You are a manager in Nelson & Co., a firm of Chartered Certified Accountants, wi
ID: 420278 • Letter: Y
Question
You are a manager in Nelson & Co., a firm of Chartered Certified Accountants, with three offices and 12 partners. About one third of the firm’s clients are audit clients, the remainder are clients for whom Nelson & Co. performs tax, accounting and business advisory services. The firm is considering how to generate more revenue, and you have been asked to evaluate two suggestions made by the firm’s business development manager.
An advertisement could be placed in national newspapers to attract new clients. The draft advertisement has been given to you for review:
Nelson & Co. is the largest and most professional accountancy and audit provider in the country. We offer a range of services in addition to audit, which are guaranteed to improve your business efficiency and save you tax.
If you are unhappy with your auditors, we can offer a second opinion on the report that has been given.
Introductory offer: for all new clients we offer a 25% discount when both audit and tax services are provided. Our rates are approved by ACCA.
A new partner with experience in the banking sector has joined Nelson & Co. It has been suggested that the partner could specialise in offering a corporate finance service to clients. In particular, the partner could advise clients on raising debt finance, and would negotiate with the client’s bank or other provider of finance on behalf of the client. The fee charged for this service would be contingent on the client obtaining the finance with a borrowing cost below market rate.
You are required to:
1. Evaluate each of the suggestions made above, commenting on the ethical and professional issues raised. Your response should be at minimum 200 words. You need to take into consideration ACCA’s Fundamental Principles and the threats to comply with them when completing your answer
2. You have set up an internal discussion board, on which current issues are debated by employees and partners of Nelson & Co. One posting to the board concerned the compulsory rotation of audit firms, whereby it has been suggested in the press that after a pre-determined period, an audit firm must resign from office, to be replaced by a new audit provider.
3. Based on the above you are required to:
(i) Explain the ethical threats created by a long association with an audit client.
(ii) Evaluate the advantages and disadvantages of compulsory audit firm rotation.
Note : This shold be a new post and not one already posted
Explanation / Answer
Answer 3ii)
advantages and disadvantages of compulsory audit firm rotation
One of the commonly used arguments in favor of audit firm rotation is based upon the assumption that a long auditor tenure may cause a relationship to be established between the auditor and the issuer, which in turn possibly may compromise the auditor’s independence and objectivity (Cameran et al., 2014). When the auditor’s independence is compromised by a relationship between the auditor and the entity that is being audited, discovered breaches in financial statements may less likely be reported (DeAngelo, 1981a). Another argument that is often used by supporters of audit firm rotation, is that audit firm rotation avoids situations in which auditors are becoming too aligned with managers of the issuer, which in turn can compromise the auditor’s independence (Jackson et al., 2008). In order to avoid such undesirable situations, it would be enhancing for the auditor’s independence if there is a fixed maximum term on the period in which one auditor may be appointed to the same client (Cameran et al., 2014). Supporting this claim on independence, Adeyemi and Okpala (2011) found evidence suggesting that a longer audit firm tenure can result in a compromised auditor’s independence. This claim is also supported by Ebimobowei & Keretu (2011) who found evidence in their study which suggests that the mandatory rotation of auditors improves audit quality by enhancing auditor independence and introducing a fresh look at the client’s financial reporting. They argue that when auditors are rotated on a regular basis, it will help to avoid situations in which auditors are becoming too familiar with one specific client. On the contrary however, mandatory audit firm rotation is also claimed to have less favorable effects. For example, audit firm rotation will cause a loss of client-specific knowledge to occur when one auditor is forced to resign from the audit services for the client (Jackson et al., 2008). As a result of the loss of client-specific knowledge, audit firm rotation The effects of audit firm rotation on audit quality 15 also requires the new auditing firm to gain knowledge on the client, which incurs additional costs for the client. According to the GAO (2003), it is estimated for most Fortune 1000 companies that the total additional costs that are incurred by the auditor selection process and additional auditor support are at least 17% of the audit fees of the initial year. As a result of these costs, it is argued by many of these Fortune 1000 companies as well as several scholars, that the costs of audit firm rotation may outweigh the benefits. Studies have also shown that the appointment of a new auditor can have other negative effects on audit quality. For example, according to Carcello & Nagy (2004) found evidence supporting this claim by concluding that in the first three years of the auditor-client relationship, fraudulent financial reporting is more likely to occur. Given the fact that mandatory audit firm rotation will cause new auditor-client relationships to be established more often, as a result of the limit on the period of years an auditor may provide audit services to the same client, the likeliness of fraudulent reporting will also increase.
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