some other
non-audit services for the year-ending 30 September 20X5. Your audit firm was recommended to
Truckers Co by an existing client, O&P, a shipping company who is also a major customer of Truckers
Co.

You have been chosen to lead the engagement as you have experience of auditing haulage
companies as you also manage the audit of O&P.

Whilst arranging the initial meeting with the directors of Truckers Co you discover that you studied
accountancy with the finance director at university.

Truckers Co has not made a profit for the last two years. The directors explain that this is largely due
to escalating costs in the industry including fuel price rises. They are confident they have now
controlled their costs for the current year. They have also been approached to tender for a large
profitable contract which would improve the company’s financial performance going forward. They
would like you to assist them with the preparation of this tender and present with them on the day.

The prior year financial statements are being audited by another audit firm. The finance director tells
you that the current auditors have identified material misstatements but the board of directors are
refusing to make these adjustments. If adjusted, it would turn the break-even position into a loss.

The current auditors have replied to your professional clearance letter and have informed you that
they are still owed fees relating to the prior year.

You calculate that the potential fees from Truckers Co would amount to approximately 14% of your
firm's total fee income

Required:
a) Identify and explain THREE threats to objectivity if Whilling and Abel accept Truckers Co as a
new audit client. For each threat, recommend how the threat can be managed.
b) Explain the matters, other than ethical threats, that should be considered by Whilling and
Abel prior to accepting the engagement.

Answer
a) Threats and Possible Safeguards

Threats and safeguards Possible safeguard

The audit manager knows one of the directors A different audit manager should be assigned to
socially. This creates a familiarity threat. The the audit of Truckers Co.
auditor may be too trusting of the client or too
sympathetic to the client's needs
You are the audit manager of one of Trucker A different audit manager should be assigned to
Co’s major customers. This creates a conflict of the audit of Truckers Co. Different teams
interest where it may be difficult to act should be used for the audit of Truckers Co and
 objectively for both clients. In addition, there is O&P and the audit team members should sign
a risk that confidential information may be confidentiality agreements.
passed between the clients.
The audit manager has been asked to present at The auditor should politely decline the
the tender for a contract. This would create an invitation to present at the tender explaining
advocacy threat as the audit firm would be their reasons.
promoting the client.
The audit firm will provide nonaudit services in The audit firm should ensure separate teams
addition to the external audit. This represents a work on each engagement.
self-review threat. The audit firm may ignore or An independent partner review of the files for
overlook their own errors when auditing the each engagement should be arranged.
financial statements.
Total fees received from Trucker Co will Whilling & Abel should to attempt to reduce
represent 14% of the audit firm’s total income. dependency by increasing its client base. An
Fee dependence creates a self-interest threat. independent review of the audit work should be
The firm may not wish to raise issues with the arranged to ensure objectivity is not impaired.
client for fear of losing them.
If the client is a listed company, fee dependency
is presumed when fees exceed 15% for two
consecutive years.

b) Acceptance considerations

Professional clearance
Truckers Co has not paid the current audit firm for the prior year audit. Whilling and Abel should
consider whether it is advisable to accept the client as there could be a risk of irrecoverable debts in
the future.

Disagreements with the current auditors

The directors are refusing to make adjustments proposed by the current auditors which is cause for
concern as Whilling and Abel may encounter the same problems in future.

Integrity of management
The issues mentioned with regard to the current auditors suggest there may be a lack of management
integrity. This increases the risk of difficulties with the audit which may mean the audit is too high a
level of risk to accept.

Financial difficulties
Truckers Co has been loss-making for two years the most recent financial statements show a break-
even position which would be adjusted to a loss if management agreed to make the adjustments
proposed by the auditors. Truckers Co may be in financial difficulties which may mean the company
ceases to trade.

Preconditions for an audit

The audit firm must only accept audits where management has confirmed the preconditions are in
place, such as confirming responsibility for the preparation of the financial statements. If the
preconditions are not present, the firm must not accept the engagement.

Money laundering client due diligence

The audit firm must comply with money laundering regulations and perform client due diligence. If
the information gathered suggests a risk of money laundering, the firm must not proceed with the
engagement.

