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Tesleem Adelodun (ACCA)




Non compliance
Non-compliance refers to acts of omission or commission by the entity, either intentional
or unintentional which are contrary to the prevailing laws or regulations.
Companies are subject to many laws and regulations for example:

Company law

Employment law

Income tax law

Labour law

Environmental Protection law etc.

Responsibilities of Management and Auditors regarding laws and regulation
Management is responsible for the prevention, detection and correction of noncompliance with laws and regulations.
The following policies and procedures may be implemented by the management in order
to prevent and detect non-compliance with laws and regulations:
1. Maintain a register of significant laws with which the entity has to comply.
2. Engage legal advisors to assist in monitoring legal requirement.
3. Institute and operate appropriate system of internal controls.
4. Develop, publicize and follow a code of conduct.
As with fraud, the auditors are not, and cannot be held responsible for preventing noncompliance but they should aim to be aware of those that could materially affect the
Financial Statements. There is unavoidable risk that some material misstatements in the
financial statements go undetected even though the audit is properly planned and

Tesleem Adelodun (ACCA)




Audit Procedures to identify non-compliance with laws and regulations
1. The auditor should obtain general understanding of the laws and regulations
affecting the entity, which includes procedures such as:
 Use the auditor’s existing understanding of the entity’s industry, regulatory and
other external factors.
 Enquire of management as to the laws and regulations that may be expected
to have a material effect on the operations of the entity.
 Enquire of management concerning the entity’s policies and procedures
regarding compliance with laws and regulations.
 Enquire of management the policies or procedures adopted for identifying,
evaluating and accounting for litigation claims.

2. The auditor should obtain sufficient appropriate audit evidence of compliance with
other laws and regulations such as entity’s license to operate (non-compliance
may doubt going concern) that may have a fundamental effect on operations of
the entity.

3. The following procedures may indicate the instances of non-compliance such as:
 Reading minutes
 Enquiring from the company’s and external legal advisors.
 Performing substantive tests of details of classes of transactions, accounts
balances and disclosures.

4. The auditor should obtain written representation from management and those
charge with governance that they have informed auditor about all known and
suspected non-compliance.

Tesleem Adelodun (ACCA)




Audit procedures when non-compliance is identified:
In such a case the auditor shall obtain:
1. An understanding of the nature of the act and the circumstances in which it has
2. Further information to evaluate the possible effect on the financial statements.
When evaluating the possible effect on the financial statements the auditor should
consider the following:
 Potential financial consequence such as fines and penalties.
 Whether potential financial consequence require disclosure
 Impact on the auditor’s report.
When non-compliance is identified the auditor should:
 Reassess the risk.
 Reassess the validity of written representation.
 Take independent legal advice.
In exceptional cases the auditor may consider whether withdrawal from the engagement
is necessary.
Reporting of identified or suspected non-compliance

Communicate to those charged with governance, unless they themselves are

If management and those charged with governance are involved consider
reporting to next level of authority like audit committee.

Where no higher authority exists, or if the auditor believes that the communication
may not be acted upon or is unsure as to the person to whom to report, the
auditor shall consider the need to obtain legal advice

Tesleem Adelodun (ACCA)




Impact of non-compliance on the auditor’s report
 When non-compliance is material and not adequately disclosed in the financial
statement the auditor shall express qualified opinion or adverse opinion.
 When the auditors is precluded by the management and those charged with
governance from obtaining sufficient appropriated audit evidence than the auditor
should express a qualified opinion or disclaim an opinion on the basis of limitation
of scope.
Reporting non-compliance to regulatory authority
If the auditor is precluded by management or those charged with governance from
obtaining sufficient appropriate audit evidence to evaluate whether non-compliance that
may be material to the financial statements has, or is likely to have, occurred, the auditor
shall express a qualified opinion or disclaim an opinion on the financial statements on the
basis of a limitation on the scope.
Consideration of withdrawal from the Engagement
The auditor may conclude that withdrawal from the engagement is necessary when the
entity does not take the remedial action that the auditor considers necessary in the
circumstances, even though the noncompliance is not material to the financial
statements. Non-compliance with regulation cast doubt on the integrity of the

Money laundering is the process by which criminals attempt to conceal the true origin
and ownership of the proceeds of their criminal activity. In order to be able to spend
money openly, criminals will seek to ensure that there is no direct link between the
proceeds of their crime and the actual illegal activities.

