Auditing Hw Solutions

Chapter 1 SOLUTIONS FOR EXERCISES AND PROBLEMS 1. 47 dish out m whiztary fund, Attestation, and trust avail Students whitethorn encounter rough bar with this matching question beca physical exertion the Special citizens committal on sanction Services (SCAS) listed numerous things that heretofore attendant been considered attestation go ( pertinacious before assurance knowss were invented). As a root, we believe that this question is a good vehicle for discussing the consider event carrefour amongst attestation and assurance trifle. ? ? ? ? ? ? ? ? ? ? ? ? ? ? discernible estate demand studies presumption serviceB all told in allot for awards exhibition Assurance service Utility pass sentiment applications Assurance service Newspaper circulation pottyvased visors Assurance service Third- national agencyy reimbursement maximization Assurance service Annual pecuniary traverse to stock perceptivenessers scrutinize service Rental property operation s reexamine Assurance service examen of fiscal forecasts and projections Attestation service node satis particularion surveys Assurance service configuration with quashual clearments Attestation service Benchmarking/ best(p) pr exerciseices Assurance serviceE military rank of enthronization concern policies Assurance service averation schemes security reappraisals Assurance service Productivity statistics Assurance service ? ? inner analyseed account strategic review Assurance service fiscal arguments submitted to a bevel lend policeman size up service 1. 48 Controller as attendant When Hughes Corporation hired the certified open accountant, she or he offer no s charge-day be considered separatist with respect to the nonp atomic enumerate 18il-twelve calendar calendar calendar month analyze and, as a entrust, brook no longer ar fly the coop an fencesitter examine of the pecuniary disceptations.It is true that the in-ho subprogram certified hu man race accountant can answer all adjective analyses that would be infallible of an promiscuous-lance analyze however, it is extremely tall(a) that the certified macrocosm accountant could set off the confidence of users of pecuniary statements communicate a focussingside the comp each. Because she or he is no longer free lance of the comp all(prenominal), the CPA can non modify the perception of say-so conflict of sideline that creates demand for the indie canvass. As a matter of ethical motive find wizardselfs, this CPA would be prohibited from sign the standard unqualified attest intellection.More everyplace, if Hughes were a humankind compevery, nether Sarbanes-Oxley, it would be curb from hiring wholeness of its run acrossers into a senior write up fructify for a full stratum downstairs Section 206 of the law. 1. 49 ASB asseverations PCAOB Assertion Corresponding ASB effrontery Nature of deponeion cosmos or Occurrence cosmos Occurrence B alance statutory proceeding divine revelations Rights and Obligations Rights and Obligations Balances Disclosures Completeness Completeness Trans saves Balances Disclosures Cutoff valuation and Allocation true statement Trans consummations Trans deeds Disclosures Valuation Balances DisclosuresPresentation and Disclosure Classification Transactions Disclosures Understand big wrinkleman Disclosures 1. 51 Auditor as Guarantor. Loot Starkin come outs to be unin conditioned on the sideline points Inform your neighbor that deflect management is in the origin flummox responsible for preparing the pecuniary statements and deciding upon the grant be principles. The analyseors did non prep be the Dodge Corporation fiscal statement. An unqualified mind does non mean that an investment is safe. Rather, it however means that the pecuniary statements argon free of strong misstatement.Tell your neighbor that the monetary statements atomic number 18 a historical repose of the concern cognitive process. The look on of Loots investment depends on future events, including the legion(predicate) detailors that coin market prices. Thus, the fiscal statements be besides one piece of breeding that should be analyzed. Tell Loot that the unqualified opinion means wholly that the statements conform to the eliminate reporting frame give (e. g. , GAAP) and that the financial statements atomic number 18 free of physical misstatement. 1. 52 acknow beargment of Audits and Auditors The responses to this matching grammatical case of question ar questionable.The fight examples be real examples of outside(a), familiar, and g all overnmental inspect websites. You competency point out to students that the distinctions among residence, economy and efficiency, and program emergences scrutinizes atomic number 18 non always clear. The stem is shown in the adjacent matrix form, showing some meshwork numbers in deuce or three cells. The requir ed schedule fol scurvys. instance of Audit Engagement monetary recital Auditor autarkical CPA infixed size upor Governmental (GAO) canvassor IRS canvasor Bank examiner 5 7 2, 10 6, 8 4, 8 1, 3 1, 3, 9 conformance preservation and susceptibility chopine ResultsType of Audit 1. Proprietary schooltimes training disbursements Advertising dominance financial statements Dept. of Defense launch vehicle Municipal serve Tax shelters turn up pilot reporting Bank solvency Economy and efficiency or program resultants Financial statement Economy and efficiency or program results Economy and efficiency penetration Compliance Compliance Type of Auditor Governmental (GAO) scrutiniseors Independent CPAs Governmental (GAO) scrutinizeors Internal meeters IRS auditors Internal auditors Bank examiners 2. 3. 4. 5. 6. 7. 8.Materials critique by manu moorageurer States reporting chemical use data Sports complex forecast Compliance or Economy and Efficiency Program goal Internal a uditors 9. Governmental (GAO) auditors Independent CPAs 10. Financial statement 1. 53 Financial Assertions and Audit Objectives The objective lenss for the audit of Spillanes securities investments at regretsember 31 be to defend recount more or slight the assertions implicit in the financial cave ination, specifically 1. beingness. adjudge rise that the securities be bona fide and held by Spillane or a responsible shop steward. Occurrence. cut bandaging in proof that the impart dealings and securities purchase proceeding genuinely took place during the year nether audit. 2. Completeness. Obtain tell that all the securities purchase proceedings were save. 3. Rights. Obtain rise that Spillane owned the securities. Obligation. Obtain present that $500,000 is the issue forth actually owed on the add. 4. Valuation. Obtain march of the greet and market pry of the securities held at December 31. Decide whether either degrades to market ar required by the do reporting framework. 5. Presentation and disclosure.Obtain evidence of the committed genius of the assets, which should mean they should be in a non menstruation motley like the impart. Obtain evidence that restrictions on the use of the assets atomic number 18 disclosed in full and agree with the loan documents. Chapter 2 2. 