Turks and Caicos Islands Community college

 


Question 1
The following are situations that may violate the Code of Professional Conduct. Assume, in each case, that the CPA is a partner. Discuss whether the facts in any of the situations indicate violations of the Code of Professional Conduct. If so, identify the nature of the violation(s).

A. Contel, CPA, advertises in the local paper that his firm does the audit of 14 of the 36
largest community banks in the state. The advertisement also states that the average
audit fee, as a percentage of total assets for the banks he audits, is lower than any
other CPA firms in the state.

B. Davis, CPA, sets up a small loan company specializing in loans to business executives
and small companies. Davis does not spend much time in the business because he
spends full time with his CPA practice. No employees of Davis’s CPA firm are
involved in the small loan company.

C. Elbert, CPA, owns a material amount of stock in a mutual fund investment company,
which in turn owns stock in Elbert’s largest audit client. Reading the investment
company’s most recent financial report, Elbert is surprised to learn that the
company’s ownership in his client has increased dramatically.

D. Able, CPA, owns a substantial limited partnership interest in an apartment building.
Frederick Marshall is a 100% owner in Marshall Marine Co. Marshall also owns a
substantial interest in the same limited partnership as Able. Able does the audit of
Marshall Marine Co.

E. Baker, CPA, approaches a new audit client and tells the president that he has an idea
that could result in a substantial tax refund in the prior year’s tax return by application of a technical provision in the tax law that the client had overlooked. Baker
adds that the fee will be 50% of the tax refund after it has been resolved by the
Internal Revenue Service. The client agrees to the proposal.        (15 marks)


Question 2

You are an audit senior at Branche & Co and have been allocated to the audit of Mello Vibes Co (Mello), a listed company which has been an audit client for eight years and specializes in manufacturing musical instruments.

Beverly Oak was the audit engagement partner for Mello and as she had completed seven years as the audit engagement partner, she has recently been rotated off the audit engagement. The current audit partner, Sandeep Pine, has suggested that to maintain a close relationship with Mello, Beverly should undertake the role of independent review partner this year. In addition, Mello has requested that Beverly assist them by attending their audit committee meetings, as a non-executive director has recently left the company. Mello has also asked Sandeep and the other partners at Branche & Co to help them in recruiting a new non-executive director.

The total fees received by Branche & Co for last year equated to 16% of the firm’s total fee income. The current year’s audit fee has not yet been confirmed, but along with taxation and other possible non-audit fees the total income from Mello this year could be greater than for last year. Last year’s audit fee was being paid monthly by Mello, but no payments have been made for the last three months. The audit manager for Mello has just announced that he is leaving Branche & Co to join Mello as the financial controller.


(i)   Identify and explain FIVE ethical threats which may affect the independence of Branche & Co’s audit of Mello Vibes Co; and (10 marks)
(ii)  For each threat explain how it might be reduced to an acceptable level.  (15 marks)

 

 

Ethical Threats and Safeguards (25 Marks)

 

 

(i) Identify and Explain FIVE Ethical Threats (10 Marks)

 

The audit engagement faces several significant ethical threats under the IESBA Code of Ethics (or equivalent) due to the firm's long association, fee concentration, personnel changes, and service requests.

Ethical ThreatExplanation
1. Familiarity Threat (Long Association)Mello has been an audit client for eight years. This long tenure risks the audit team, including the former engagement partner, becoming too sympathetic to Mello's management. This familiarity can lead to a loss of professional skepticism, making the team less likely to objectively challenge management’s judgments.
2. Self-Review Threat (Former Partner as Reviewer)The proposal for Beverly Oak (the former engagement partner of seven years) to act as the Independent Review Partner is highly problematic. Having just finished a long tenure as the key decision-maker, she would be reviewing her own judgments and work, impairing her objectivity.
3. Self-Interest Threat (Fee Dependence)The total fees received from Mello last year equated to 16% of the firm's total fee income, exceeding the typical independence threshold of 15%. This creates a significant financial dependence on the client. The firm might fear losing Mello and, consequently, may not challenge management effectively, compromising professional skepticism.
4. Intimidation/Familiarity Threat (Former Manager joins Client)The immediate departure of the audit manager to become Mello's Financial Controller creates a strong familiarity threat. This close personal relationship can compromise the objectivity of the remaining audit team, who may be hesitant to challenge the judgments of a former colleague now in a key financial reporting role. The client's management is now intimately familiar with the firm's audit procedures and personnel.
5. Self-Interest/Advocacy Threat (Recruitment and Attendance)Mello asking the firm to assist in recruiting a new non-executive director (NED) and asking the former partner to attend audit committee meetings creates a complex threat: The firm acts as an advocate for the client (recruitment) and gets too close to management (attendance), blurring the lines between audit assurance and management function.

 

(ii) Explanation of Safeguards (15 Marks)

 

For each identified threat, the firm must implement safeguards to reduce the threat to an acceptable level, maintaining independence and objectivity.

Ethical ThreatSafeguard and Explanation
1. Familiarity Threat (Long Association)Partner Rotation and Cooling-Off Period: The rotation of Beverly Oak after seven years is mandatory and effective. However, the firm must ensure the entire audit team has not served too long. The primary safeguard is to enforce a strict cooling-off period for the former partner, Beverly, prohibiting her from taking any role that involves the audit for at least two years (or the required period in the jurisdiction, often five years for partners).
2. Self-Review Threat (Former Partner as Reviewer)Strict Prohibition on Reviewer Role: The firm must prohibit Beverly Oak from undertaking the role of Independent Review Partner (IRP) or any quality control role related to Mello. The IRP role must be filled by a partner who is not associated with the Mello audit team, has no previous financial relationship with the client, and has sufficient experience to objectively review the new partner's work.
3. Self-Interest Threat (Fee Dependence)External Quality Control Review: Given the 16% fee concentration, the firm must arrange for a pre-issuance independent external quality control review of the audit. This review, conducted by a CPA firm or a regulatory body, would ensure the audit conclusions and opinion are not influenced by the fee dependency. Additionally, the firm must actively explore increasing its client base to reduce fee concentration below the 15% threshold in the subsequent year.
4. Intimidation/Familiarity Threat (Former Manager joins Client)Modifying the Audit Plan and Assigning New Personnel: The firm must immediately change the core audit team members who worked closely with the departing manager. The audit plan should be modified to include higher professional skepticism in areas where the former manager was heavily involved (e.g., control testing, estimates). The remaining team should receive specific training to ensure they understand their obligation to challenge the new financial controller's judgments.
5. Self-Interest/Advocacy Threat (Recruitment and Attendance)Decline Recruitment and Restrict Partner Contact: Decline the request to assist in recruiting the NED, as providing such a service constitutes an advocacy threat and involves taking on a management responsibility. The firm must also prohibit the former partner, Beverly, from attending audit committee meetings in any capacity. Contact between partners and the client should be restricted to matters necessary for the audit, ensuring the firm maintains a distance appropriate for an objective external auditor.

Sample Answer

 

 

 

 

 

 

Code of Professional Conduct Violations (15 Marks)

 

This discussion assumes the CPA is subject to the AICPA Code of Professional Conduct or an equivalent international code (such as the IESBA Code) regarding Independence, Integrity, Objectivity, and Advertising.

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