Dada Adefolami

Practice management issues
The International Standard on Quality Control (ISQS) 1, and ISA 220, Quality Control, state that firms should only undertake engagements where they are competent to do so and have the appropriate capabilities and resources.

The APB bulletin points out that there is an obvious issue where the client has financial instruments whose fair value must be determined, so auditors of banks and other financial institutions must take particular care.

Valuation and disclosure requirements of financial instruments are complex, so audit firms should consider:

1. Enhanced training courses for audit staff;
2. Recruiting staff with experience in auditing banks etc; and
3. Retaining experts to assist in valuation, particularly in
classes of assets that have become illiquid.

Competence could also be an issue for most other audits. There are few, if any, recession-proof industries and most clients are likely to face declining sales or operating difficulties as a result of the crisis and its impact on consumer confidence. For some clients, the impact will cause potential going-concern problems, increasing the risk of material misstatement at the overall entity level. ISA 330, The Auditor’s Responses to Assessed Risks, includes assigning more experienced staff and emphasizing the need for professional skepticism in its list of appropriate responses.

Audit firms may find they have insufficient staff with the levels of skill and experience required to audit the increased number of risky clients.

Increased fees
ISA 330 states that increased supervision is an appropriate overall response, and the APB bulletin says the audit engagement partner should consider being involved in the audit. This, combined with the higher level staff required, the increased time commitment that risky clients require, and the use of experts, means higher audit fees should be charged to cover increased costs. Firms’ overheads are also likely to increase due to increased insurance costs resulting from expected legal actions against auditors.

As increased fees will not be particularly easy, clients with financial difficulties may delay payment. This leads to a potential breach of the International professional rules”ACCA’s Rules of Professional Conduct”, I quota say that overdue fees can lead to a self-interest threat – the firm may be tempted to give an unqualified report in order to recover fees from the previous year. Outstanding fees could also be interpreted as a loan to the client, also in breach of the Rules.

Firms therefore need to put pressure on clients to pay but, if a client later goes out of business, the firm may be accused of using confidential information about a client’s pending insolvency for its own benefit and to the detriment of the other creditors. Firms may want to take legal advice before aggressively pursuing outstanding fees from clients whom they suspect to be facing serious difficulties.

Threat
Banks may require companies to submit forecasts on which assurance firms have expressed an opinion before granting/renewing finance. Firms will be aware of the importance of this finance, and there is a danger they may so strongly advocate their client’s position they lose their objectivity.

Obvious safeguards are concurring reviews and having the work performed by staff that have no other contact with that client.

Quality control
To prevent legal actions, or defend themselves against them, it’s critical to have sound quality control procedures.

Adequate audit documentation is also necessary; firms need to be able to justify how they reached decisions with respect to, for example, going concern.

ISA 220 requires engagement quality control reviews (‘hot’ reviews) to be undertaken for listed clients and all other clients where they are thought to be necessary. This is usually taken to mean risky clients, and there are a lot more of those at the moment. Time spent on more hot reviews again increases firms’ overheads.

Finally
With an increasing number of firms in financial difficulty, firms need to ensure there are sufficiently robust. It could well be the case that an audit client (A) experiencing financial difficulties owes money to another audit client (B), and that defaulting on the debt could cause B to face financial problems. The audit team of B may be unaware of A’s difficulties and may be planning to give an unmodified report, but the audit team of B may realize this report is potentially inappropriate. Team B is precluded under the rules on confidentiality from informing team A of B’s financial difficulties.

There is also a risk that the insolvency department’s clients may owe money to the audit department’s clients.

Staff should be reminded of the importance of confidentiality, and controls over the security of files – both paper and electronic – should be reviewed. Firms should consider segregating and restricting access to the insolvency department.

However, the term financial crisis is applied broadly to a variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these panics. Other situations that are often called financial crises include stock market crashes and the bursting of other financial bubbles, currency crises, and sovereign defaults.[1][2] Financial crises directly result in a loss of paper wealth but do not necessarily result in significant changes in the real economy (e.g. the crisis resulting from the famous tulip mania bubble in the 17th century).

Many economists have offered theories about how financial crises develop and how they could be prevented. There is no consensus, however, and financial crises continue to occur from time to time

Dada Suraju Adefolami, Professor of Finance, School of Business Administration. UNEM University, Costa Rica, is a Finance / management Consultant and Certified Forensic Accountant. You can reach him via: [email protected]: 08052043855