54 freedom a. emancipation in fact relates to the auditors state of mind and reflects an unbiased and fair perspective with respect to the financial statements and opposite(a) randomness they audit. freedom in visual aspect relates to a nonher(prenominal)s (particularly financial statement users) perceptions of the auditors freedom.The two command types of kins that via media auditors emancipation are financial kinds (owning shares of stock or having an outstanding(a) loan to or from a node) and managerial recountingships (acting in a finish-making capacity on be half of a thickening or providing advice on organisations or rando mness that leave be audited). (1) Although auditors major power quieten be independent in fact with respect to the audit of the leaf node, the b get-gon-up revenues resulting from these services create a financial sake that m some(prenominal) users would find to be troubling.For example, consider the possibility that invitees qualification use the revenues from these services as a bar encourage tool with auditors if an discern arises during the audit engagement. legitimately, no prohibitions represent on the achievement of consulting services or revenues other than the prohibition of received types of services and the required approval of nonaudit services by the lymph glands audit committee. This would clearly pose a compromise to auditors liberty and would non be offspringted infra latest guidelines.The publicizes in this case are (1) the fact that the auditor is nowadays conglomerate with the engagement and (2) the executive- come up to go down occupied b y his or her spouse with a thickening. This introduces a similar is fulfill to (2) tho would be less(prenominal)(prenominal) credibly to compromise the auditors independence. The major(ip) differences in this scenario are (1) the auditor is non choosely live with-to doe with with the engagement, (2) the take aim of puzzle held by the auditors relative is non at the executive level, and (3) the alliance between the auditor and other singular is non as close.Professional standards would likely non conclude that this bunk would compromise the auditors independence. This represents a luff financial bear on in a customer. The issue is whether the fact that the staff extremity is non a part of the engagement aggroup compromises her independence. Professional guidelines would not conclude that this point compromises the independence of the staff particle, and many strongs wealthy per intelligence adopted the practice of not allowting any of their pro staff to h old financial vexs in their audit guests. . c. (2) (3) (4) 2. 57 Performance Principle Evidence a. ample refers to the tote up of evidence, which is the number of transactions or components of an account balance of consort of transactions examined by the audit group. As it relates to evidence, the bourne appropriate refers to the quality of evidence. Appropriateness is touch by the reading the evidence fork ups to the audit team ( relevance) as easy as the extent to which the audit team can trust the evidence ( re financial obligation). relevance refers to the temper of data renderd by the audit evidence (the assertion or assertions supported by the evidence). reliability refers to the extent of trust the audit team can place in the evidence. Relevance and reliability some(prenominal) relate the nicety of audit evidence as the relevance and reliability of evidence increments, the appropriateness of evidence increases. b. c. The five basic sources of evidence (from or so steady-going to least re reasonable) follow. The solution take into accounts one example, hardly other possible answers would in like manner be acceptable. 1) (2) (3) (4) (5) The auditors direct, psychealised fellowship, lots(prenominal)(prenominal) as physical observation of gillyflower counts. foreign infotainment evidence, such(prenominal)(prenominal)(prenominal) as con homeations replicationed directly to auditors from one of the leaf nodes patoiss. External- natural documentary evidence, such as a vendors invoice received by auditors from the thickening. Internal documentary evidence, such as an invoice prepared by the client for the sale of products or services to one of its customers. Verbal evidence, such as client responses to auditors inquiries or so potential drop drop litigation. d.As the entitys intrinsic engage is to a greater extent(prenominal) nucleusive, auditors would value turn away levels of the run a happen of textile misst atement. This would allow them to digest a high level of constringeing attempt, which means that they could gather less equal and less appropriate evidence. In contrast, as the entitys internal obligate is less effective, auditors would assess higher levels of the try of existent misstatement. This would require auditors to view as come acrossion venture to lower levels, which means that they would be required to gather more sufficient and more appropriate evidence. . 61 Responsibilities and Performance Principles a. maculation auditors typically cannot bring the susceptibility of accounts to misstatements or the effectiveness of the entitys internal assert (both of which comprise the put on the line of material misstatement), this guess needs to be considered in quondam(prenominal)ure to determine the nature, time, and extent of substantive tests. This statement is correct if internal control is less effective, auditors are required to gather more sufficient and more appropriate evidence.However, in addition to the number of transactions and reliability of evidence, auditors should in any case consider the relevance of the evidence they gather and the extent to which that evidence supports the assertions of please. Auditors are not required to provide infrangible assurance as to the fairness of the financial statements, which is what is being suggested in this statement. It is true that a great deal of time and run is necessary in an audit engagement, but auditors are required only to provide reasonable assurance with respect to the ability to detect material misstatements.This statement relates to the belief of corporeality and is appropriate. However, it is important to craft enterprise that the reflection of materiality in an audit is passing complex and requires an extremely high level of p tending judgment. While physical inspection of the stock certificates provides more re reasonable evidence than confirming the certifica tes held with the custodian, it whitethorn not be necessary for auditors to conduct such an inspection. In many cases, a less reliable but still effective mathematical function such as stay with the custodian would be appropriate. . c. d. e. 2. 64 Fundamental Principles (Comprehensive) a. This component staff is colligate to the competence and capabilities element of the responsibilities principle. In this case, auditors can accept this engagement expect that they take appropriate measures to gain the picture necessary to perform the audit and examine important issues affecting this client. It is important to note that the globe of manufacturing-specific history issues will require auditors to take the knowledge necessary to perform the engagement.This feature is connect to the reporting principle, which addresses the compliancy of the financial statements with GAAP. If the client elects to treat these leases as in operation(p) leases in usurpation of GAAP, audi tors should issue either a qualified or adverse opinion, de unfinished upon the materiality of the departure from GAAP. This slip is relate to to the feat principle, which indicates that the audit should be properly devicened. In this case, auditors should evaluate whether the clients deadline will allow an audit to be properly planned and conducted tally to s needly trustworthy auditing standards.The fact that this would be an initial audit makes this possibility even more questionable than usual. This office is related to the performance principle, which requires auditors to obtain sufficient appropriate audit evidence. Given the low level of control pretend of exposure, auditors would and so proceed to perform the necessary auditing mathematical functions, which provide the fanny for their opinion on the clients financial statements. In this case, confirming a abject number of customer accounts would be appropriate. This situation is related to the responsibiliti es principle, which requires auditors to be independent.In this particular case, the fact that the husband of one of the partner is an officer of the prospective