Tesleem Adelodun (ACCA)




Factors indicating money laundering:
 Transactions routed through several jurisdiction.
 High level of secrecy over transactions.
 Excessive use of wire transfers
 High value deposits or withdrawals not characteristics of the type of account
 A pattern that after a deposit, the same amount is wired to another financial
The three stages of the money laundering process


Layering.; and


Anti-money laundering procedures
The firm must gather know your client information (KYC) to assist in spotting suspicious
transactions. This includes:
1. Who the client is
2. Who controls it
3. The nature of the client
4. The client’s sources of funds
5. The client’s business and economic purposes.
In the UK, the basic requirements are for accountants to keep records of client’s identity
and to report suspicions of money laundering to the Serious Organized Crime Agency

Tesleem Adelodun (ACCA)




Elements of basic money laundering program
1. Appoint Money Laundering Reporting Officer (MLRO).
2. Train the individuals to ensure that they are aware of relevant legislation, know
how to deal with potential money laundering, how to report suspicions to MLRO.
3. Establish internal procedures such as know your client and client acceptance
procedures to prevent money laundering.
4. Verify the identity of new and existing clients and maintain evidence of
5. Maintain records of identification, and any transactions undertaken for or with the
6. Report suspicions of money laundering to SOCA.
1. Concealing and tipping off (MLRO or any individual discloses something that
might prejudice any investigation) is itself a criminal offence.
2. The obligation to report money laundering act does not depend on the amount
involved or the seriousness of the offence.
The need for ethical guidance on money laundering
This is needed because there is a clear conflict between the following two situations:
1. The accountants’ professional duty of confidentiality in relation to client’s
business, and
2. The duty to report suspicions of money laundering to the appropriate authorities
as required by law.
Professional accountants are not in breach of their professional duty of confidentiality if
they report in good faith their knowledge or suspicions of money laundering to the
appropriate authority.
Disclosure without reasonable grounds would possibly lead to the accountants being
sued for breach of confidence.
Tesleem Adelodun (ACCA)




The auditor is advised to always seek legal clarification as regards money laundry
A) Comment on the need for ethical guidance for accountants on money laundering.
(4 marks)
B) The Financial Action Task Force on Money Laundering (FATF) recommends
preventative measures to be taken by independent legal professionals and accountants
(including sole practitioners, partners and employed professionals within professional
Describe FOUR measures that assist in preventing professional accountants from
being used for money laundering purposes.
(8 marks)
Part A
1) In a jurisdiction where money laundry constitutes criminal offence, accountants
need guidance on the correct interpretation of the laws relating to money laundry. This
is because accountants are not lawyers and may lack technical understanding of the
money laundry laws.
2) Further guidance is needed to explain the interaction between accountant’s
responsibilities to report money laundering offences according to the law and auditor’s
responsibility to report to those charged with governance.
3) If he resigns from an engagement as a result of money laundry suspicion, auditor
needs guidance is responding to the clearance letter regarding any necessary
4) Where there is conflict between the legal responsibility and professional
responsibility as regards disclosure of information, accountants need guidance on
which of the responsibilities overrides another.

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Part B
1) Audit firm should appoint a compliance officer with suitable level of seniority and
The compliance officer will be responsible for:
 receiving and assessing money laundering reports from colleagues
 making reports to the relevant agency
2) The audit firm should ensure there is adequate training of its staff regarding:
 relevant money laundering legislation
 ethical and professional guidance relating to the responsibilities of
accountants regarding money laundry
 how to report money laundry suspicions
3) Firms should Perform customer due diligence before accepting an engagement.
Firms should verify the following:
 the ownership structure of the client
 the identities of the major shareholders
 the identities of the directors
 the nature of transactions of the client
4) The firm should maintain adequate records of the client including details of its

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ACCA members are expected to carry out their work with due skill and care while giving proper
regards to technical and professional standards.
Auditors are not only required to be ethical but they must be seen to be ethical. It is on this note
that ACCA publishes rules of professional conduct which all members and students must adhere
The fundamental principles

Members should strive to be objective in all professional and


business judgments.

Professional behavior

Members should desist from any act that can bring disrepute to






Members should be straightforward and honest in their


Auditors should not disclose client’s information to a third party

the accounting profession.






knowledge that will enable them to competently carry out their

professional dealings.

without due permission from the client.