Competence
The audit firm must ensure it is competent to perform the work otherwise audit risk will be too high

Resources
The firm must assess whether it has sufficient resources available at the required time to perform
the engagement.
 Questions No. 5
You are the audit manager of Currant & Co and you are planning the audit of Orange Financials Co
(Orange), who specialize in the provision of loans and financial advice to individuals and companies.
Currant & Co has audited Orange for many years.

The directors are planning to list Orange on a stock exchange within the next few months and have
asked if the engagement partner can attend the meetings with potential investors. In addition, as the
finance director of Orange is likely to be quite busy with the listing, he has asked if Currant & Co can
produce the financial statements for the current year.

During the year, the assistant finance director of Orange left and joined Currant & Co as a partner. It
has been suggested that due to his familiarity with Orange, he should be appointed to provide an
independent partner review for the audit.

Once Orange obtains its stock exchange listing it will require several assignments to be undertaken,
for example, obtaining advice about corporate governance best practice. Currant & Co is very keen
to be appointed to these engagements, however, Orange has implied that in order to gain this work
Currant & Co needs to complete the external audit quickly and with minimal questions/issues.

The finance director has informed you that once the stock exchange listing has been completed, he
would like the engagement team to attend a weekend away at a luxury hotel with his team, as a thank
you for all their hard work. In addition, he has offered a senior member of the engagement team a
short-term loan at a significantly reduced interest rate.

Required
Identify and explain FIVE ethical threats which may affect the independence of Currant & Co’s audit
of Orange Financials Co, and

For each threat, recommend an appropriate safeguard to reduce the threat to an acceptable level.

Answer
Ethical threat Appropriate safeguard
Orange Financials Co (Orange) has asked the The engagement partner should politely decline this
engagement partner of Currant & Co to attend request from Orange, as it represents too great a threat
meetings with potential investors. to independence.

This represents an advocacy threat.

The audit firm may be perceived as promoting

investment in Orange and this threatens
objectivity.
Due to the stock exchange listing, Orange has As Orange is currently not a listed company then Currant
requested that Currant & Co produce the & Co are permitted to produce the financial statements
financial statements. and also audit them.
This represents a self-review threat. However, Orange is seeking a listing, therefore, ideally
The auditor may not detect errors in the Currant & Co should not undertake the preparation of the
financial statements they were responsible for financial statements as this would represent too high a
risk.
preparing, or, may not wish to admit to errors
that are detected. If Currant & Co chooses to produce the financial
statements then separate teams should undertake each
assignment and the audit team should not be part of the
accounts preparation process. The preparation must be
routine and mechanical in nature, therefore the audit
firm must not be responsible for selecting accounting
policies or determining accounting estimates.
The assistant finance director of Orange has This partner must not be involved in the audit of Orange
joined Currant & Co as a partner and has been until a cooling-off period has been served. An alternative
proposed as the review partner. review partner should be appointed.

This represents a self-review threat.

The new review partner will not be independent

and may not detect errors, or may not wish to
admit to errors that are detected in the financial
statements he was responsible for whilst in the
position of FD. He will also lack professional
skepticism.
Orange has several potential assurance The firm should assess whether these assignments,
assignments available and Currant & Co wish to along with the audit fee, would represent more than 15%
be appointed to these. of gross practice income for two consecutive years.
These assurance assignments will only arise if the
There is a potential self-interest threat as these company obtains its listing and hence will be a public
assurance fees along with the external audit fee interest company.
could represent a significant proportion of
Currant & Co’s fee income. If the recurring fees are likely to exceed 15% of annual
practice income then additional consideration should be
The firm may be reluctant to upset its client for given as to whether these assignments should be sought
fear of losing the work and associated fees. by the firm.

Fees will need to be discussed with the audit committee.