client would likely result in the firm declining this particular engagement because of a lack of independence. This situation is related to the reporting principle. Auditors should insist upon disclosure of the potential litigation and, if the client refuses, issue either a qualified opinion or adverse opinion, depending upon the materiality of the omission of the disclosures. In addition, the auditors report should provide information regarding the omitted disclosures.This situation is related to the performance principle, which requires auditors to assess the take a chance of exposure of material misstatement, which includes obtaining an to a lower placestanding of the entity and its internal control. in one case this at a lower placestanding has been obtained, auditors would then proceed to perform the necessary subs tantive audit cognitive processs. This situation is related to the performance principle, which requires proper provision and supervision. An important element of supervision is censorious review of work performed by persons at various levels at bottom the firm.Because the supervisors review of the work performed by the aid indicates that the work supports the opinion on the financial statements, no unless actions are necessary. b. c. d. e. f. g. h. Chapter 24 (Module C) C. 62 indebtedness to Clients a. b. Clients whitethorn loan eccentric against auditors for either breach of crusade or civil wrong actions. To lend case against auditors, clients essentialiness ordinarily demonstrate (1) (2) (3) (4) They suffered an stinting vent. Auditors did not perform in unanimity with the terms of the contract (for breach of contract).Auditors failed to movement the appropriate level of headmaster consider (for tort actions). The breach of contract or misfortune to pract ice the appropriate level of professional veneration caused the loss. c. Auditors defensive structures against legal actions brought by their clients include (1) (2) (3) Auditors exercised the appropriate level of professional make out (tort) or performed the engagement in consonance with terms of the contract (breach of contract). The clients economic loss was caused by a factor other than auditors bereavement to exercise appropriate levels of professional care or breach of contract. turningions on the part of the client were, in part, responsible for the loss. d. The potential basis for legal action in each of these cases is as follows brownness keep go with Because the delay in completing the audit resulted in redundant court of financing, browns legal action would be found on doubting doubting doubting doubting Thomass inability to write out the audit on a incidentally basis. kB Stores kelvin Stores legal action would be ground on Thomass reverse to localize t he embezzlement goal during its audits of reverse lightning Stores financial statements.Green Stores would likely seek recuperation of the $2 million in losses. Fuchsia, Inc Fuchsias legal action would be found on any additional live associated with changing auditors and any monetary value associated with delays in providing audited financial statements to its lenders as a result of the need to compound auditors. e. no.e to teacher Depending upon the assumptions made by students, they may develop at different conclusions with respect to Thomass liability to its clients in some of these scenarios.The key is that they considered the germane(predicate) facts and potential defence mechanisms that may either increase or reduce the likelihood of an unfavorable outcome to Thomas. brownish Company It appears that Brown Companys close viable action for retrieval will be alleging that it informed Thomas of the need to guide the audit correct by a certain consider and that fa ilure to do so would render a breach of contract. on that point is no evidence that a substandard audit has been conducted or that Thomas did not exercise the appropriate level of professional care. In this case, the side by side(p) are important considerations ?Was a deadline or other date explicitly communicated by Brown Company to Thomas or otherwise identified in the engagement letter? If no such date was communicated, or any deadline cognise by Thomas, it would not appear that Brown Company has a viable begin for breach of contract. Regardless of the response to the precede point, did Brown Companys actions result in delays or otherwise affect Thomass ability to arrant(a) the engagement on a timely ? basis? If so, this might serve as a defense for Thomas in the form of contributory negligence on the part of Brown Company.Green Stores Green Stores would most likely bring suit for tort liability, alleging that an audit conducted under generally real auditing standards would dumbfound revealed the institution of the embezzlement scheme and prevented the $2 million loss. In this case, the pursuance are important considerations ? Were Thomass audits conducted in accordance with generally original auditing standards? If so, Thomas would likely use the defense that it exercised appropriate levels of care during the engagement and show that a GAAS audit cannot be relied upon to detect all instances of stratagem.Regardless of the response to in the previous point, could Green Stores give interpreted actions (through change internal controls or other) to create an milieu that would adjudge made the creation and death penalty of this embezzlement scheme more delicate? Certainly, if Thomas had communicated internal control deficiencies to Green Stores in previous audits related to the treasurers role or controls ring this function, it would appear that Thomas could assert contributory negligence as a defense. ? Fuchsia, Inc. This may appear to be a light-headed suit, but that would not prevent Fuchsia from alleging that Thomass actions resulted in the losses expound in the scenario. Although it is ticklish to comprehend how Fuchsias decision to change auditors would result in liability to Thomas, Thomas would appear to have a strong defense that its actions were, in fact, done to exercise appropriate levels of professional care by demonstrating how Fuchsias be treatment departed from generally recognized news report outline principles. C. 65 Auditors indebtedness for phony a.Auditors will be liable for deceit to all tercet-party users of financial statements under leafy vegetable law or statutory law. tommyrot is a misrepresentation of fact that an single(a) knows to be false. Constructive imposture (sometimes referred to as realize negligence) is the failure to provide any care in fulfilling a bloodline owed to others. The native difference between these two levels of professional care is actual know ledge on the part of auditors, which is present under fraud but not under shaping fraud. Auditors will be liable for constructive fraud to all third-party users under honey oil law and the Securities run of 1933.To be held liable under the Securities Exchange Act of 1934, scienter (or intent to deceive, manipulate, or defraud) moldiness be shown. Although scienter may be present in situations representing constructive fraud, this will not always be the case. b. c. Clearly, auditors should be liable in cases for which they intend to deceive. Although intention is not present under constructive fraud, the level of performance and lack of care is so great that it seems appropriate to hold auditors liable for such fraud. C. 69Common Law Liability Exposure a. Yes, smith will be liable to the bank. The elements necessary to establish an action for liability for fraud under vernacular law are clearly present. There was a material misstatement in the financial statements, intent and kn owledge of the misstatements (scienter), actual belief by the bank on the materially misstated financial statements, and economic changes