Threats to the fundamental principles

(AFISS) - These are situations that make auditor not

to adhere to the fundamental ethical codes.


This is a situation where the auditor finds himself in a position he has


This threat arises as a result of the auditor becoming unduly


This threat arises when the auditor comes under intimidation by

Self interest

This arises when personal interest of the auditor conflicts with that of

Tesleem Adelodun (ACCA)

to defend or promote the interest of its client before a third party.

sympathetic towards its client as a result of long association

dominant individual or aggressive atmosphere at the clients

the client



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This threat arises when the auditor has to review or audit the work
that he helps to carry out.

Gift and hospitality
This may create self-interest and familiarity threat. The IESBA code of ethics states that when a
firm or a member of the assurance team accepts gift and hospitality, unless the value is clearly
insignificant, the threat to independence cannot be reduced to acceptable level by applying
appropriate safeguards, so the firm or team member should decline the gift and hospitality.
Possible safeguards:
 Inform the client’s management
 Seek legal advice
 Inform the auditor’s professional body to seek for advice

Audit firm carrying out actuarial service for clients
Going by IESBA code of ethics, provision of actuarial service and other valuation services may
give rise to self-review threat.
If the service involves evaluating matters that are material to the financial statement and the
valuation involves a high degree of subjectivity, the threat to objectivity and independence cannot
be reduced to an acceptable level by applying appropriate safeguards. The service should
therefore not be provided, or the audit firm should withdraw from the engagement if it wants to
carry out the service.
Possible safeguards:
 Audit firm should ensure that members doing the valuation work are not part of the audit
 Auditor should obtain management’s acknowledgement that it is responsible for the result
of the valuation
 Audit work done for the client should be reviewed by an independent accountant

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Audit firm offering internal audit services to client
Offering of this service may result in self-review threats to objectivity. To reduce the threat to an
acceptable level, the firm should ensure that management is ultimately responsible for the control
and management of internal audit.
Possible safeguards:
 The client should acknowledge that it is responsible for establishing and monitoring the
system of internal controls
 The scope of work to be done should be set by the client’s management
 The audit firm should ensure that members responsible for the internal audit service are
not part of the assurance team.
Contingent fee
This is a situation whereby the auditor’s fee depends on the outcome of uncertain future event.
IESBA code of ethics out rightly prohibit contingent fee for audit engagement. It creates selfinterest threat to objectivity. No level of safeguards will be adequate in this regards, contingent
fee arrangement should be rejected by audit firm.
Long association with audit client
This may lead to familiarity threat. The auditor may not see anything wrong in what the client is
doing now because it has always got things right in the past. This makes the auditor to lose his
professional skepticism as a result of the close relationship. It may equally lead to self-interest
threat because the auditor does not want to lose a source of income.
For listed clients, the IESBA code requires the key audit partner to be rotated after 7 years and
should not be involve in the audit for 2 years.
Recruitment of staff on behalf of audit clients
Provision of this service is not prohibited by the IESBA code. It could however lead to the
following threats:
 Self-interest threat. This is because the firm will want to protect its fee income from the
recruitment. The firm may compromise quality in order to earn its own fee
 Self-review threat. If the staff recruited is responsible for the financial statement, this will
amount to the firm auditing its own work.
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 Familiarity threat. The interaction made during the process of interview will create
familiarity with the staff. The firm may be less critical of the work of such employee based
on the impression created by the employees during the interview.
 Management threat. Recruitment of staffs is management’s responsibility. Offering of this
service will amount to making management decision and auditors are not allowed to be
acting in management’s capacity
Possible safeguards:
 Request management to acknowledge that it is responsible for the recruitment of staff
 The firm should only make recommendation, the selection should be made by the
 The fee charged should be disclosed to the audit committee
Temporary staff assignment
This is a situation whereby staffs of audit firm are temporarily assigned to work in a client. This
arrangement will lead to the following threats to objectivity and independence:
 Management threat. Depending on the seniority of staff and the position they are
assigned to work, the assigned staffs may be making management decision. In no way
should auditor be making management decision. It will lead to self-review threat because
the auditor will be part of the system he set out to audit.
 Self-review threat. The seconded staffs will be auditing the work they help to prepare and
may never want to fault their own work. The other staffs of the firm on the audit team may
not want to fault the work prepared by their colleagues.
 Familiarity threat. The seconded staffs will be familiar to the members of the audit team
and as a result the team may not be performed the audit with required level of
professional skepticism.
Possible safeguards:
 The firm should ensure the seconded staffs do not take on management role or take any
management’s decision.
 Seconded staffs should not be included in the audit team to the client
 Audit work performed should be reviewed by an independent accountant

