Outline of the case

You are a partner in a three-partner firm of accountants. The firm generates fees of approximately 1.4 million per annum. Within your portfolio of clients is Company A, which has been very successful since it first came to your firm five years ago. It now has an annual turnover in excess of 15 million.

Company A generates annually recurring fees for the practice of approximately 50,000, of which approximately 35,000 is in respect of audit work and 15,000 relates to routine tax calculations and preparation of the corporation tax return. Your firm has a separate tax department, which performs the tax compliance work in respect of Company A.

The companys financial year end is December. Last year the audit work commenced in June, and the audit report was finally signed in August. By the end of August, the tax return had been submitted to the taxation authority, and the firms invoice had been issued to Company A.

In September a significant customer of Company A went into receivership, and Company A suffered a large bad debt. The directors approached you immediately, and were very open about the companys short-term cash flow problem. Therefore, you agreed that payment of the firms invoice of 50,000 could be spread over ten months, commencing in October.

Company A also needs the support of its bank and, in December, it was negotiating a modest increase in its overdraft facility. It is now early March, and the bank has requested audited financial statements by the end of the month. The audit is well underway, and you have promised the directors of Company A that the bank will have the audited accounts on time.

The planning of the audit was performed by the audit senior and reviewed by the audit manager for the assignment (in whom you have a great deal of confidence). Due to pressure of work, you did not review the audit plan in detail before the audit team commenced the year end audit work, and so you decide to review and sign off that section of the audit file now.

You note that the audit manager has correctly identified going concern as the area of the audit attracting greatest risk. However, at the time of planning the audit, the manager was unaware of the credit agreement reached with regard to the payment of last years fees. You check your firms records, and determine that Company A still owes the firm 25,000.

Key fundamental principles

Integrity: There was a flaw in the planning of the audit, which was not noticed by the audit manager before the audit work commenced. Is it possible to ignore the flaw and yet act with integrity, given that the flaw was unintentional?

Objectivity: Can you reach an objective audit conclusion in view of your wish for Company A to continue trading and settle its outstanding fees to your firm?

Professional competence: You need to bear in mind any ethical standards for auditors relevant to the country in which you practice.

Professional behaviour: Regardless of the actual impact of the outstanding debt on your

objectivity, if the bank (or a hypothetical, objective, well-informed third party) knew of the outstanding fees, what impact would it have on your firms reputation?

Considerations

Identify relevant facts:

Through a combination of circumstances, your firm is under pressure to complete an audit assignment while it has a financial interest in the client. The debt of Company A to your firm was not as a result of an investment decision, but a pragmatic solution to a problem being faced by an honest client. Nevertheless, your firm has a clear interest in the clients ongoing existence, and would not want the audit opinion to jeopardise the repayment of the debt.

Identify affected parties:

Potentially, the affected parties are you and your firm, Company A, the bank, and any stakeholders in Company A who will refer to your firms audit opinion.

Who should be involved in the resolution:

You may involve the audit manager in discussions, although he can do nothing to make your opinion more objective. He can only provide advice (as can your professional body). You should certainly involve your partners, and consider who else you may involve who is free from any personal interest in Company A.

Possible course of action

You need to ensure that the audit opinion is reached objectively, but also that a reasonable and informed third party would conclude that objectivity has been adequately safeguarded. Any discussion with the audit manager and the audit senior, who performed the planning initially, should have the objective of amending the firms planning procedures to ensure that outstanding fees are always considered in the future.

The bank will probably have reviewed Company As debtors and creditors at various times, and may, at any time, question how your firm could retain objectivity. You may wish to pre- empt such a question by disclosing to the bank (with the consent of your client) the safeguards you have put in place. In any event, you should discuss those safeguards with the directors of Company A, as there will be costs associated with the safeguards, and it would appear reasonable to pass these costs on to the client.

The appropriate safeguards will depend on the significance of the threat presented by the outstanding fees of 25,000. This will depend on many factors, including the personal circumstances of you and your partners. In the context of the firm, the debt of 25,000 represents less than 2% of the firms annual income. However, the annual fee income from the client (50,000) equates to 3.6% of the firms income and, when the invoice is raised for the current audit, the outstanding debt will be significant.

You must minimise the threat to objectivity brought about by the firms interest in Company A continuing to trade. A possible solution may be to obtain directors guarantees in respect of the outstanding fees and the invoice which is soon to be raised. Provided the directors are in a position to provide such guarantees, this would have a commercial benefit as well as an ethical one. It will almost certainly be necessary to obtain legal advice before entering into such an agreement.

However, even if this possible course of action is pursued, it may not be sufficient to reduce the threat to objectivity to an insignificant level. This may only be achieved by introducing an independent auditor to review your firms audit work before the audit report is signed. This should be someone who is independent of the firm and, therefore, unsympathetic to the firms interests. It may be advisable to engage a consultancy company to perform the review, and to discuss with your client how the additional costs will be met.

You should keep your partners informed of the issue, and the safeguards you intend to implement, throughout the resolution process.

You should document, in detail, the steps that you take in resolving your dilemma, in case your ethical judgement is challenged in the future.