Before taking on an audit engagement, auditors must evaluate their independence and objectivity for it. If any threats exist to these, auditors must determine the appropriate safeguards to employ against them. There are five threats that auditors may find during this process. These include familiarity, self-review, self-interest, advocacy, and intimidation threats.
Each of these threats may come from specific sources. The safeguards that auditors employ against these depend on the type of threat they face, its severity, its impact on the assignment, etc. Sometimes, having such countermeasures may not suffice either. In those cases, auditors may need to cancel their engagement.
What Is the Familiarity Threat?
The familiarity threat is when an auditor allows their familiarity with the client to threaten their independence. Usually, their familiarity leads them to become too trusting of the client and can cause them to make biased decisions. Similarly, if the auditor becomes too indulged in the client’s business, they may face the familiarity threat.
The familiarity threat can come from various sources. If the auditor becomes personally close to the client’s management, they will allow familiarity to impact their audits. Similarly, having familiarity with one of the employees working at the client can also cause the familiarity threat to increase. Overall, being too familiar with the client or their personnel can cause auditors to impact their opinion.
How Does the Familiarity Threat Work?
The familiarity threat usually stems from previous relationships with the client or their management. The longer an audit firm works with a single client, the more familiar they will become. However, being familiar is not a threat to the audit engagement as long as this familiarity does not impact the financial statements.
The familiarity between an auditor and a client may exist before their relationship starts. For example, an auditor having a close or immediate family member in the client’s management. Sometimes, it may also develop as a result of past transactions between both parties. For instance, when senior audit personnel serves as a client’s auditors for a long time. Given below is an example of how the familiarity threat works.
An auditor becomes a part of an audit engagement team for a long-term client. However, the auditor failed to disclose to the audit firm that they have a relative in the client. The relative is a part of the client’s accounting team and is responsible for the preparation of the financial statements. It signifies that the relative can exert significant influence over the financial statements.
During the audit, the auditor discovers some material misstatements in the client’s financial statements. Upon further investigation, the auditor learned that their relative is involved in causing these errors. When they discuss the matter with their relative, the relative mentions that they will lose their job if the auditor discloses this information.
The auditor has two options when it comes to these material misstatements. They can disclose this information to the audit firm. In that case, the audit firm will issue a modified report and a qualified opinion. Similarly, their relative will end up losing their job. On the other hand, they can withhold this information and help their relatives save their job. However, the auditor will have to face professional and potentially legal action for it.
The familiarity threat is the highest when auditors allow their relationship with the client or their employees to influence their decisions. Familiarity threats may also cause or stem from other threats. For example, the familiarity threat may cause self-interest threats or come from advocacy. Either way, it is crucial for auditors to identify such threats and eliminate them promptly.
How to Avoid the Familiarity Threat?
Like all other threats to auditors’ independence and objectivity, the familiarity threat is also avoidable. In most cases, auditors can employ some safeguards against such threats to avoid any adverse influences. Usually, the audit firm may remove the affected person from the audit engagement team to eliminate the familiarity threat.
Similarly, regular rotation of audit personnel, both senior and junior, can be crucial in avoiding this threat. Audit firms also assign an audit engagement team with sufficient experience with such issues to ensure these don’t cause biased decisions. Regular quality control reviews can also be essential in avoiding any threats to auditors’ independence and objectivity.
In most cases, the responsibility of revealing any familiarity with the client lies with the auditors. For example, if an auditor has a close family member at the client, they must disclose it before joining the engagement. If the specific auditor is crucial to the audit engagement, the firm can also structure the engagement team so that the auditor does not deal with their family member.
The familiarity threat to the independence of the auditor is when auditors let their familiarity with the client influence their decisions. This threat may stem from experiences or relationships with the client. In most cases, auditors can avoid the familiarity threat by removing the affected auditor from the team. Additionally, auditors can also employ other safeguards.