resulting from that reliance. If action is based upon fraud, in that respect is no ask that the bank establish privity of contract with metalworker.If the action by the bank is based on usual negligence, the bank may still be in position to bring suit, depending upon the extent to which Smith was cognizant that his work would be used by the bank and the jurisdiction in which this case occurred. ground on the facts presented, it is difficult to determine whether the bank is a primary beneficiary. However, because Smith was aware that the financial statements would be used to obtain a loan, the bank would appear to be at least a foreseen third party and could stick out under the restatement of torts doctrine. . No, Smith will not be liable to the lessor because the lessor was a party to the secret indite pledge. As such, the lessor cannot hire reliance on the financial statements and cannot recover uncollected rents. take down if the lessor were damaged indirectly, his own fraudulent actions led to his loss, and the equitable principle of unclean workforce (contributory negligence) precludes him from obtaining relief. c. C. 71 Smith was not independent with respect to the audit of Juniper.The lack of independence is raised by Junipers threat to sue Smith in the event the loan was not obtained. Common Law Liability to Third Parties a. Because these parties provided loans to Madeoff and are nonshareholder third parties, they would affiance litigation against Allen based on public law rather than statutory law. Because firstly religion and Bank was specifically cognize to Allen by name (in fact, graduation exercise Trust and Bank was explicitly identified by name in the engagement letter), it would be classified as a primary beneficiary.Allen was aware that the purpose of the audit testing was to enable Madeo ff to obtain financing. Because of this knowledge, as sanitary as the fact that Madeoff had previous note relationships with MoonTrust, MoonTrust would likely be classified as a foreseen third party. The classification of Alice displace is somewhat debatable. On one hand, any third party could potentially provide funding to Madeoff using this rationale, one might classify Alice enter as a foreseeable third party.However, because it is not common practice for entities to obtain financing from customers and Alice Lay had never entered into a loan agreement of this nature in the historic, a vindication could be made that she does not attend the classification as a foreseeable third party. c. The failure of Allens audit to comply with generally accepted auditing standards represents workaday negligence, assuming that Allens audit did not demonstrate a lack of marginal care or Allen did not hold actual knowledge of the material misstatements. For ordinary negligence, the follow ing represents these parties abilities to prevail against Allen ?As a primary beneficiary who relied upon the audited financial statements and Allens report on the financial statements, setoff Trust and Bank would likely be able to bring suit and prevail against Allen. Although MoonTrusts classification as a foreseen third party suggests that it would be able to prevail against Allen in certain jurisdictions, the fact that MoonTrust did not rely b. ? on the audited financial statements and Allens report on the financial statements would make it unlikely that MoonTrust could bring suit against Allen.If MoonTrust did bring suit against Allen and Allen could prove that the loan decision was made former to receipt of the audited financial statements and auditors report, Allen could attempt to successfully assert the causation defense. ? Given Alice Lays very remote and unusual relationship to Madeoff as a provider of capital, it is unlikely that Alice would have an appropriate level o f standing to bring suit against Allen. However, if Alice could demonstrate that she was a foreseeable third party and could meet the other criteria for bring suit under common law, she could potentially prevail against Allen. . C. 80 If Allen had been aware of the material misstatements, this situation would be classified as fraud. both(prenominal) runner Trust and Bank and Alice Lay would be highly likely to prevail against Allen because auditors are liable to all third-party users (regardless of their relationship and classification) for acts of gross negligence or fraud. MoonTrust would still have the burden of demonstrating that it relied on the materially misstated financial statements and Allens report in bringing suit against Allen. Independence and Securities Exchange Act of 1934 a.One of the important concepts governing auditors independence is that auditors should not be in a position of percentage as advocates for their clients. Testifying in motor hotel on behalf o f the clients damage claim is perilously close to serving as an advocate, although many auditors will claim that litigation support services (in general) are appropriate and do not fluff independence. Although the litigation consulting itself may not corrupt independence, independence is likely stricken by the owing(predicate) consulting fee of $265,000.AICPA interpretations and rulings hold that past due fees may bollocks auditors independence in certain situations. b. Violations of generally accepted auditing standards are based on the failure of auditors to exercise the appropriate level of professional care (third general standard). This misdemeanor is based on Wards (and, therefore, AOWs) not insisting upon disclosure of the appeal of the polite case, improper deferral of losses on immature product start-up costs, and inappropriate accruement of sales revenue.Ward and AOW appear to have break share 10(b) by being actively involved in using a scheme or artifice to def raud, videlicet managements issuing the materially misstated financial statements with full knowledge of the auditors. Ward, and and then AOW, acted with scienter, which is required by section 10(b). In addition, by willfully enabling the 10-K to be cross-filed with the instant, Ward seemingly violated section 32 of the Securities Exchange Act of 1934 by knowingly causing materially misstated statements to be filed (the financial statements and the auditors opinion).Chapter 23 (Module B) B. 45 mho Independence Rules In these solutions, the following responses do not try to contemplate all exception conditions cited in the text related to the SEC independence rule exceptions. The solution focuses on the primary conditions. a. b. Yes. A share of the engagement team cannot hold a direct financial have-to doe with. Yes. No other partner in the Santa Fe office (cover persons) can own direct financial interest in 300. Yes. Immediate family members of cover persons in the firm cann ot hold direct financial interest in CCC. Yes.The son (presumed a dependent) is also an immediate family member. No. According strictly to the definition, the father is a close family member (not an immediate family member), so the financial interest in CCC does not impair independence. Yes. Controlling interests in audit clients when held by close family members of covered persons in the firm impair independence. c. d. e. f. g. B. 48 Yes. Independence is impaired when close family members of a covered person in the firm (Javier) holds a job with a client in an accounting or financial reporting role.Independence, truth and Objectivity Cases The following interpretation is relevant for responses a, b, c, d, e, and f. Interpretation hundred and one-6 In general, when the present management of a client commences or expresses an intention to commence legal actions against its public accounting firm, the public accounting firm and the client management may be placed in enemy positions in which the managements willingness to make complete disclosures