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Financial interest in an audit client
Auditors are not allowed to have financial interest in audit client as the following threats as it
could lead to self-interest threat to objectivity. This threat is so enormous that it may not be
surmounted by safeguards in place.
The auditor should dispose of the investment in order to continue with the audit. If the auditor
is interested in keeping his investments in the client, the he must resign as the auditor.
Preparing financial statement for audit client
Auditors are prohibited from preparing financial statements for public entities (listed clients).
However, auditors may prepare financial statements for non-listed entities provided adequate
safeguards are in place to mitigate the effect of the threats. Offering this service will lead to
the following threats:
 Self-review threats: auditor will be reviewing his own work if the financial statements
being audited are prepared by him
 Self-interest threat: the fees charged for the service constitute self-interest threat. The
fee charged for this service may increase the percentage of total fees from the client
to more than 15% of income of the auditor.

 Use of separate engagement team. The team that prepares the financial
statement should not audit it.
 Review of the work done by an independent accountant.

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Question DEPECHE
You are a manager in Depeche, a firm of Chartered Certified Accountants. You have
specific responsibility for undertaking annual reviews of existing clients and advising
whether an engagement can be properly continued. The following matters arose in
connection with the audit of Duran, a company listed on a stock exchange, for the
year to 31 December 2008:

The audit team included a manager, two supervisors, two qualified seniors
and six trainees. The final audit, which lasted approximately five weeks, was
very time-pressured and the team worked late into the night towards the end
of the audit. Duran’s staffs were very supportive throughout and paid for
evening meals that were brought in so that the audit team could work with
minimum disruption.


Duran’s chief finance officer, Frankie Sharkey, was so impressed with the
commitment of the audit staff that he asked that Depeche pay them all a
bonus through an increase in the audit fee. In April 2009, Depeche paid all
the members of the team below manager status a bonus amounting to a
week’s salary. The bonus was processed through Depeche’s payroll, in the
same way as overtime payments, and recharged to Duran as part of audit


One of the points initially drafted for possible inclusion in the report to the
company’s audit committee concerned the illegal dumping of drums,
containing used machine oil, on nearby wasteland. Notes of discussions
between the audit manager and Frankie show that it is the company’s
unwritten policy to disregard the local environmental regulations and risk
incurring the fines, which are only small, as it would be costly to use the
nearest licensed disposal unit. The matter is not referred to in the final report.

(a)Comment on the ethical and other professional issues raised by each of the above
matters. (10 marks)
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(b)Discuss the appropriateness of available safeguards and advise whether or not
Depeche should continue as the auditor to Duran.
(15 marks)
Part A

Hospitality-client paying for evening meals

Hospitality is prohibited for audit client unless it is clearly insignificant

Depeche will have to determine if the meal is significant to pose a threat to
the objectivity of its staff. While the meal may not be significant to the audit
seniors, it may have serious significance on the objectivity of the juniors.

Depeche is unlikely to be seen as objective given that it has accepted the
hospitality. Instead, Depeche could have made arrangement for its own
meal knowing the team could work late.


Financial reward

The bonus was not accepted in respect of the audit manager’s
involvement. Therefore there is no obvious threat to his objectivity.

The bonus may be perceived to be a reward (or “bribe”) for having not
detected or reported on a matter and acceptance of it may cast doubt on the
audit team’s integrity.

The increase in audit fee as a result of the bonus should be included in the
amount disclosed in the note to the financial statements as auditors’

If the audit team had any expectation that a bonus might be awarded to
them it is likely that there will be a perception that their objectivity could
have been impaired.

