Pressure on an Audit Senior Over a Related-Party Loan
You are the senior on the audit of Crescent Traders Ltd (CTL), a private company. During fieldwork you discover that CTL's managing director, who owns 60% of the shares, borrowed Tk 25 million from CTL in November 2025 at 0% interest, repayable on demand. The loan was not disclosed to the board and was recorded as a receivable from 'other debtors'. CTL's profit before tax is Tk 8 million and its bank covenant requires profit before tax above Tk 7 million; had the loan carried a market interest rate of 10%, imputed interest would reduce profit by Tk 2.5 million, breaching the covenant. The engagement partner tells you the amount is immaterial, the MD will repay before the audit report is signed, and the matter should be left out of the representation letter. The partner has known the MD for 20 years and the audit fee is 40% of the firm's annual revenue.
1. Evaluate the ethical and professional issues and state what you should do.
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Several issues arise. First, the loan is a related-party transaction with a director and majority shareholder; under IAS 24 it requires disclosure regardless of amount, because related-party disclosures are not subject to a materiality threshold in the ordinary sense. Second, the 0% interest is a potential benefit to the MD and may have tax and company-law implications, including possible restrictions on loans to directors. Third, the covenant proximity means the imputed interest is material in context: Tk 2.5 million against Tk 8 million profit and a Tk 7 million covenant threshold.
Ethically, the partner's instruction to omit the matter from the representation letter is a threat to integrity and objectivity, and the 20-year relationship plus fee dependence (40% of firm revenue) creates self-interest and familiarity threats. I should not comply. I should document the finding, raise it formally with the partner in writing, and if unresolved escalate to the firm's ethics partner or those charged with governance. The MD's promise to repay before signing does not cure the period-end misstatement or the disclosure obligation.
2. Explain the audit response, including procedures and reporting consequences, if the matter is not corrected.
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Procedures: obtain the loan agreement and board minutes; confirm whether board approval was obtained; recalculate imputed interest at a market rate and assess the effect on profit and the covenant; review the bank loan agreement for covenant terms and any cross-default; obtain a written representation on related-party transactions and completeness; and consider whether the concealment indicates management override of controls under ISA 240, which would require journal testing and review of other 'other debtor' balances.
If management refuses to disclose or adjust: the matter is material in context because it breaches a covenant and involves a related party. I would consider a qualified or adverse opinion depending on pervasiveness, and communicate with those charged with governance. The firm should also assess whether it can continue the engagement given fee dependence and the partner's conflict. If the partner persists, I should decline to sign the file as senior, document my concerns, and refer the matter under the firm's whistleblowing and ethics procedures.