(a)    Asp Co
Self-review threat
If Cobra & Co accepts the audit of Asp Co and continues to provide the other services, this would create a self-review threat to objectivity. This would arise because all of the other services would have an impact on the financial statements which Cobra & Co would then be responsible for forming an opinion on. Given the nature of the services, the impact on the financial statements would most likely be material.
The IESBA Code of Ethics for Professional Accountants (the Code) does not prohibit firms from providing bookkeeping and tax services to non-listed audit clients but requires that sufficient safeguards are implemented to reduce any threat to an acceptable level. The response should, however, be considered in light of the complexity of the other services and amount of judgement required in providing the other services, particularly in relation to the application of relevant tax regulations.
Management responsibility
Undertaking bookkeeping and taxation services on behalf of a client may require the service provider to make decisions on behalf of the client or may create the perception that the service provider is acting in a managerial capacity. If Cobra & Co were to assume such responsibility for an audit client, this would create a threat to their objectivity.
This is particularly relevant for a small company such as Asp Co where management is more likely to rely on Cobra & Co for advice. To avoid the risk of assuming a management responsibility, the firm should ensure that Asp Co has procedures in place to ensure that the management team makes all judgements and decisions including:
– designating an individual who possesses suitable skill, knowledge and experience to be responsible for the client’s decisions and to oversee the services being provided;
– provision of oversight of the services and evaluation of the results of services performed for the client’s purposes; and
– accepts responsibility for the actions to be taken as a result of the services.
If all the services currently provided to Asp Co are administrative and routine, then the threat will be minimal. If, however, Cobra & Co assumes any responsibilities normally carried out by management, then the Code states that this threat is so significant that no safeguards can reduce this to an acceptable level.
Audit of financial statements for 31 July 2017
Cobra & Co has already had significant involvement in the preparation of amounts which have been included in the financial statements for this year end and they may have already applied significant judgement in determining those figures, particularly in relation to any tax amounts or liabilities. Given this heightened risk, as well as using a separate team to do the audit, it would be prudent to ensure that an engagement quality control review is carried out prior to signing the auditor’s report.
Actions
If Cobra & Co accepts the audit engagement, they will need to use different staff to undertake the audit to those involved in the other services. Cobra & Co must ensure that they have sufficient staff with the necessary competence within the firm to enact such segregation of duties and they must ensure that the client understands that different teams will be used for the various services provided.
If Cobra & Co has been responsible for any managerial decisions, they must cease this if they accept the audit engagement. However, it is likely that the firm would have to wait a period of time before they would be able to audit the financial statements, as even if they cease to assume management responsibility in the current year, the firm will have influenced the financial statements for the year ended 31 July 2017. They should communicate this to the management of Asp Co and obtain written confirmations from the client that they understand and accept this. If this requires any change in the nature of the engagements provided, new engagement letters must be issued and signed before the services can be continued.
(b)    Viper Co
Self-review threat
Once again, providing both audit and tax services creates a self-review threat to objectivity, but as Viper Co is a non-listed client, Cobra & Co may accept the assignment provided sufficient safeguards are implemented. However, the issue identified in relation to the outgoing auditor does raise concern as to whether these engagements should be accepted.
Acceptance procedures
ISA 220 Quality Control for an Audit of Financial Statements requires that Cobra & Co obtains sufficient information to consider a range of matters before accepting an audit engagement. One of the matters is considering the integrity of the owners and management of the client. One such procedure to obtain this information is to communicate with the outgoing auditor.
If the engagement partner is not satisfied that they have obtained sufficient information and that they have not concluded sufficiently rigorous procedures to investigate this matter, they should not accept the engagement.
Previously modified opinion
It appears that the management of Viper Co has had a significant disagreement with their outgoing auditor over a certain accounting treatment. This raises a number of separate issues:
– If management is applying an incorrect accounting treatment and the effect on the financial statements is material, it will lead to a modification in future periods. If management does not accept their responsibility to apply appropriate accounting treatment, then the preconditions for accepting the audit, as prescribed in ISA 210 Agreeing the Terms of Audit Engagements, will not have been met. In these circumstances Cobra & Co must not accept the engagement.
– There is a doubt over the integrity of management as they appear to have disagreed with the auditor, an expert in the application of financial reporting standards, over an accounting treatment. This may indicate an unwillingness to accept financial reporting requirements or a conscious effort to distort the financial statements. Either way, if Cobra & Co is not satisfied as to the integrity of management, they should not accept the engagement.
– The lawsuit indicates that Viper Co believes that they are correct and that the auditor is incorrect in the matter disputed. This may indicate that, contrary to the previous point, management is not at fault. If this is the case and the auditor is indeed negligent, then there is no reason for Cobra & Co to refuse the engagement.
Actions
Cobra & Co should try to obtain further information from management relating to the lawsuit. It is likely that in these circumstances additional expertise has been sought to determine if the auditor has acted negligently or not. If this is the case, Cobra & Co should request to see any communications with the experts, if permitted.
If not, Cobra & Co should request to review information relating to the matter under dispute. Cobra & Co should be able to use their own expertise to determine an appropriate accounting treatment.
If, following these procedures, Cobra & Co decides that they can proceed with the engagement they should first of all consult with their own legal team, or at least with senior partners responsible for executive decisions, before accepting given the potentially litigious nature of Viper Co.
If Cobra & Co determines that Viper Co is incorrect or that there is insufficient information to enable a satisfactory conclusion, then it would be prudent in the circumstances to politely decline the engagement.
(c)    Adder Co
Conflict of interest
The Code defines a conflict of interest as arising when a firm provides a service in relation to two or more clients whose interests in respect of the matter are in conflict.
In this case, the interests of Adder Co and Slowworm Co will be conflicting; Adder Co will want to purchase the shares for the lowest possible amount and the owner of Slowworm Co will want to sell them for the highest possible amount. This creates, therefore, a significant threat to the objectivity of Cobra & Co, who may be seen to be acting in the interest of one party at the expense of the other.
The problem is exacerbated by the nature of the engagement; Adder Co will use information about the company, including operational information, to bargain over the price. Cobra & Co may be privy to private information gained during their time as auditor of Slowworm Co which Adder Co might not have become aware of during normal due diligence procedures. If Cobra & Co were to divulge this to Adder Co, it would give them a potentially unfair advantage over the other client and would be a breach of confidentiality.
Self-review threat
Performing the valuation service for Adder Co would also create a self-review threat because Cobra & Co would have a significant influence over the valuation of Slowworm Co, which would consequently be used to consolidate their accounts into the new, enlarged group which Cobra & Co would be responsible for auditing in the future.
Actions
It is possible to reduce both the conflict of interest and self-review threats by using different teams to conduct the various services provided.
The Code stipulates, however, that a firm should not provide valuation services for a listed client if the valuation has a material effect on the financial statements which are consequently audited.
​​​​​​​Therefore, before accepting the assignment, Cobra & Co should consider the potential impact of the transaction and, if they believe it will be material, they should politely decline the engagement.