That the bonus was not accepted at the manager level suggests that this
was considered to be a threat to objectivity. This consideration and the
decision to accept the bonus for other staff should have been

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Illegal dumping of drums

Frankie Sharkey’s intentional dumping of drums shows that management
of the company has no regard for environmental regulation. This cast
doubt on the integrity of the management. Depeche will have to reexamine the validity of previous representation made by the management
to determine the extent of reliance that can be placed on such
Depeche should evaluate the financial implication of the breach and
determine if provision or disclosure is required in the financial statement.
The illegal dumping with the financial implication should be communicated
to those charged with governance. The fact that management intentionally
breaches environmental regulation should be equally communicated.

Available safeguards

The audit staff that collected the bonus should be removed from
the audit team.

The partner’s decision to accept the bonus should be investigated
by other partners in the firm.

To prevent future ambiguity, the firm should have a system in place
to determine the significance of hospitality

Audit work already performed should be reviewed by a partner who
was not part of the audit.

The gift of the hospitality should be disclosed to the audit
committee. Potential threat to the auditor’s independence and
available safeguards should equally be disclosed to the committee.

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Advice whether or not the audit of Duran should continue
If Depeche consider the available safeguards to be adequate, the engagement
should be retained, otherwise Depeche may have to withdraw from the audit

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Fraud involves the use of deception to obtain an unjust or illegal financial advantage and
intentional misrepresentation by management, employees or a third party. Fraud may be
categorized as below:
 Fraudulent financial reporting, which involves the following:
Falsification or alteration of accounting records
Misrepresentation of transactions
Intentional misapplication of accounting standards
Omitting the effect of transactions
 Misappropriation of assets or theft
Detection and prevention of fraud
Management responsibilities
Client’s management and those charged with governance are primarily responsible for the
detection and prevention of fraud. The management of the client is responsible for establishing
strong system of internal controls to be able to detect and prevent fraud.
Auditor’s responsibility
Auditor is not primarily responsible for detecting fraud. Rather ISA 240 requires auditor to be
aware, when planning and performing their audit, that fraud may have taken place. Auditor is
only responsible for detecting fraud to the extent that it is material to the financial statements.
On discovering fraud by auditor, ISA 240 the auditor’s responsibility relating to fraud in an audit
of financial statements prescribes the following:
 Auditor should communicate the discovered fraud to management as soon as
discovered or suspected
 If the discovered fraud involves management, the auditor must communicate the matter
to those charged with governance
 The auditor should consider if he has statutory duty to report the fraud to a regulatory
and enforcement authorities
 The auditor should consider the effect of the fraud on the audit opinion

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Error is an unintentional mistake. Auditors have the following duties regarding detection and
reporting of error:
 The auditor has the responsibility of discovering material errors
 The auditor should assess whether immaterial errors discovered during the audit are
material in aggregate
 The records of all errors discovered by the auditor should be communicated to the
management as soon as possible
 Auditor should request the discovered errors be corrected by management
 The aggregate of uncorrected misstatement that were determined by management not
to be material, both individually and in aggregate to the financial statements should be
communicated to those charged with governance by the auditor

Auditors have a duty of care to the body of the shareholders (not to individual shareholder) and
may be found liable to them if the auditor was negligent.
Generally, auditors do not owe a duty of care to third parties and cannot be liable to them. For
auditor to be held liable to a 3rd party, the followings must be established:
 There was duty of care at the time of the audit owed by the auditor to the 3rd party
 The duty of care was breached by performing negligent audit by the auditor
 The 3rd party has suffered a loss as a result of the breach

Ways of reducing auditor’s liabilities:
 The audit firm may operate as a limited liability company
 The audit firm may use insurance to limit exposure to claims from third party
 The firm may operate as a limited liability partnership
 Use of liability limitation CAP

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 Use of disclaimer in the audit report
 Performing the audit according to international standards

Auditor’s liability (Non audit assignment)
The auditor will only be liable to the following persons:
 Persons with whom proximity can be established
 The direct beneficiaries of the information in the report
 Persons who can reasonably be foreseen to rely on the report
Ways to reduce auditor’s liabilities (Non audit assignment):
 The report should contain a statement that management is responsible for the
underlying information
 The auditor should clearly state in the report that it is only the intended recipient that can
rely on the report
 Liability cap may be included in the engagement letter
 The assignment should be strictly performed according to the terms of engagement
 Use of liability disclaimer paragraph

Ways of reducing auditor’s exposure to litigation
 Firm should develop a robust client acceptance procedure. This should ensure that only
client with manageable level of risk is accepted.
 Firms should follow quality control procedures as contained in ISQC 1. This will reduce
the risk of performing negligent audit.
 Auditors should work to the terms of the engagement.
 Signing of limited liability agreement with client. The disadvantage of this is that the
auditor may not be conscious of quality anymore, knowing that arrangement exist to limit

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his liability, and leading to poor quality audit. This may reduce the overall value placed
on the auditor’s opinion.