Orange has implied to Currant & Co that they The engagement partner should politely inform the
must complete the audit quickly and with finance director that the team will undertake the audit in
minimal questions/issues if they wish to obtain accordance with all relevant NSAs and the firm’s own
the assurance assignments. quality management procedures. This means that the
audit will take as long as is necessary to obtain sufficient,
This creates an intimidation threat on the team. appropriate evidence to form an opinion. If any residual
concerns remain or the intimidation threat continues
They may feel pressure to cut corners and not then Currant & Co may need to consider resigning from
raise issues, and this could compromise the the engagement.
objectivity of the audit team.
The finance director has offered the team a free Acceptance of goods and services, unless clearly trivial
weekend away at a luxury hotel. and inconsequential in value, is not permitted. As it is
unlikely that a weekend at a luxury hotel for the whole
This represents a self-interest threat. team has an insignificant value, then this offer should be
politely declined.
The audit team may feel indebted to the client
and reluctant to raise issues identified during
the audit.
Questions No. 6
Prizma Private Limited is tendering for an important contract to supply Om Shree Private Limited.
Both the companies are the audit client of OT Associates, Chartered Accountants. Prizma Private
Limited’s management has requested OT Associates to provide advice on the tender it is preparing.
What matters should OT Associates consider in deciding whether to provide advice to Prizma Private
Limited on the tender?

Answer
A potential conflict between the interest of two audit client arises from OT Associates offering advice
to Prizma Private Limited on the tender being presented to Om Shree Private Limited. A conflict of
interest may create potential threats to objectivity, confidentiality or other threats to compliance
with the fundamental ethical principles.

In this scenario, OT Associates faces the problem of potentially giving advice to one audit client in
relation to another audit client, which threatens objectivity. There may also be problem to do with
confidentiality of information, as either party could benefit from information obtained from the audit
firm about the other party. In dealing with conflicts of interest, the significance of any threats should
be evaluated and safeguards must be applied when necessary to eliminate the threats or reduce
them to an acceptable level. The most important safeguard is disclosure by OT Associates. The audit
firm should notify both Prizma Private Limited and Om Shree Private Limited of the potential conflict
of interest and obtain their consent to act.

Other possible safeguards include:

• The use of separate engagement teams
• Procedure to prevent access to information (for example, strict physical separation of such
teams, confidential and secure data filing).
• Clear guidelines for members of the engagement team on issues of security and
confidentiality.
• The use of confidentiality agreement signed by employees and partners of the firm and
• Regular review of the application of safeguards by a senior individual not involved with the
relevant client engagements
• OT Associates may decide having evaluated the threats and available safeguards, that the
threats can’t be reduced to an acceptable level, in which case the firm should decline from
giving advice to Prizma Private Limited regarding tender service.

Question No. 7

Discuss the circumstances that might create conflict of interest for professional accountants in
business. How do professional accountants address such conflicts of interests created?

Answer
Handbook of Code of Ethics for Professional Accountants, 2023 issued by the Institute, in Section
210, provides for conflicts of interest.

A conflict of interest creates threats to compliance with the principle of objectivity and might create
threats to compliance with the other fundamental principles.
Circumstances that might create conflict of interest for professional accountants in business

Following are some examples of circumstances that might create a conflict of interest include:
• Serving in a management or governance position for two employing organizations and
acquiring confidential information from one organization that might be used by the
professional accountant to the advantage or disadvantage of the other organization.
• Undertaking a professional activity for each of two parties in a partnership, where both
parties are employing the accountant to assist them to dissolve their partnership
• Preparing financial information for certain members of management of the accountant‘s
employing organization who are seeking to undertake a management buy-out.
• Being responsible for selecting a vendor for the employing organization when an immediate
family member of the accountant might benefit financially from the transaction.
• Serving in a governance capacity in an employing organization that is approving certain
investments for the company where one of those investments will increase the value of the
investment portfolio of the accountant or an immediate family member.

Addressing the Conflicts of Interests

A professional accountant in business shall take reasonable steps to identify circumstances that
might create a conflict of interest, and therefore a threat to compliance with one or more of the
fundamental principles. Such steps shall include identifying the nature of the relevant interests and
relationships between the parties involved, and the activity and its implication for relevant parties. A
professional accountant shall remain alert to changes over time in the nature of the activities,
interests and relationships that might create a conflict of interest while performing a professional
activity.

