This case relates to independence and objectivity and conflicts of interest. An independent financial audit of a firm’s financial records can provide confidence to clients, investors, and counterparties that the firm is in good financial health and is not engaged in financial fraud. When an auditor has a thorough knowledge of a firm’s business, this knowledge can help the auditor to perform a compressive, in-depth, and accurate audit, which will benefit both the firm and its stakeholders by enhancing the effectiveness of the audit. But there may be the appearance of a conflict of interest and a concern that the auditor’s objectivity may be impeded if it also earns large consulting fees from the same client. If accounting firms sell extra services based on their knowledge of the company they are auditing, will independence related to the audit be compromised?
There may be a perception that an auditor is more likely to provide a favorable assessment of a company’s finances to protect a lucrative consulting relationship with the firm. In this case, JOFL collects five times more fees from Bolton for consulting services than for auditing their financial records. Smithson can avoid this conflict by hiring a third-party consultant, rather than JOFL, for these additional consulting services, or at least could restrict the consulting services (and therefore fees) given to JOFL. If Smithson did not want to lose the benefits of having JOFL, a firm intimately familiar with Bolton’s business through the audit relationship, provide advice on a number of other issues, Smithson could try to mitigate the conflict by being fully transparent about Bolton’s relationship with JOFL, including the nature of the consulting JOFL provides and the fees paid to JOFL by Bolton. In some situations, accounting firms should be able to offer additional services to their auditing clients. But with respect to verification of performance history, CFA Institute guidance on the GIPS standards would prevent JOFL from providing a third-party verification of Bolton’s claim of compliance while also providing assistance in the firm’s ongoing compliance with the GIPS standards. In regards to the GIPS verification and consulting, choice D is the best response.
For the other consulting services, it does not appear that regulatory rules would prevent JOFL from performing both audit and consulting services. In addition, it does not appear that JOFL’s performance of the audit on Bolton is influenced by its consulting work or that mitigation of the conflict through disclosure would not be effective. In these cases, choice C is an acceptable answer. But many accounting firms may determine to refrain from engaging firms for both audit and consulting work to maintain their independence.