Advanced Audit

Legal Issues Associated with FRA’s Ability to Audit PGM

  1. Independence

One of the key requirements of the auditing process is the need to maintain the independence of the audit firm. The auditor’s independence is said to be impaired in the situation where he is unable to exercise with objectivity and offer impartial judgment on all issues that are required under the audit engagement. The auditor’s independence may be affected by the nature of the relationship between himself and the company (U.S Security and Exchange Commission , 2017). In this case, FRA through its partner OFA had been bookkeeping for PGM for 4 years. From year 5, FRA has been involved in offering tax advice to PGM. This implies that the audit firm has developed a close relationship with the management of PGM which may compromise its independence thus creating a legal liability.

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Rule to address the issue. The audit firm may use auditing standards to avoid legal liability. In this case, the Independence Standards Board Standards No. 1 mandates the auditor to disclose to the audit committee in writing the relationships that are believed to have considerable effect on the independence of the firm. These issues should then be discussed prior to the actual engagement. 

  1. Offering of Non-Audit Services

The law prohibits the auditor from taking up the audit job for an organization where it is affiliated with non-audit services like bookkeeping, design and implementation of financial information systems, appraisal and valuations, internal audit function, investment adviser, and other services not related to the audit (U.S Security and Exchange Commission , 2017). FRA has been involved in offering other services to the PGM such as tax consultancy and book keeping. This, therefore, increases overfamiliarity with the client which poses challenges to the independence of the client. 

Rule. The audit firm may use the pre-approval of permitted services where the audit committee under certain limited exceptions needs to pre-approve all the permitted services offered by the independent auditor. This process requires following the guidelines provided by the Securities and Exchange Commission. 

  1. Familiarity 

This issue arises due to the general closeness between the auditor and the client. The closeness here is introduced by the fact that FRA has worked for PGM and continues working for it. This poses the challenge where the auditors would lose their objectivity during the audit process and end up acting inappropriately. 

Rule. Audit Partner Rotation may be an effective approach to deal with this issue. This would work by ensuring that the audit partner who has been involved in engaging the client prior to audit is not the one who carries out the audit process.

Legal Issues Associated with FRA’s Ability to Audit PGM’s 401 (K) Plan

  1. Prohibited Relationships

This refers to the nature of relationships that are not permitted to happen between auditor companies and their clients. The main prohibited relations that may inhibit FRA from auditing the 401 (K) plan is employment relationship. The law requires a one year cooling period before a firm can hire out individuals formerly employed by its auditor. In this case, the PGM hired the director of one of its subsidiaries as the chief financial officer in year 6. With the audit expected to happen in year 7, there is no cooling off period required by the law.

Rule. The audit committee should review whether the hiring of this personnel that was formerly employed by the subsidiary of FRA that supplied the 401(k) plan might affect the audit firm’s independence. 

  1. Independence

This is the nature of relationship between FRFS, a subsidiary of FRA, where it sold the 401(k) plans to PGM and continues to service it, which poses challenges to the issue of independence of the auditor. This implies that the 401 (k) plan is partially the product of FRA which creates a form of bias or conflict of interest. It creates a situation of self-audit which is detrimental to the independence requirement (U.S Security and Exchange Commission , 2017). 

  Rule. The independence standard as indicated by SEC comes to play in determining how the level at which the audit firm will maintain a state of objectivity and lack of bias. The rule provides that an auditor cannot be objective if it is a reasonable investor. This implies that under this rule, FRA is not capable of offering an objective and impartial judgment.

  1. Non-audit services

SEC observes the increased concerns on the effects of audit firms offering non- audit services to clients. The concern is on the growing concern of significant increases in the value of the amounts of non-audit services offered by the companies. In this case, the subsidiary of the FRA still offers the servicing of the 401(k) plan. This may impair the independence of the company in the audit process. 

Rule. Sec rules that not all non-audit services are restricted. In this sense, it will be important to establish the level of risk posed to the independence and integrity of the nature of services offered (Revision of the Commission’s Auditor Independence Requirements, 2001). The situation at hand creates a risk of self-interest, where the firm is aware that if a qualified report is issued with regard to the plan their subsidiary sold and services, FRA would feel its effects due to reduce profits for it subsidiary.

Ethical Issues or Conflicts Associated with FRA’s ability to Audit PGM


In accounting, there exist various cognitive, organizational, and political forces that have eroded the independence of auditors (Creswell, Stokes & Laughton, 2002). The ability of FRA to audit PGM will generally be impacted by self-serving biases and motivated reasoning in human cognition, defined by the incentive and accountability matrix of the environment through which the auditors work. The role of FRA in offering tax advice to PGM raises doubts on the call for the accountant to ensure complete independence from the client at all times and the total fidelity requirement to the public trust. 

The use of outside auditors who are not offering financial advisory services to PGM would help to immunize the threats posed by PGM manager’s powerful incentives, aimed at making the company’s performance look better beyond the real situation. In order to provide independent reviews, the auditor’s report should not be affected by other goals other than accuracy (Kinney, Palmrose & Scholz, 2004). 


