Question Tag: Ethical Safeguards

Cringe Professional Services has been auditing Kogberegbe Limited for about 20 years. Being a limited liability company, no regulation imposed restriction on the tenure of the auditors.

The firm also provides taxation and valuation services for the company. The company has just adopted International Financial Reporting Standards and has employed the services of Cringe Professional Services for conversion services from local GAAP. The firm experienced a high staff turnover in the year and has no choice but to include the daughter of the Managing Director of the company as part of the engagement team, although as a support staff.

Management has indicated in confidence that the audit fee for the year will not be increased, except the firm can guarantee them that no adverse management letter will be issued and no loss will be made by the company as they are planning to go to the capital market to raise capital for expansion. With poor management letter and loss position, they believe that it will be difficult to achieve this.

At the end of the audit exercise, the company made a huge profit even with unfavorable economic climate, thanks to challenges associated with COVID-19. There was public outcry because it was believed that the financial statements of the company were misstated, and the auditor was accused of negligence. This necessitated the Financial Reporting Council to conduct an investigation on the company. It was found that the company restructured its debt portfolio, which was denominated in foreign currency with attendant foreign exchange risks to Naira.

The company restructured a huge intercompany loan to a 7-year principal payment holiday with principal repayment commencing September 30, 2025. The interest on the loan for the period was not brought into the books of account.

The company accrued for a NGN70.60m benefit from a transaction in 2019 from operating fees. This has been treated as income in the financial statements.

There were identified defaults by the company in relation to the payment of interests and principal on its outstanding loans and borrowings.

There were adverse ratios in the company’s financial performance ratios in the year due to interest on borrowings from financial institutions and related parties.

A revisit of the operating performance for the year revealed the following:

• The entity made an operating loss of N1.22 billion.
• It generated negative operating cashflows of N2.15 billion.
• There was positive working capital as the current assets exceeded the current liabilities by N1.2 billion in the year.
• The net assets position of the company was in the negative as the total liabilities exceeded the total assets by N9.8 billion.

The Financial Reporting Council concluded that there were threats to the auditors’ independence, hence the professional firm was penalized for that.

A concerned staff of the company asks you of the implications of the issues raised by the Financial Reporting Council.

Required:

a. Identify and explain the threats to independence of the auditor in the above scenario. (7 Marks)

b. Discuss circumstances that could give rise to threats to independence. (7 Marks)

c. Suggest appropriate safeguards which could be put in place to mitigate the identified threats. (6 Marks)