DAA 3023
AUDIT II
MAIZATUL AFFIAN BINTI ANIZAN
D2220071
DA SEMESTER 5
PUAN NURUL AINI BINTI MD RAIS
7 MAC 2025
QUESTION :
You are an external auditor at XYZ Audit Firm. Your firm has been engaged to audit the
financial statements of ABC Ltd., a mid-sized manufacturing company. During the audit,
you discover that the audit engagement partner, Mr. John, has a close personal friendship
with the CFO of ABC Ltd., Mr. Smith. They often socialize outside of work, and you
suspect that this relationship might affect the independence and objectivity of the audit.
Furthermore, you come across some questionable accounting entries related to revenue
recognition. When you raise concerns, Mr. John downplays the issue and suggests that you
should "not dig too deep" as ABC Ltd. is a valuable client.
1. Can the audit firm maintain independence when the engagement partner has a
personal relationship with the client’s CFO?
2. Should you comply with Mr. John’s suggestion or report the potential
misstatement?
3. If the issue is serious, should you report it to the regulatory authorities?
During the course of the audit of ABC Ltd.’s financial statements, several issues have
been identified that raise concerns about the independence of the audit and potential
misstatements in the financial records. This report addresses the key concerns, analyzes the
ethical implications, and outlines the necessary actions in accordance with professional
auditing standards.
Issue: The audit engagement partner, Mr. John, has a close personal friendship with the CFO
of ABC Ltd., Mr. Smith. They socialize outside of work, and this relationship may influence
the objectivity and independence of the audit.
Analysis: According to international auditing standards (such as the IFAC Code of Ethics for
Professional Accountants and AICPA Code of Professional Conduct), auditors are required to
maintain both actual and perceived independence in performing their duties. A personal
relationship between the engagement partner and the CFO of the client could create a conflict
of interest, whether or not it affects the actual objectivity of the auditor’s work.
Even the appearance of a conflict of interest can undermine public trust in the audit, and it
may lead to questions about the integrity of the audit process. A relationship of this nature
could result in unconscious bias or the perception that the auditor may not be impartial, which
could ultimately compromise the audit opinion.
Conclusion: The audit firm cannot maintain independence when the engagement partner has
a personal relationship with the client’s CFO. To preserve the integrity of the audit and
maintain public confidence, the firm should take steps to mitigate this conflict of interest.
2. Should You Comply with Mr. John’s Suggestion or Report the Potential
Misstatement?
Issue: While reviewing the financial statements, you discovered questionable accounting
entries related to revenue recognition. When you raised concerns, Mr. John downplayed the
issue, suggesting that you should not investigate further because ABC Ltd. is a valuable
client.
Analysis: As an external auditor, your primary responsibility is to ensure the integrity and
accuracy of the financial statements. If you suspect that there are misstatements or fraudulent
activities (such as improper revenue recognition), you are ethically and professionally
obligated to investigate further. The International Standards on Auditing (ISA 240) stress the
importance of identifying and addressing the risks of fraud, particularly in areas such as
revenue recognition, which is often a significant risk.
Mr. John’s suggestion to downplay the issue raises serious concerns. Ignoring or not pursuing
potential misstatements can lead to misleading financial statements, which could misinform
investors, regulators, and other stakeholders. Moreover, the auditor’s failure to act could
expose the firm to legal and reputational risks.
Conclusion: You should not comply with Mr. John’s suggestion to overlook the potential
misstatements. You have a duty to investigate and report any findings that could affect the
accuracy and fairness of the financial statements.
3. If the Issue is Serious, Should You Report It to the Regulatory Authorities?
Issue: If the questionable accounting entries are material and the issue is not addressed
adequately by the management of ABC Ltd. or the engagement partner, you must consider
whether the issue should be reported to regulatory authorities.
Analysis: In accordance with ISA 250 ("Consideration of Laws and Regulations in an Audit
of Financial Statements"), if the auditor uncovers evidence of non-compliance with laws or
regulations (such as fraud or material misstatements), the auditor has an obligation to report
the matter. If management refuses to address serious misstatements, or if the audit partner
fails to take appropriate action, the auditor may need to escalate the issue to regulatory
bodies.
Failure to report material issues could have serious consequences for the firm and undermine
the audit's credibility. Regulatory authorities such as the Financial Reporting Council (FRC),
the Securities and Exchange Commission (SEC), or other relevant bodies have the
responsibility to ensure that public companies adhere to financial reporting standards and
laws.
Conclusion: If the issue is material and management or the engagement partner fails to take
the necessary actions, the auditor may need to report the matter to the relevant regulatory
authorities to ensure compliance with the law and safeguard the integrity of the financial
reporting process.
The audit of ABC Ltd. presents significant concerns about both the independence of
the audit and the integrity of the financial statements. The personal relationship between the
engagement partner and the client’s CFO raises questions about the audit’s objectivity, and
the potential misstatements related to revenue recognition need to be investigated thoroughly.
To uphold the firm’s reputation and adhere to professional standards, it is essential to:
Remove the engagement partner from the audit and appoint an independent partner.
Investigate the questionable accounting entries in detail and document all findings.
Report the matter to the relevant regulatory authorities if the issue is not adequately
addressed by management or the engagement partner.
The audit process must be conducted with the highest level of professionalism, integrity, and
adherence to ethical standards to ensure that the financial statements of ABC Ltd. are fairly
and accurately presented.
Reference :
1) Public Company Accounting Oversight Board. (n.d.). ET 101 - Independence and
Ethics Rules. PCAOB. https://pcaobus.org/oversight/standards/ethics-independence-
rules/details/ET101
2) Investopedia. (n.d.). Audit. Investopedia. Retrieved March 13, 2025, from
https://www.investopedia.com/terms/a/audit.asp
3) Public Company Accounting Oversight Board. (n.d.). AS 3101: The auditor's report on
an audit of financial statements. PCAOB. Retrieved March 13, 2025, from
https://pcaobus.org/oversight/standards/auditing-standards/details/AS3101
4) OpenAI. (n.d.). ChatGPT. OpenAI. Retrieved March 13, 2025, from
https://chatgpt.com/