Question T U R N A L S
Turnals is an unlisted manufacturing company with 120 employees, projected sales of $12
million, and estimated profit before tax of $1.5 million. During the current year the
directors’ attention had been brought to a recently discovered fraud perpetrated by Mr.
Jones, the purchasing manager: He had set up a fictitious business that had invoiced
Turnals for goods that had never been supplied. The fraud had been going on for over two
years. Mr. Jones was immediately suspended from all duties and the police informed. During
their investigation, Mr. Jones admitted to the police that he had perpetrated a similar fraud at
his previous employers, who had not informed the police. When Mr. Jones had been
employed, no reference had been sought from his previous employers.
Mr Jones had responsibility for obtaining competitive quotes, checking and initially
approving new suppliers. Final approval was authorised by the Managing Director but in
practice this was a formality. Mr. Jones also raised most of the purchase requisitions based
on information supplied by the storekeeper and approved any requisitions made by other
members of staff.
The storekeeper’s responsibility was to match each delivery note to a copy of the purchase
requisition before the goods were taken into inventory. The two documents were then
sent to Mr. Jones who matched them with the purchase invoice before passing the invoice
to the payables ledger cashier for payment. When the storekeeper was on holiday the
system of internal control specified that a deputy should perform the delivery note
matching procedure. In practice this had always been done by Mr. Jones.
The fraud took place during the storekeeper’s holidays (4 weeks each year). It was
discovered when the cashier had to query one of the fraudulent invoices with the
storekeeper because Mr. Jones was absent on company business.
Subsequent investigation revealed that approximately $50,000 had been misappropriated by

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Mr. Jones.
Garner & Co has been the auditor of Turnals for many years. The firm has 12 partners
and 60 audit staff. The internal control over Turnal’s purchase system was recorded and
tested for the first time during last year’s interim audit. In previous years a fully substantive
approach to purchases had been applied and no review of the internal controls over the
purchase system had ever been carried out.
No comments were made to management by the auditors on their findings from the interim
work on the purchase system.
Garner & Co had also acted as management and systems design consultants during the
implementation of Turnals’ purchase system at the beginning of last year. As a result the
directors believe that Garner & Co should be liable for the losses suffered by Turnals as
they employed the audit firm in a dual capacity.


Describe the regulations and other audit practices that are designed to avoid conflicts of

interest in the provision of non-audit services to an audit client.

(5 marks)


Discuss why the following audit procedures may have failed to detect the above fraud:


evaluation of the prescribed system of controls;


tests of controls on the authorisation of new suppliers;


analytical procedures.

(10 marks)

Discuss the bases on which Turnals believe they have a claim against their auditors and

the likelihood of its success. (5 marks)
(20 marks)

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Regulations and practices that avoid conflicts of interest

It is recommended that the recurring fees from a single client should not
exceed 15% of the gross practice income. If the fee from a single client is
too high, it will cause self-interest threat to objectivity.

Auditors are prohibited from having direct financial interest in an audit
client. When auditors have financial interest in a client, the interest of the
auditor becomes conflicting with that of the client. This situation will lead
to the auditor protecting his own interest against the interest of the client

Auditors are required to strictly adhere to the IESBA codes of ethics in their
audit practice. Where there is perceived threat to auditors adherence to the
codes, he is required to consider the adequacy of safeguards. For
example, where an audit client intends to outsource its internal audit to the
same audit firm, this situation will lead to self-review threat and could make
the auditor lose its objectivity. Though, it is not prohibited for audit firm to
carry out internal audit service for audit clients, but the auditor must ensure
adequate safeguards are in place. Where the auditor considers the
safeguards inadequate, such service may need to be declined.

It is prohibited for audit firm to prepare financial statement for its listed
clients unless in times of emergency. Provision of this service may make
the auditor lose his objectivity and independence. Where auditors are
allowed to carry out this service, adequate safeguards must be put in

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