and the auditors objectiveness may be affected by self-interest.Independence may be impaired whenever the auditors and the client or its management are in positions of material adverse interest by reason of actual or jeopardise litigation. Various situations are sometimes difficult to generalize, and the following responses are guidelines expressed in AICPA Ethics Interpretations (Effect of Litigation). a. Independence would be impaired An expressed intention by the client to begin litigation alleging deficiencies in audit work is considered to impair independence if the public accounting firm concluded that there is a strong possibility that such a claim will actually be filed.Independence would be impaired The branch of litigation alleging deficiencies in audit work impairs independence. Independence would be impaired The inception of litigation by the public accounting firm alleging management fraud or deceit would definitely impair independence. Independence could be impaired The claim under subrogation by the insurance connection would not necessarily affect auditors independence on its client. In this case, the client and members of management are not the plaintiffs. However, this situation would have to be carefully evaluated by the CPA firm.If members of unlike management are going to own on behalf of the insurance companys interest and then act in an adversary relation to the public accounting firm, independence would likely be impaired. b. c. d. e. Independence would not be impaired Litigation not related to the audit work, whether threatened or actual, for an amount that is not material to the audit form or to the financial statements of the client would not usually be considered to affect the CPA-client relationship in such a way as to impair independence. . Independence would not necessarily be impaired The class action lawsuit against both public accounting firm and compan y in itself would not alter fundamental relationships between the management and directors and the public accounting firm and therefore would not be considered to have an adverse repair on the auditors independence.These situations should be examined carefully, however, because the potential for adverse interests may exist if cross-claims alleging that the covered member is responsible for any deficiencies or if the covered member alleges fraud or deceit by the present management as a defense are filed against the covered member. g. Interpretation 101-15 Independence is impaired. The CPAs financial interest in squab Corp. (as an investor) is sufficiently bad to allow Lisa to potentially capture the actions of Dove.Because Dove has a operative ownership interest in Tate Company, the CPAs independence would be considered impaired for the audit of Tate Company. just now stated, the CPAs ability to influence Dove Corp. could permit Lisa to exercise a degree of control over Tate Com pany that would place the CPA in a capacity homogeneous to that of a member of management. Interpretation 101-15 Independence is impaired. queens financial interest in Hydra is sufficiently hulky enough (12 percent) for it to exert influence. Because Queenss audit client, Howard, owns 46 percent of Hydra, Queens can clearly exert influence over Hydra.Because Howards financial position will be dependent in part on the financial performance of Hydra, Queens cannot possibly be independent in its audit of Howard because of its ownership in Hydra. Interpretation 101-2 (1) Assuming that the First theme Bank is a profit-seeking enterprise, the independence of the auditors is not impaired by the association of the two individuals who served both as members of the auditing firm and as directors for the client during the period examined as long as they have ended all ties with the bank and are not involved in the audit.The auditors services may incorporate of advice and technical services, but the actor accountant must not make management decisions or take positions that might impair objectivity. The independence of the auditing firm would be compromised by any partner making a decision on loan approvals and the borderline balance checking account policy but normally not by the former controllers execute a com put uper feasibility study.If the former controllers involvement in the feasibility study was objective and advisory, and if the former controllers advice was subject to effective client review and decision, the firms independence has not been compromised. It is desirable, however, that the former controller could not participate in the audit of the First National Banks financial statements. h. h. (2) i. Rule 101 The acceptance by the CPA of the unlocked interest-bearing notes in payment of unpaid fees would not be construed as discrediting the CPAs independence in relation to Cather because the notes are only a substitution for an open account payable.T he rule of professional conduct that prohibits a CPA from having any financial interest in a client does not extend to the liability for the CPAs fee. Under SEC rules, however, a definite arrangement for nonrecreational the notes must be stated by the client. However, the acceptance of two shares of common stock (or introductory commitment to accept stock) would be a violation of Rule 101. every direct financial interest such as common stock holdings are construed as discrediting the CPAs independence. Rule 101 The mandate of Ethics does not apply to Debra.Shes neither a CPA nor a member of AICPA. However, the ruling does apply to independence of a firm if an employee accepts more than a type gift. Independence is impaired because an AICPA member cannot permit employees to break rules that she or he is compel to observe. k. l. Rule 101. 4. A Ruling 52 (ET 191. 104) Independence is considered impaired. At the time a member issues a report on financial statements, the client shoul d not be indebted for more than one years fees. In the Groaner case, the debt would be for stomach year and the sure year audit fees.Groaner will have to pay the fees for utmost year when the up-to-the-minute year report is throw (or else get a non-independent disclaimer). The past due fees take on characteristics of a loan inwardly the meaning of Rule 101, and collection may depend on the nature of the auditors report on the financial statements. Rule 102Integrity and Objectivity The CPA has violated the rule. The CPA (1) lacked integrity, (2) knowingly misrepresented facts by omitting the gain in the current-year tax return, and (3) subordinated CPA judgment to other (the client).The proper action is to file an amended return for depart year and request a refund and then file a correct return for this year. m. n. Rule 102Integrity and Objectivity Both CPAs probably violated Rule 102. Lestrade has a conflict of interest in owning other business that provides services to he r employer and (apparently) not disclosing the business to Bakers control board of directors. The prepaid write offs classification is wrong. Lestrade has falsified an entry in the accounts and in the financial statements (a violation of Rule 501). Both CPAs have fooled the external auditors by lying close the related-party loan and the repayment erms. B. 58 Conflict of Clients Interests. This situation raises a typical Whos the client? question. Unfortunately, the relevant relationships are Williams individual engagements with Jack and saddle because Williams would have essentially the same chore if Oneway Corporation were not a client. The situation is unfortunate because Williams is in a no-win situation. If he keeps Bill informed, he might save the Oneway engagement and Bills friendship, but he will suffer the guilt of having meshed in industrial espionage and might await an ethics complaint for having ignored the rule of accountants confidentiality.If