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CFA Level I · CFA Level I Exam · Financial Reporting Quality

An analyst notes that a firm's auditor also earns consulting fees from the firm that are several times larger than its audit fee. Relative to the mechanisms that limit reporting quality issues, this situation most likely:

Large consulting fees relative to the audit fee create a self-interest threat because the auditor becomes economically dependent on the client and may be less willing to challenge management. This weakens the audit as a constraint on poor reporting, which is why such non-audit fees are a red flag.

  1. Aimproves the auditor's understanding of the business and therefore its independence.
  2. Bindicates the auditor is complying with the requirement for audit rotation.
  3. Ccreates a self-interest threat that can reduce the effectiveness of the audit as a constraint.Correct

Explanation

Large non-audit fees create economic dependence on the client, a self-interest threat that may make the auditor less willing to challenge management. Knowledge gained from consulting does not improve independence, and fee mix has no connection to rotation requirements.

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