In general, the more direct the connection between the professional activity and the matter on which
the parties‘ interests' conflict, the more likely the level of the threat is not at an acceptable level.
Examples of actions that might be safeguards to address threats created by conflicts of interest
include
a) restructuring or segregating certain responsibilities and duties,
b) obtaining appropriate oversight, for example, acting under the supervision of an executive or
non-executive director.

It is generally necessary to disclose the nature of the conflict of interest and how any threats created
were addressed to the relevant parties, including to the appropriate levels within the employing
organization affected by a conflict; and obtain consent from the relevant parties for the professional
accountant to undertake the professional activity when safeguards are applied to address the threat.
If such disclosure or consent is not in writing, the professional accountant is encouraged to
documents

a) the nature of the circumstances giving rise to the conflict of interest;

b) the safeguards applied to address the threats when applicable; and
c) the consent obtained
Q. No. 7
It is 1 July 20X5. You are an audit supervisor of Caving & Co and you are planning the audit of Hurling
Co, a listed company, for the year ending 30 September 20X5. The company manufactures computer
components and forecast profit before tax is $33.6 million and total assets are $79.3 million.

Hurling Co distributes its products through wholesalers as well as via its own website. The website
was upgraded during the year at a cost of $1.1 million. Additionally, the company has recently
entered into a transaction to purchase a new warehouse which will cost $3.2 million. Hurling Co’s
legal advisers are working to ensure that the legal process will be completed by the year end. The
company issued $5 million of irredeemable preference shares to finance the warehouse purchase.

During the year the finance director has increased the useful economic lives of fixtures and fittings
from three to four years as he felt this was a more appropriate period. The finance director has
informed the engagement partner that a revised credit period has been agreed with one of its
wholesale customers, as they have been experiencing difficulties with repaying the balance of $1.2
million owing to Hurling Co. In June 20X5, Hurling Co introduced a new bonus based on sales targets
for its sales staff. This has resulted in a significant number of new wholesale customer accounts
being opened by sales staff. The new customers have been given favorable credit terms as an
introductory offer, provided goods are purchased within a two-month period. As a result, revenue
has increased by 5% on the prior year.

The company has launched several new products this year and all but one of these new launches
have been successful. Feedback on product Luge, launched four months ago, has been mixed, and
the company has just received notice from one of their customers, Petanque Co, of intended legal
action. They are alleging the product sold to them was faulty, resulting in a significant loss of
information and an ongoing detrimental impact on profits. As a precaution, sales of the Luge product
have been halted and a product recall has been initiated for any Luge products sold in the last four
months.

The finance director is keen to announce the company’s financial results to the stock market earlier
than last year and in order to facilitate this, he has asked if the audit could be completed in a shorter
timescale. In addition, the company is intending to propose a final dividend once the financial
statements are finalized.

Hurling Co’s finance director has informed the audit engagement partner that one of the company’s
non-executive directors (NEDs) has just resigned, and he has enquired if the partners at Caving & Co
can help Hurling Co in recruiting a new NED.

Specifically he has requested the engagement quality reviewer, who was until last year the audit
engagement partner on Hurling Co, assist the company in this recruitment. Caving & Co also
provides taxation services for Hurling Co in the form of tax return preparation along with some tax
planning advice. The finance director has recommended to the audit committee of Hurling Co that
this year’s audit fee should be based on the company’s profit before tax. At today’s date, 20% of last
year’s audit fee is still outstanding and was due to be paid three months ago.

A) Describe EIGHT audit risks, and explain the auditor’s response to each risk, in planning the
audit of Hurling Co.
 B) Identify and explain FIVE ethical threats which may affect the independence of Caving & Co’s
audit of Hurling Co, and for each threat, recommend an appropriate safeguard to reduce the
threat to an acceptable level.

Answer
A) Audit Risks and Risk Response

Audit Risks Auditor’s response

Upgrade of website Review a breakdown of the costs and agree to
Hurling Co upgraded its website during the year invoices to assess the nature of the expenditure
at a cost of $1.1m. The costs incurred should be and if capital, agree to inclusion within the
correctly allocated between revenue and asset register or agree to the statement of profit
capital expenditure. or loss.