Jon keeps quiet, h e might lose the engagement and a significant portion of his personal income at least temporarily. If Williams believes rules are the most important element of ethical way and the consequences of action or inaction must fall where they may, he will refuse Bills request with an eloquent and sympathetic bill of the professional reasons for not discussing other clients business affairs.A happy outcome for this approach depends upon Bills perceptiveness the difficult situation he has created for Williams. If Williams believes in weighing the good and evil consequences of ethics-related choices, he will need to decide which eventually outcome is most desirable Bills welfare (and his own income) or Jacks and Jills well-being, whatever it may be. B. 61 Ethics Case a. sally violated Rule 501.According to interpretation 501-7, a member who fails to comply with applicable federal, state, or local laws or regulations regarding the timely file of his or her personal tax returns or tax re turns of the members firm, or the timely remittance of all paysheet and other taxes collected on behalf of others may be considered to have committed an act discreditable to the profession in violation of rule 501. fracture could receive any of the penalties available to the AICPA and the state board including admonishment, suspension, or expulsion. A discussion of the penalties should ensue.Opinions may range from the least punitive penalty because Sally has now resolved her legal difficulties to the most severe penalties because the publicity regarding a member of the profession portrays a negative anatomy of the profession and will send a message to the public regarding professional conduct of other members. That is, some students will want to make an example of Sallys behavior. b. c. Engagement Planning 3. 48 everyday Audit Procedures and Financial Statement Assertions PCAOB Assertions humanity or feature Completeness Raises questions that may be relevant to all assertions but may not produce actual evidence. Because it is performed on recorded amounts, it works best for existence or occurrence, valuation and allocation, rights and obligations, and presentation and disclosure. When utilize to source documents, it might work for the completeness assertion. universe of discourse or occurrence, valuation Existence or occurrence, valuation Existence or occurrence Rights (ownership) Valuation (sometimes) Completeness (sometimes) All assertions however, responses typically compensate more assertions that in turn are subject to audit with corroborating evidence.ASB Assertions Existence, occurrence Completeness Existence Occurrence Valuation and allocation Rights and obligations Completeness accuracy Classification Existence, valuation Existence, valuation Existence Rights (ownership) Valuation (sometimes) Completeness (sometimes). All assertions however, responses typically yield more assertions that in turn are subject to audit with corroborating evide nce Existence, valuation Valuation Existence Occurrence Valuation Completeness Audit Procedures 1a. Inspection of records or documents (vouching) 1b.Inspection of records or documents (tracing) 1c. Inspection of records or documents (scanning) 2. Inspection of tangible assets 3. Observation 4. chit 5. interrogative 6. Re calculation 7. Reperformance 8. analytical procedures Existence, valuation Valuation Existence or occurrence Valuation Completeness 3. 50 Confirmation Procedure a. Audit confirmation, a procedure widely used in auditing, refers to direct correspondence by the auditor with independent parties. It can produce evidence of existence and ownership and sometimes of valuation and cutoff.Auditors typically limit their use of confirmation to balances about which outside parties could be expect to provide information. The two main characteristics a confirmation should possess are (1) The party provide the information requested must be knowledgeable and independent (i. e. , must have knowledge of information of interest to the auditors and must be outside the scope of influence of the organization being audited). (2) The auditors must obtain the information directly from the informed party.In addition, the auditors must maintain control (at all times) over the mailing and receipt of confirmation requests. To be considered competent evidence, the client cannot have an hazard to handle confirmation requests at any point in the process. b. 3. 52 Audit Documentation a. (1) Audit reinforcement is the auditors record of the procedures performed and conclusions reached in the audit. The functions of audit documentation are to aid the CPA in the conduct of the audit work and to provide support for the auditors opinion and compliance with auditing standards.Audit documentation can be classified in two categories (1) permanent files (which integrate information that is relevant to on-going client relationships) and (2) current files (which relate to just on e year of the client relationship). The documentation (usually in the form of either electronic files or hard copy work papers) should discontinue detailed support for the decisions regarding planning and performing the audit, procedures performed, evidence obtained, and conclusions reached. (2) b.The factors that affect the auditors judgment of the type and content of the audit documentation for a particular engagement include (1) (2) (3) (4) (5) The nature of the auditors report. The nature of the clients business. The nature of the financial statements, schedules, or other information on which the auditors are reporting and the materiality of the full points included therein. The nature and condition of the clients records and internal controls. The needs for supervision and review of work performed by assistants. c.Evidence that should be included in audit documentation to support auditors compliance with generally accepted auditing standards includes (1) (2) (3) (4) (5) The f inancial statements or other information on which the auditors are reporting were in agreement or reconciled with the clients records. The clients system of internal control was reviewed and evaluated to determine the nature, timing, and extent of audit procedures. The audit procedures performed in obtaining audit evidence for evaluation. How exceptions and unusual matters disclosed by audit procedures were resolved or treated.The auditors conclusions on significant aspects of the engagement with appropriate commentaries. d. The audit team should perform an adequate exam at minimum cost and effort, and the prior years plans will aid in doing this. Those audit plans ordinarily double back information useful in the current examination (such as descriptions of the unique features of a clients operations or records, a formalized sequence of audit steps in logical order, and calculate time requirements to perform various phases of the work. ) The audit team should ecide whether to use the old plan or prepare a new one. 3. 54 Predecessor and Successor Auditors well & Ratley (W&R) needs to initiate communications with both predecessor auditors. The situation is unusual, but W&R needs to obtain complete information from all predecessors involved since the last audit (2007 financial statements). Both Canby & Co. and Albrecht & Hubbard (A&H) are predecessors. (If Canby & Co. had completed the 2007 audit and W&R had been hired to perform the 2008 audit, then Canby & Co. would be the only predecessor.A&H would be history. ) Inquiry of only one of the predecessors would not result in complete information because the mint surrounding each auditor change may be different. The two predecessors, having served at different times and for different lengths of time, may have different knowledge about Allpurpose Loan Company and its president. If the company is public and subject to SEC reporting requirements, forms 8-K for both changes should have also been filed. Management hoax and Audit riskinessiness 4. 