The controller of Kim Engineering Ltd. (KEL) sent a legal representation letter to KEL’s law firm at the request of the company’s auditors. The controller told the auditors that there are no lawsuits presently ongoing. The lawyers replied to the letter, agreeing that there were no outstanding or possible claims of which they have knowledge, or for which their advice has been sought.
However, the controller was not aware that the board of directors had sought legal advice from a second law firm regarding a harassment lawsuit. Due to the nature of the matter, the board of directors did not want anyone to know about the possible claim. There are no records of it outside of the president’s office, but the auditor noticed it when reviewing the minutes of the board of directors’ meetings. The auditor, therefore, requested that a letter be sent to the second law firm as well.
One of the members of the board of directors is Yung, who had started the company 20 years ago, but is now retired from any duties other than being a director. When the company first started, Yung performed almost all of the duties himself, but over the years, his duties have been assigned to other people. For example, only the controller or the president of the company can sign cheques on behalf of the company, and the controller’s authority is limited to $15,000. Any cheque request must be supported by an authorized purchase requisition, and any request over $15,000 must be authorized by the president. The accounting manager does all of the bank reconciliations herself, but her assistant enters the journal entries according to the accounting manager’s instructions.
a. Indicate what the effect would be on the audit if the auditor receives no response from the second law firm.
b. If the second law firm replies and provides information to the auditor, indicate how the auditor should treat this information for financial statement purposes.
c. State whether the control risk is high or low, and support your decision with four points.