As a prerequisite for acting in the public interest, integrity requires that auditors act not only with honesty, but also with qualities related to fairness, courage, candor, confidentiality, and intellectual honesty (Schweitzer, 2004). For FRA to audit PGM effectively, it should not be affected by conflict of interest. Given that FRA is the financial advisor of PGM and the source of their 401 (k) plan, conflict of interest may arise due to the relationship between the audit firm and the audit entity. 

Rule: the SEC offers guidance on an organization that qualifies to be an audit client. In this case, the auditor is required to consider any relationships with the client of any of its affiliates as this poses an issue of integrity. The problem of integrity can be addressed by minimizing conflict of interest within the audit engagement team. This can be achieved by ensuring that financial, personal, employment, business, and other relationships that exist between the audit entity and the audit firm do not influence the audit function.


Objectivity refers to the state of mind that eliminates bias, partiality and compromise by subjecting all relevant matters in a task a fair and impartial consideration, while at the same time, ignoring the irrelevant matters (Ronen, 2002). FRA needs to consider the choices made by the directors of PGM regarding the process and preparation of financial statements and give a conclusion whether the results present a true and fair view of the entity. Objectivity requires FRA to express an impartial opinion based on the available audit evidence as well as its professional judgment. 

Rule: Quality control 

SEC provides that quality controls of accounting firms need to be put in place t detect and prevent issue that compromise the independence and objectivity of the auditor. The rule allows audit firms to serve the client so long as certain quality controls are in place. Under this light, FRA should adopt a rigorous and robust approach and be prepared to disagree with the PGM directors’ judgments where necessary.

Ethical Issues or Conflicts Associated with FRA’s ability to Audit PGM’s 401 (k) Plan

Two major issues raises concern over the ability of FRA to audit PGM’s 401 (k) plan. First, the 401 (k) plan was sold to PGM by FRA who continues to service as the registered representative of record to the plan. Secondly, the chief financial officer of PGM was the former director of FRA who left employment in year 6. Given the above scenario, the FRA’s ability to audit PGM may be impacted by prevention of lawful disclosure of financial and non-financial results, pressure from management, and influenced objectivity and integrity of auditors by management. The audit firm might be pressured to alter the content of the PGM’s 401 (k) plan, in a situation where the plan contents do not reflect favorably on management. Objectivity of the audit team can also be influenced through poor resource allocation to impact the performance of the audit function.   

In an effort to deal with the existing relationship between the audit firm and the audit entity regarding the 401 (k) which seems to impact the ability of FRA to audit the plan, an audit committee should be established. According to Moore and Loewenstein (2004), audit committees are vital in the promotion of audit ethics through working together with auditors to support, encourage, and guide the audit process to comply with the established code of ethics. They are also important in dealing with any attempts to influence the audit process by the management personnel.  

Rule: AIPCA Code of Professional Conduct 

This represents rules set out to help the accountants and auditors in solving the ethical dilemmas they might face in the course of carrying out their duties. The code of conducts covers acts such as the acceptable level at which a reasonable and good placed and well informed third party could reach a conclusion that given all the facts in a given situation, the compliance to rules would not be comprise. The code’s Rules of Conduct helps govern the performance of auditors in offering the professional services. It points out to various rules that apply in specific situations.

Fraud Risks within PGM or with PGM’s 401 (k) Plan

Fraudulent statements and Misappropriation of assets within PGM’s financial statements are the major fraud risk facing the company. For instance, intentional manipulation of financial statement which can result to improper reflected balance sheet amounts can be identified from the company’s books of account. For example, the value of milling and packing equipment in PGM balance sheet year 5 is inappropriately recorded, and the figure affects the value of total assets for the company. The incentive or pressure to perpetrate the above frauds as well as the opportunity to carry out the risks may impact the financial stability and the operating conditions of the company (Schweitzer et al., 2004). 


Craswell, A., Stokes, D. and Laughton, J. (2002). Auditor independence and fee dependence. 

Journal of Accounting and Economics, 33(1), 253-275

Kinney, W., Palmrose, Z.and Scholz, S. (2004). Auditor independence, non-audit services, and restatements. Journal of Accounting Research, 42(3), 561-588. 

Schweitzer, M., Ordonez, L. and Duouma, B. (2004). Goal setting as a motivator of unethical behavior. Academy of Management Journal, 47(3), 422-432

Ronen, J. (2002). Post-Enron reform: Financial statement insurance, and GAAP revisited. Stanford Journal of Law, Business, and Finance, 8(1), 1-30

Revision of the Commission’s Auditor Independence Requirements, S7-13-00 (Securites and Exchange Commission 2001).

Moore, D. and Loewenstein, G. (2004). Self-Interest, automaticity, and the psychology of conflict of interest. Social Justice Research, 17(2), 189-202

U.S Security and Esion . (2017). Audit committees and auditor independence . Retrieved from Commis

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