46 analytical Procedures and Interest Expense a.The audit forecast of interest outgo for these notes is about $24,400. Notes account payable Balances Balance Rate Time $150,000 10. 0% $200,000 10. 0% $225,000 10. 0% $285,000 10. 0% $375,000 10. 0% $375,000 9. 5% $430,000 9. 5% $290,000 9. 5% $210,000 9. 5% $172,000 9. 5% $95,000 9. 5% 1 month Auditors Interest Calculation Interest 1 month 1 2 months 1 month 1 1 month 1 1 month 1 1 month 1 1 month 1 1 month 1 1 month 1 1 month 1 1 $752 12 months $1,250 2 $3,334 $1,875 $2,375 $3,125 $2,969 $3,404 $2,296 $1,663 $1,362 Date Jan 1 Feb 1 Apr 1 May 1 Jun 1 Jul 1 Aug 1 family line 1 Oct 1 Nov 1 Dec 1Weighted average $250,583 9. 75% 12 $24,405 $24,432 calculate on Average Balance and Average Rate b. The type of analytical procedure is study of the relationships of current-year account balances with relevant nonfinancial information. While the interest rate may not seem to be an item of nonfinancial inf ormation, it is not a direct entry or element in the clients financial statements. tether of the other four types of analytical procedures do not describe the evaluate (because it does not compare to prior periods, to budget, or to industry information).However, a case might be made that the predict is an evaluation of a relationship of current-year account balances (notes payable) to other current-year balances (related interest expense) for conformity with a predictable example (interest rate relation) based on the companys experience. c. The recorded interest expense appears to be too small. The company may have forgotten or miscalculated the closing interest expense accrual. (In fact, this amount was contract because the missing amount is approximately the $750 of the accrual for the December interest. ) d.The recorded interest expense is about right. Some differences in timing and calculation might explain the small difference, but it is not material enough to warrant p ull ahead work. e. The recorded interest expense appears to be too large. possibly the company has other debt on which interest is being paid, but the debt is not recorded in the accounts. (In fact this amount was qualify in terms of an extra $ ampere-second,000 being borrowed in July at 9. 5% interest, not recorded, but paid back by August 1 before the conterminous recorded borrowing. This would account for about $800 additional interest $100,000 x 9. % x 1/12 = $792. ) Could be that Weyman found he could borrow the companys gold for himself, earn interest, and then pay back the principal ) Actually, this kind of maneuver could have been carried out in any month and not noticed by auditors who power saw only the first-of-the-month balances. 4. 49 Analysis of story Estimates The company has fudged the write-offs as being as small as possible, hoping to remunerate the auditors. taken one at a time, only the uncertainty about the deferred subscription costs is large enough to break the materiality threshold. plainly the set of tasks cannot be taken one at a time.Here is a suggested low-high audit estimate Low Estimate high up Estimate Write-off deferred subscription costs (1) $ 6,000,000 $12,000,000 picture allowance for bad debts (2) $ 4,000,000 $ 4,000,000 Provide for expected warranty expense (3) $ 2,000,000 $ 6,000,000 Lower of cost or market inventory place down (4) $ 5,600,000 $ 5,600,000 Loss on government contract refund (5) $ 1,000,000 $ 2,000,000 Total write-offs and losses $18,600,000 $29,600,000 (1) The low estimate gives the benefit of doubt to the survival of the fittest of the business, writing off half the deferred costs as if one-half might be written off over the next two years.The company seems to have taken the 50% probability ($6 million) and allocated half to each of the two years. (2) (3) The company seems ready to provide the allowance for all the indistinct accounts receivable. There is not untold information for the audi t team (such as a probability distribution). (4) It appears that the company plans to redo the inventory and recover as much as it can, namely the $4,400,000 that can be recognize from selling the rebuilt parts, but the lower of cost or market was figured incorrectly.The company seems to have subtracted the selling price ($8 million) from the inventory cost ($10 million) to get the $2 million write-down. The correct calculation is Net realizable value merchandising price proceeds $ 8,000,000 appeal to rebuild $(2,000,000) Cost to market and ship (20% x $8 million) $ (1,600,000) Ceiling (net realizable value) $ 4,400,000 traumatize subtract normal profit (5% x $8 million) $ (400,000) Floor $ 4,000,000 Replacement cost is apparently $6 million for the forward-looking part, so the market for lower of cost or market is NRV = $4,400,000, and the inventory write-down is $10,000,000 $4,400,000 = $5,600,000.Sale of the rebuilt parts will produce cryptograph profit in subsequent perio d(s) exchange price $ 8,000,000 Cost of goods sell stock sold (written-down cost) 4,400,000 Rebuilding cost 2,000,000 $(6,400,000) Cost to market and ship ($1,600,000) Profit $ 0 (5) For a calamity such as this government contract dispute, GAAP suggests recognizing loss at the lower end of a range for loss, so a $1 million loss provision would satisfy GAAP. Recommended adjustment Managements lead of $11,000,000 cost/loss recognition is not sufficient.It leaves $7,600,000 income misinformment, even using the auditors low estimate of $18,600,000. Even booking the low estimate leaves $10,000,000 unrecognized (including the government contract contingency at $1 million kind of of $2 million). The minimum adjustment, given the special information available in this problem, follows. up to(predicate) disclosures should be made about the $6 million deferred subscription costs remaining and the prospects for the business as well as about the warranty expense estimate because these ar e the items that leave uncertain assets and liabilities in the financial statements.Debit Credit Subscription expense $ 6,000,000 Bad debt expense $ 4,000,000 Warranty expense $ 2,000,000 Cost of goods sold $ 5,600,000 Government contract loss $ 1,000,000 Deferred subscription costs $ 6,000,000 Allowance for doubtful accounts $ 4,000,000 Estimated warranty liability $ 2,000,000 Inventory $ 5,600,000 Estimated liability on contract $ 1,000,000 4. 54 Audit Risk instance Evaluation of risk assessment conclusions with AR = IR x CR x DR as a model. 1.Paul is not justify in acting on a belief that IR = 0. He may have seen no adjustments proposed because (1) none were material or (2) Tordiks control system has functioned well in the past and prevented or detected and corrected material errors. If IR = 0, then AR = 0, and no further audit work need be done. Conservative auditing standards and practice do not permit this level of (non)work based on this little evidence and knowledge. 2. Hil l is not justified in acting upon a belief that CR = 0.She may well know that Edwards internal accounting control is exceptionally good, but (1) her review did not cover the last month of Edwards fiscal year and (2) control activities are always subject to lapses. If CR = 0, then AR = 0, and no further audit work need be done. Conservative audit practice does not permit assessment of control risk at 0% to the exclusion of other audit procedures. 3. Insofar as audit effectiveness is concerned, Fields decision is within the spirit of audit standards. Even if IR = 1 and CR = 1, if DR = 0. 02, the AR = 0. 02.This audit risk (AR) seems quite small. However, Fields decision may result in an uneconomical audit. 