PLD Associates Co, a large quoted company, was founded and controlled by Mr J Scott. The principal business of the company was to develop derelict land in city centres into office accommodation. In 20X3, the taxation authorities became suspicious of the nature of the operations being carried out by the company and an investigation into its affairs commenced.
The resultant report stated that the organisation's internal controls had deficiencies and were non-existent in many cases. The investigators found payments to unknown persons, and fictitious consultancy firms. In addition, J Scott had maintained a secret expense account that was used to disburse funds to himself. The board of directors of PLD Associates Co did not know of the existence of this account. The expense account was maintained by the partner of the firm of accountants responsible for the audit of the company. The auditors were heavily criticised in the report of the investigators.
The firm of auditors, Allcost & Co, had an aggressive marketing strategy and had increased its audit fees by 100% in two years. The audit firm had accepted the appointment in 20X1 after the previous auditors had been dismissed. The audit report for the year ended 20X0 had been heavily qualified by the previous auditors on the grounds of poor internal control and lack of audit evidence. J Scott had approached several firms of auditors in order to ascertain whether they would express a modified auditor's opinion given the present systems of control in PLD Associates Co. Allcost & Co had stated that it was unlikely that they would modify their opinion. They realised that J Scott was 'opinion shopping' but were prepared to give an opinion in order to attract the client to their firm.
PLD Associates plc subsequently filed for insolvency and Allcost & Co were sued for negligence by the largest loan creditor, its bankers.
Required
(a) Describe the procedures which an audit firm should carry out before accepting a client with potentially high audit risk such as PLD Associates Co.
(b) Discuss the ethical problems raised by the maintenance of the secret expense account for Mr J Scott by the audit partner.
(c) Suggest measures that audit firms might introduce to try and minimise the practice of 'opinion shopping' by prospective audit clients.
(d) Explain how audit firms can reduce the risk of litigation and its effects upon the audit practice.