Independence and Quality Control in a Small Audit Firm
You are the engagement partner at 'Armenia Audit' LLC, a small audit firm with 5 auditors. You are auditing 'Sunrise Bank' CJSC, a listed bank. Your firm has provided tax advisory services to Sunrise Bank for the past 3 years, generating 30% of the firm's total revenue. The tax advisory team is separate from the audit team, but the same partner (you) oversees both. The bank's management has offered you a 10% discount on a personal mortgage if you agree to a favorable audit opinion. Additionally, the bank's CFO is your cousin. The audit engagement is up for renewal. The firm's quality control procedures are informal: there is no independent engagement quality control review for listed entities, and the firm does not have a documented independence policy.
1. Identify the threats to independence and quality control issues in this scenario, and evaluate the severity of each. Refer to the IESBA Code and ISQC 1.
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Threats to independence: (1) Self-interest threat: the firm derives 30% of revenue from the bank, creating financial dependence; the mortgage discount offer is a self-interest threat. (2) Self-review threat: providing tax advisory services that may affect the audit (e.g., tax provisions) and the same partner overseeing both creates a self-review threat. (3) Familiarity threat: the CFO is a cousin, creating a close relationship. (4) Intimidation threat: the offer of a mortgage discount could be seen as an inducement to influence the audit opinion. Quality control issues: (1) Lack of engagement quality control review for a listed entity, required by ISQC 1 for listed entities. (2) No documented independence policy, violating ISQC 1 requirements for independence. (3) Informal quality control procedures, indicating a weak system of quality control. (4) The firm is small, but must still comply with ISQC 1. Severity: The revenue dependence (30%) is significant; the mortgage discount is a clear inducement and should be rejected. The family relationship with the CFO creates a familiarity threat that may need safeguards or withdrawal. The self-review threat from tax services may be reduced if the tax services are routine and separate teams, but the same partner oversight is problematic. Overall, the threats are so significant that independence may be compromised; the firm should decline the mortgage offer, consider resigning from the audit, or implement safeguards (e.g., independent review, separate engagement partner).
2. What actions should the firm take to address these issues and comply with professional standards? What are the potential consequences of non-compliance?
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Actions: (1) Reject the mortgage discount offer immediately and document the rejection. (2) Assess the familiarity threat from the CFO relationship: if the relationship is close family (cousin is considered close family under IESBA? Actually, IESBA defines immediate family as spouse/dependent, close family as parent, child, sibling; cousin is not close family, but still may create familiarity threat. Evaluate and apply safeguards such as removing the partner from the engagement or having an independent review. (3) For the tax advisory services: evaluate whether they create a self-review threat; if so, implement safeguards such as using separate teams and not having the same partner oversee both, or discontinue the tax services. (4) Establish a documented independence policy and quality control procedures, including an engagement quality control review for listed entities. (5) Consider the revenue dependence: if the firm cannot reduce dependence, it may need to resign from the audit to avoid self-interest threat. (6) Consult with the firm's ethics partner or external advisor. Consequences of non-compliance: disciplinary action by the Armenian audit regulator (e.g., Ministry of Finance), fines, revocation of license, reputational damage, and potential legal liability. The auditor's report may be challenged, and the firm could be subject to peer review or investigation.