Practice Question 2

Johnson and John & Co is a firm of Chartered Accountants which has seen its revenue decline
steadily over the past few years. The firm is looking to increase its revenue and client base and
so has developed a new advertising strategy where it has guaranteed that its audits will
minimise disruption to companies as they will not last longer than two weeks.
In addition, Johnson and John have offered all new audit clients a free accounts preparation
service for the first year of the engagement, as it is believed that time spent on the audit will be
reduced if the firm has produced the financial statements.
The firm is seeking to reduce audit costs and has therefore decided not to update the
engagement letters of existing clients, on the basis that these letters do not tend to change
much on a yearly basis.
One of Johnson and John’s existing clients has proposed that this year’s audit fee should be
based on a percentage of their final pre-tax profit. The partners are excited about this option as
they believe it will increase the overall audit fee.
Johnson and John have recently obtained a new audit client, Cinnamon Brothers Co
(Cinnamon), whose year end is 31 December. Cinnamon requires their audit to be completed by
the end of February; however, this is a very busy time for Johnson and John and so it is
intended to use more junior staff as they are available.
Additionally, in order to save time and cost, Johnson and John have not contacted Cinnamon’s
previous auditors.
Required:
i) Identify and explain FIVE ethical risks which arise from the above actions of Johnson and
John & Co; and
ii) For each ethical risk, explain the steps which Johnson and John & Co should adopt to reduce
the risks arising.
Note: The total marks will be split equally between each part. (10 marks)

Ethical risk Steps to reduce the risk

Johnson and John have guaranteed that their Johnson and John should cease this
audit will not last longer than two weeks and advertising campaign
will minimise disruption to companies. immediately as it is not in compliance with the
code of ethics and conduct for a chartered
accountant

every audit engagement is different and for any potential clients who have
hence will require a approached salt &
differing amount of time. complex audits pepper as a result of this advert, the firm
cannot possibly be should inform
completed within two weeks as the team them that the audit duration will be based on
would not be able the level of
Ethical risk Steps to reduce the risk
to gather sufficient and appropriate audit audit risk present, and this could be
evidence in this time, leading to an incorrect considerably longer
opinion. than two weeks.

Johnson and John have offered all new audit for engagements where Johnson and John is
clients a free to prepare the
accounts preparation service for the first year accounts, they must ensure that this work is
of the engagement. undertaken by
a team separate from the audit team.

Whilst Johnson and John is able to prepare

accounts for unlisted
clients, this does increase the risk of self-
review as the audit team could be auditing
their own work.

additionally, if this service is offered for free, in addition, the firm should ensure that all
then in order to audit
make a profit on the total engagement, engagements are conducted in accordance
Johnson and John could international standards on auditing.
be inclined to substantially reduce the
procedures undertaken on the audit
engagement.

The firm is not updating the engagement Johnson and John should comply fully with
letters for existing isa 210 and
clients on the basis that they do not change annually review the need for revising the
much on a engagement letters.
yearly basis.

This is not in accordance with ISA 210

agreeing the terms
of audit engagements as even if engagement
letters are not
changed, they should still be reviewed to
ensure that they are still relevant and up to
date.

An existing client of Johnson and John has Johnson and John should politely decline the
proposed an audit fee based on a percentage proposed
of the client’s final pre-tax profit. contingent fee arrangement as it would be a
breach of code of ethics and conduct. instead
they should
inform the client that the fees will be based
on the level of
work required to obtain sufficient and
appropriate audit
evidence.
Ethical risk Steps to reduce the risk
this is a contingent fee arrangement and is
prohibited as it
creates a self-interest threat which cannot be
reduced to an adequate level.

Johnson and John intend to use junior staff Johnson and John should review the staffing
for the audit of their of cinnamon and
new client cinnamon, as the timing of the make changes to increase the amount of the
audit is when the firm is very busy. experienced team
members. if this is not possible, they should
discuss with
the directors of cinnamon to see whether the
timing of the
audit could be moved to a point where the
firm has
adequate staff resources.

as a new engagement, Johnson and John

has little knowledge of
the risks associated with this audit. if they use
too junior
staff, they will not be competent enough to
assess whether
they have performed adequate work, and the
risk of giving an incorrect audit opinion is
increased.

Johnson and John has not contacted Johnson and John should contact the
cinnamon’s previous auditors. previous auditors to
identify if there are any ethical issues which
would prevent them from acting as auditors of
cinnamon.

contacting the previous auditors is important

as the firm
needs to understand why cinnamon has
changed their
auditors. they may have been acting
unethically and their
previous auditors therefore refused to
continue.

in addition, it is professional courtesy to

contact the previous auditors.