Intangible assets and expenses will be The audit team should document the revised
misstated if expenditure has been treated system and undertake tests over the
incorrectly. completeness and accuracy of data recorded
from the website to the accounting records.
In addition, as the website has been upgraded,
there is a possibility that the new processes and
systems may not record data reliably and
accurately.

This may lead to a risk over completeness and

accuracy of data in the underlying accounting
records.
Warehouse acquisition Discuss with management as to whether the
warehouse purchase was completed by the
Hurling Co has entered into a transaction to year end. If so, inspect legal documents of
purchase a new warehouse for $3.2m and it is ownership, such as title deeds ensuring these
anticipated that the legal process will be are dated prior to 1 October 20X5 and are in the
completed by the year end. company name.

Only assets which physically exist at the year-

end should be included in property, plant and
equipment

If the transaction has not been completed by

the year end, there is a risk that assets are
overstated if the company incorrectly includes
the warehouse at the year end.

Irredeemable preference shares Review share issue documentation to confirm

that the preference shares are irredeemable.
Significant finance has been obtained in the Confirm that they have been correctly classified
year, as the company has issued $5m of as equity within the accounting records and
irredeemable preference shares. This finance
needs to be accounted for correctly, with that total financing proceeds of $5m were
adequate disclosure made. received.
As the preference shares are irredeemable,
they should be classified as equity rather than In addition, the disclosures for this share issue
non-current liabilities should be reviewed in detail to ensure
compliance with relevant accounting
Failing to correctly classify the shares could standards.
result in understated equity and overstated
non-current liabilities
Appropriateness of asset lives Discuss with the directors the rationale for any
extensions of asset lives and reduction of
The finance director has extended the useful depreciation rates. Also, the four-year life
lives of fixtures and fittings from three to four should be compared to how often these assets
years, resulting in the depreciation charge are replaced, to assess the useful life of assets.
reducing. Under IAS 16 Property, Plant and
Equipment, useful lives are to be reviewed
annually, and if asset lives have genuinely
increased, then this change is reasonable.

However, there is a risk that this reduction has

occurred in order to boost profits. If this is the
case, then fixtures and fittings are overvalued
and profit overstated.
Receivables valuation Review the revised credit terms and identify if
any after date cash receipts for this customer
A customer of Hurling Co has been have been made.
encountering difficulties paying their
outstanding balance of $1.2m and Hurling Co Discuss with the finance director whether he
has agreed to a revised credit period. intends to make an allowance for this
receivable. If not, review whether any existing
If the customer is experiencing difficulties, allowance for uncollectable accounts is
there is an increased risk that the receivable is sufficient to cover the amount of this receivable
not recoverable and hence is overvalued.

Sales-related bonus scheme Increased after date cash receipts testing to be

undertaken for new customer account
A sales-related bonus scheme has been receivables.
introduced in the year for sales staff, with a
significant number of new customer accounts Increased sales cut-off testing will be
on favorable credit terms being opened pre year performed along with a review of any post year-
end. This has resulted in a 5% increase in end returns as they may indicate cut-off errors.
revenue.

Sales staff seeking to maximize their current

year bonus may result in new accounts being
opened from poor credit risks leading to
irrecoverable receivables.
In addition, there is a risk of sales cut off errors
as new customers could place orders within the
two-month introductory period and
subsequently return these goods post year end.

Product recall Discuss with the finance director whether any

Hurling Co has halted further sales of its new write downs will be made to this product, and
product Luge and a product recall has been what, if any, modifications may be required with
initiated for any goods sold in the last four regards the quality.
months.
If there are issues with the quality of the Luge Testing should be undertaken to confirm cost
product, inventory may be overvalued as its and NRV of the Luge products in inventory and
NRV may be below its cost. that on a line by-line basis the goods are valued
correctly.

