You are an audit manager at Thornhill & Co responsible for the audit of Northwest Co, a subsidiary of Valerian Co. A different audit firm is responsible for the audit of Valerian Co and the Valerian Group financial statements.

The audit of the financial statements of Northwest Co for the year ended 31 July 2016 is nearing completion, but the following issues require your attention before the auditor’s report is signed and your final communication is made to the group auditor in response to their request for information. The draft financial statements of Northwest Co recognise a loss before tax of $50,000.

Northwest Co has been loss making for several years and it generates insufficient cash to meet its significant debt obligations. The company relies on support from Valerian Co in order to continue trading. The management of Valerian Co has confirmed verbally that it will continue to support Northwest Co, but has not provided a formal letter of support despite a number of requests.

You are aware that Valerian Co is the subject of a major lawsuit following an industrial accident which resulted in significant pollution of local agricultural land and, most seriously, loss of life. You attempted to discuss the matter with the directors of Valerian Co but they refused, saying that it had already been investigated by the group auditor. The group auditor informed you that the case is ongoing and that they have obtained satisfactory representations from both management and legal advisers stating that they were confident of successfully defending the claim. When you asked for copies of the representations, the group auditor refused saying it was a matter relevant to the parent company and that it was not relevant to the audit of Northwest Co.

Shortly after making your enquiries, you received a phone call from the group engagement partner who said that the board of Valerian Co was concerned that you might modify the auditor’s report of Northwest Co. He also said that, as the only person with full oversight of audit matters relating to the Valerian Group, he did not think that it would be necessary to modify the auditor’s report of Northwest Co and that he would oppose any attempt to do so. He suggested that if the debt in the financial statements of Northwest Co was the reason for seeking parental support that he would transfer it to the Group and the letter of support would no longer be necessary.

Required:
(b) Comment on the ethical and professional issues raised, considering any implications for completion of the audit, in respect of:
(i) The evidence obtained in relation to the support offered by Valerian Co.
(ii) The request not to modify the auditor’s report of Northwest Co.

Note: The total marks will be split equally between each part. (14 marks)