Reference no: EM132606764

You are a trainee accountant in the audit department of Fawlty Bean & Co, a large regional accountancy practice based in Hull, East Yorkshire. The audit Manager (who is your line manager and supervisor) is Mr B Johnson. He is due to go on two weeks' holiday tomorrow with his fiancé and new baby son. In his absence he has asked you to look at some client work and prepare detailed responses ready to discuss with him on his return from vacation. He has also given you some file notes he has made on a competitor firm who are undertaking practices which he considers to be unethical and, as a trainee with up-to-date knowledge, he would like your observations. The following are summaries of the files:

File- Notes made by B Johnson for comment

A local firm of Registered Auditors, Dubious & Co, has seen a decline in revenue in recent years, so is looking to increase its number of clients. It has advertised a new audit approach, guaranteeing that its audits will minimise disruption to companies as they will last no longer than two weeks. Moreover, the firm has offered all new audit clients an initial year's free accounts' preparation service, on the basis that preparation of a client's financial statements will reduce audit time.

The partners of Dubious & Co are also keen to accept a suggestion made by Tryiton Ltd (one of the firm's existing, larger clients), that the current year's audit fee should be based on a percentage of their final pre-tax profit, as shown in the final, audited financial statements: they believe this will increase the overall audit fee. Mr Fawlty, one of the partners of Dubious & Co, has known the finance director (Mr Fruadi) of Tryiton socially for many years and he and his wife went on holiday with Mr Fruadi and his family last summer. During the past year too, Dubious & Co sent one of their qualified audit seniors, Joe, on secondment to Tryiton to act as the company's financial controller as Tryiton's financial controller went on sick leave for several months and the company had no suitably qualified staff to fulfil the role. The audit partner for Tryiton has recommended that Joe work on the Tryiton audit, as he has a good knowledge of the system used within Tryiton.

Dubious & Co have recently been approached a potential new audit client, Yorkshire Tours Ltd (YTL), which is a travel firm organising luxurious holidays to European and Mediterranean destinations. YTL's year end is 31st December, and it requires its annual audit to be completed by mid-February. January and February are extremely busy months for Dubious & Co, so they intend to use more junior staff on this audit. To save time and costs, Dubious & Co have not contacted YTL's previous auditors before taking on YTL as a client.

A sticky note on the inside of this file indicates that in an attempt to reduce audit costs, Dubious & Co has elected not to update the engagement letters of existing clients because such letters tend to remain largely unchanged from year to year.

Required:

Question a) Identify and explain the ethical risks which arise from the above actions of Dubious & Co and the steps which should be taken to mitigate the risks.

Question b) Explain the purpose of an audit engagement letter, and list six matters that should be included on such a letter. Having regard to your answer critically evaluate the decision of Dubious & Co not to update the engagement letters.