Provision for refunds Review the list of sales made of product Luge
prior to the recall, agree that the sale has been
Additionally, products of Luge sold within the removed from revenue and the inventory
last four months are being recalled, this will included. If the refund has not been paid pre
result in Hurling Co paying customer refunds. year-end, agree it is included within current
The sale will need to be removed and a refund liabilities.
liability should be recognized along with the
reinstatement of inventory, although the NRV of
this inventory could be of a minimal value.
Failing to account for this correctly could result
in overstated revenue and understated
liabilities and inventory.

Legal action Caving & Co should write to the company’s

Petanque Co, a customer of Hurling Co, has lawyers to enquire of the existence and
announced that it intends to commence legal likelihood of success of any claim from
action for a loss of information and profits as a Petanque Co. The results of this should be used
result of the Luge product sold to them. to assess the level of provision or disclosure
included in the financial statements.
If it is probable that the company will make
payment to the customer, a legal provision is
required. If the payment is possible rather than
probable, a contingent liability disclosure
would be necessary.

If Hurling Co has not done this, there is a risk

over the completeness of any provisions or the
necessary disclosure of contingent liabilities.
Audit timetable – detection risk The timetable should be confirmed with the
finance director. If it is to be reduced, then
The finance director has requested that the consideration should be given to performing an
audit completes one week earlier than normal interim audit to reduce the pressure on the final
as he wishes to report results earlier. audit.
A reduction in the audit timetable will increase The team needs to maintain professional
detection risk and place additional pressure on skepticism and be alert to the increased risk of
the team in obtaining sufficient and appropriate errors occurring.
evidence.
In addition, the finance team of Hurling Co will
have less time to prepare the financial
information leading to an increased risk of
errors arising in the financial statements.
Proposed dividend Discuss the issue with management and
confirm that the dividend will not be included
The company is intending to propose a final within liabilities in the 20X5 financial
dividend once the financial statements are statements.
finalized. This amount should not be provided
for in the 20X5 financial statements as the
obligation only arises once the dividend is The financial statements need to be reviewed to
announced, which is post year end. ensure that adequate disclosure of the
proposed dividend is included.
In line with NAS 10 Events After the Reporting
Date the dividend should only be disclosed. If
the dividend is included, this will result in an
overstatement of liabilities and
understatement of equity.

B) Ethical threats and appropriate safeguards

Ethical threat Appropriate safeguard

The finance director is keen to report Hurling The engagement partner should discuss the
Co’s financial results earlier than normal and timing of the audit with the finance director to
has asked if the audit can be completed in a understand if the audit can commence earlier,
shorter time frame. so as to ensure adequate time for the team to
gather evidence
This may create an intimidation threat on the
team as they may feel under pressure to cut If this is not possible, the partner should politely
corners and not raise issues in order to satisfy inform the finance director that the team will
the deadlines and this could compromise the undertake the audit in accordance with all
objectivity of the audit team and quality of audit relevant ISAs and quality management
performed standards. Therefore the audit is unlikely to be
completed earlier

If any residual concerns remain or the

intimidation threat continues, then Caving & Co
may need to consider resigning from the
engagement.
A non-executive director (NED) of Hurling Co Caving & Co is able to assist Hurling Co in that
has just resigned and the directors have asked it can undertake roles such as reviewing a
whether the partners of Caving & Co can assist shortlist of candidates and reviewing
them in recruiting to fill this vacancy. qualifications and suitability. However, the firm
must ensure that it is not seen to undertake
This represents a self-interest threat as the management decisions and so must not seek
audit firm cannot undertake the recruitment of out candidates for the position or make the final
members of the board of Hurling Co, especially decision on who is appointed.
a NED who will have a key role in overseeing the
audit process and audit firm.
The engagement quality reviewer (EQR) As Hurling Co is a listed company, then the
assigned to Hurling Co was until last year the previous audit engagement partner should not
audit engagement partner. be involved in the audit for at least a period of
five years. An alternative ECQR should be
This represents a familiarity threat as the appointed instead.
partner will have been associated with Hurling
Co for a long period of time and so may not
retain professional skepticism and objectivity.
Caving & Co provides taxation services, the Caving & Co should assess whether audit,
audit engagement and possibly services related recruitment and taxation fees would represent
to the recruitment of the NED. more than 15% of gross practice income for two
consecutive years.
There is a potential self-interest or intimidation If the recurring fees are likely to exceed 15% of
threat as the total fees could represent a annual practice income this year, additional
significant proportion of Caving & Co’s income consideration should be given as to whether the
and the firm could become overly reliant on recruitment and taxation services should be
Hurling Co. undertaken by the firm.