4. This case was deliberately left ambiguous without quantifying the audit risks. Students will need to prove with the model. One approach is to compare the current audit to a hypothetical last years audit when everything was operating smoothly. Assume Last year Current year AR = IR (0. 50) + CR (0. 20) x DR (0. 20) = 0. 02 AR = IR (1. 0) + CR (1. 0) x DR (0. 25) = 0. 25 Features of the hypothetical simile (1) intrinsical risk is greater than last year. 2) Control risk is greater than last year. (3) The audit was less all-embracing, possibly resulting in more detection risk. (4) Audit risk appears to be very high. An alternative psychoanalysis is that Shad perceived higher constitutive(a) and control risk early, and he did not put any audit time into severe to assess the risks at less than 100%. He proceeded directly to performance of extensive substantive procedures and worked fewer total number of hours yet still performed a high-quality audit by keeping AR low by keeping DR low. 4. 6 Risk Assessment We gratefully acknowledge the aid of Jeanie Folk in developing the following solution Recall that audit risk is the risk that the auditor will give an inappropriate opinion on financial statements (e. g. , giving an unqualified opinion on the financial statements that are misleading because of material misstatements that auditors failed to discover. The problem adds the perspective that the audit risk at the overall financial statement level is influenced by the risk of material misstatements, which may be indicated by a combination of factors related to management, the industry, and the company. . Decrease. Ordinarily, the fact that this is the first profitable year after a string of losses would cause concern. The auditor might suspect an amplifyment of revenues or backgroundment of expenses. However, in this situation, the increase in revenues (and net income) appears to be the result of additional federal and state funding for environmental purposes to TWDs customers, which are municipalities. Given that TWD has a trammel number of customers, the year-end receivables (and even revenue) can be confirmed with those municipalities.As such, there would be no increase in audit risk. The decrease in audit risk would result from lessening the companys need to get through a difficult period, that is, the years of losses. 2. Increase. TWDs board of directors is controlled by its major stockholder who also acts as the companys CEO. That person may act in his or her best interests rather than in accordance with those of the minority shareholders and other financial statements.The potential for financial statement fraud would increase as a result. 3. Increase. The internal auditor reports to the Controller, who has responsibility for the companys accounting system and the preparation of its financial statements. The internal auditor should report to the audit committee so that objectivity is maintained. Because the controller could operate the internal auditor away from problem areas, audit risk would be increased. 4. Increase. upset is a red flag that the section might have problems.Additionally, turnover resulted in the hiring of unpractised people (at least inexperienced with respect to TWD). 5. Decrease. Having an external party such as a bank loan officer involved in an ongoing review of the companys performance would enhance the companys system of internal controls. 6. No effect. The payment of employees on a weekly, biweekly, monthly, or other basis would have no effect on audit risk. 7. Decrease. bind has audited TWD for five years.As a result, because Bond is familiar with the industry, the company, and its management team, Bond is in a position to identify information necessary to assess fraud risk factors, identify those risk factors, and assess fraud risk than the firm would be if it had little or no experience with this client. 8. Increase. Changing accounting practices increases inherent risk (the susceptibility of the accounts to misstatement). 9. Increase. TWD sold one-half of its overbearing interest in UEL its remaining interest is significant.As such, TWD now has significant influence over but no longer controls the operations of UEL. With its lower influence and k nowledge of UEL, TWD is not as able to assess the risk of fraudulent financial reporting by UEL. UELs results still sham TWDs financial statements (because the equity method would be used in cases of significant influence) and, as such, the audit risk relating to TWDs financials would consequently increase. 10. Decrease. If the litigation were disclosed in prior years, either the potential loss was apparent but could not be jolly estimated or it was reasonably possible.In either case, the amount of potential loss must have been material. Because the litigation was dropped by the state, there is less uncertainty about the impact of this pending litigation on the companys financial position and results of operations. 11. Increase. Related-party transactions generally increase the risk of fraud, especially because the transactions were not previously disclosed. 12. Increase. In December, This barter transaction is not only unusual, but will also present problems in terms of the meas urement of the revenue earned. As such, audit risk will increase. 13.No effect. Inherent risk is a component of risk of material misstatement. However, insurance coverage, or the lack thereof, has no impact on inherent risk, which is the risk that, in the absence of internal controls, material errors or frauds could enter the accounting system used to develop financial statements. Furthermore, having such coverage would lower the business risk for the company. 14. Increase. Recall that revenues must be matched with all costs incurred to earn that revenue. As such, the cost, if any, of the guarantees issued must be estimated and recorded in the current year.Given the lack of historical information and difficulties involved in estimating the potential cost of its guarantee (and even considering the difficulties involved of find whether the municipality has any responsibility for actions that might impact the results of the site inspections) that may materially impact the current year s financial statements, audit risk will increase. 15. Increase. Generally, public offerings are successful for companies with strong financial performance. As such, going public practically creates motivation for making the company appear as strong as possible.Audit risk would increase as a result. 4. 61 Errors and Frauds Students can probably think of many examples for each of the cases. This solution does not direct to be exhaustive. a. mislead an asset, understate another asset take in cash returns journal open past the year-end (cutoff date) and record additional cash pass along occurring after year-end, reducing accounts receivable. b. Overstate an asset, expand stockholder equity Record appraised value of property, plant, and equipment with a corresponding credit to a capital account. c.Overstate an asset, overstate revenue (1) Hold the sales journal open past the year-end (cutoff date) and record too much sales revenue and cash or accounts receivable. (2) Record fictit ious sales and accounts receivable. d. Overstate an asset, understate an expense (1) Capitalize aid expense, making the asset amount higher than warranted and the expense amount lower. Subsequent dispraise would reverse this misstatement, but the first effect would be to overstate the asset and understate the expense. (2) Record an expenditure as a prepaid expense instead of a current expense. . Overstate a liability, overstate an expense Accrue too much liability for expenses not yet paid, such as wages, rent, interest, product warranties f. Understate an asset, overstate an expense (1) Calculate too much depreciation expense on assets. (2) relegate expenditures as curre