This could result in the firm being less In addition, if the fees do exceed 15%, then this
challenging or objective due to fear of losing should be disclosed to those charged with
such a significant client. governance at Hurling Co.

If the firm retains all work, it should arrange for

a pre-issuance (before the audit opinion is
issued) or post-issuance (after the opinion has
been issued) review to be undertaken by an
external accountant or by a regulatory body.
The finance director has suggested that the Caving & Co will not be able to accept
audit fee is based on the profit before tax of contingent fees and should communicate to
Hurling Co which constitutes a contingent fee. those charged with governance at Hurling Co
Contingent fees give rise to a self-interest threat that the external audit fee needs to be based on
and are prohibited under ICAN’s Code of Ethics the time spent and levels of skill and experience
and Conduct. of the required audit team members.

If the audit fee is based on profit, the team may

be inclined to ignore audit adjustments which
could lead to a reduction in profit.
 At today’s date, 20% of last year’s audit fee is Caving & Co should discuss with those charged
still outstanding and was due for payment three with governance the reasons why the final 20%
months ago. of last year’s fee has not been paid. A revised
payment schedule should be agreed which will
A self-interest threat can arise if the fees remain result in the fees being settled before any more
outstanding, as Caving & Co may feel pressure work is performed for the current year audit. The
to agree to certain accounting adjustments in auditor’s report for this year must not be issued
order to have the previous year and this year’s until the fees from last year have been paid.
audit fee paid
In addition, outstanding fees could be
perceived as a loan to a client which is strictly
prohibited.

Q. No. 8
The professional accountants/ or accounting firms in public practice may provide different non
assurance services to an audit client. Such non-assurance services may include accounting and
bookkeeping, valuation, tax audit, internal audit, and recruitment services etc. Explain, in brief, the
requirements that the professional accountants are expected to comply with to accept non
assurance services to an audit client.
Answer:
✓ Handbook of the Code of Ethics for Professional Accountants, 2023 issued by the ICAN sets
out the requirements in Section 600 for professional accounting firms and accountants for
providing non-assurance services to an audit client. As per Section 600, specific
requirements are discussed as below

✓ Firms are required to comply with the fundamental principles, be independent, and apply the
conceptual framework set out in Section 120 to identify, evaluate and address threats to
independence.

✓ Before accepting an engagement to provide a non-assurance service to an audit client, the

firm shall determine whether providing such a service might create a threat to independence.

✓ The firm should consider factors that are relevant in evaluating the level of threats created
by providing a non-assurance service to an audit client which include:
• The nature, scope and purpose of the service.
• The degree of reliance that will be placed on the outcome of the service as part of the
audit.
• The legal and regulatory environment in which the service is provided.
• Whether the outcome of the service will affect matters reflected in the financial
statements on which the firm will express an opinion,
• The level of expertise of the client’s management and employees with respect to the
type of service provided.
• The extent of the client’s involvement in determining significant matters of judgment.
• The nature and extent of the impact of the service, if any, on the systems that generate
information that forms a significant part of the client’s:
✓ Accounting records or financial statements on which the firm will express an opinion.
 ✓ Internal controls over financial reporting
• Whether the client is a public interest entity. For example, providing a non-assurance
service to an audit client that is a public interest entity might be perceived to result in
a higher level of a threat.
✓ A firm or network firm might provide multiple non-assurance services to an audit client. In
these circumstances the consideration of the combined effect of threats created by
providing those services is relevant to the firm’s evaluation of threats.
✓ A firm or a network firm shall not assume a management responsibility for an audit client.
Management responsibilities involve controlling, leading and directing an entity, including
making decisions regarding the acquisition, deployment and control of human, financial,
technological, physical and intangible resources.
✓ A non-assurance service provided, either currently or previously, by a firm or a network firm
to an audit client compromises the firm’s independence when the client becomes a public
interest entity unless:
• The previous non-assurance service complies with the provisions of this section that
relate to audit clients that are not public interest entities;
• Non-assurance services currently in progress that are not permitted under this section
for audit clients that are public interest entities are ended before, or as soon as
practicable after, the client becomes a public interest entity.
• The firm should address threats that are created and not at an acceptable level before
accepting any non-assurance engagements of the audit client.

Q. NO. 9
You are an audit manager at S&T Associates, a firm of Chartered Accountants. The Senior Partner of
S&T had summarized a number of matters he had identified for different clients and wants you to
help him to address them. You have been provided with the following summary of such matters:

✓ S&T has been invited to be the statutory auditors of Regent Ltd., a company listed in Nepal
Stock Exchange and is engaged in hospitality business. Mr. Suresh Pradhan, who is an
assurance partner of S&T is also a Director of Awas (Pvt) Ltd, which is controlled by Regent
Ltd.
✓ Enlight (Pvt) Ltd is an audit client of S&T and is in the tourism business. They had offered a
holiday package in a five-star hotel to the audit partner and his family. This is for a period of
one week with access to other facilities such as gym, spa, and bar.
✓ S&T had been providing internal audit services to Nature Cosmetics (Pvt) Ltd for over 5 years.
The Board of Directors of Nature Cosmetics (Pvt) Ltd has now invited S&T to be the statutory
auditor.
✓ Continental (Pvt) Ltd is an audit client of S&T. During the course of the current audit, the team
had noted inappropriate capitalization of interest costs on construction of a building even
after the building was made available for use for the said purpose. The interest cost
capitalized was material, but the client did not agree to adjust the financial statements or
agree to a qualification in the audit report. Further, the Managing Director had stated that the
Board of Directors will decide whether to reappoint S&T as statutory auditors, based on this
matter.
For each of the above scenarios, identify and assess the possible threats to independence of S&T
when complying with the fundamental and ethical principles, giving your reasons for each threat
identified. (2.5*4= 10 Marks)

Answer

Scenario Possible Threat/ Risk Explanation

New appointment and a Threat to Objectivity Since a partner is also a director of the
partner is a director of the and Self-interest risk subsidiary company of the potential audit
potential audit client’s client, there is a threat to the objectivity of
subsidiary company the auditor as it gives rise to a self-interest
risk

Further the Companies Act prohibits

appointing an audit firm when a partner is a
director of the potential audit client or
related entity of the potential audit client

If this appointment is to be accepted, the

assurance partner (Suresh Pradhan) will
have to agree to resign as a director;
otherwise, S&T cannot accept this client as
an audit client.
Audit client (Enlight (Pvt) Ltd) Threat to Objectivity The gift and hospitality treatment cannot
offered a holiday package in and Self-interest/ and be considered as a token of love and it is a
five-star hotel advocacy risk costly and exclusive offer to the audit
partner and his family. If it is accepted, it
will be a threat to the objectivity of the
auditor. As the audit partner gets
significant benefits, the audit client might
be able to influence the decisions of the
audit partner and make him take decisions
in the interest of the company
Internal audit client (Nature Self-review threat (i.e. If internal audit services are provided, the
Cosmetics (Pvt) Ltd) offering review of own work) auditor needs to understand whether the
for a statutory audit service work involved as the internal auditor would
be subject to the review as part of the audit.
In this case it is important to be aware of
the scope of the internal audit (e.g., if the
internal auditor has been involved in
designing and implementing the internal
controls over financial reporting, then
there is a threat of reviewing own controls.
If these controls were operational and had
no direct impact on the financial
statements, then the threat is reduced. The
significance of the threat and the
 safeguards that should be in place should
be assessed).
Inappropriate capitalization of Intimidation threat In this instance, the audit partner is
interests by the audit client threatened and there is a fear of losing the
and not agreeing to correct FS, audit client. If a good audit fee is generated
rather considering whether to it will have an impact on the audit firm. If
re-appoint that is the case, the firm will be under
pressure to issue an unmodified audit
opinion.