1. Rogers and Green, CPAs, admit they failed substantially to follow generally accepted auditing standards in their audit of Martin Corporation. “We were overworked and understaffed and never should have accepted the engagement,” said Rogers. Does this situation constitute fraud on the part of the public accounting firm? Explain.
2. Many CPA firms are taking a business risk approach to audits. Define what is meant by business risk. Provide an example of a business risk that could result in a risk of material misstatement of financial statements.
3. You have discussed with the president of Vista Corporation several material weaknesses in internal control that have come to your attention during your audit. At the conclusion of this discussion, the president states that he will personally take steps to remedy these problems and that there is no reason for you to bring these matters to the attention of the board of directors. He explains that he believes the board should deal with major policy decisions and not be burdened with day-to-day management problems. How would you respond to this suggestion? Explain fully.
4. Explain briefly the term systematic selection as used in auditing and indicate the precautions to be taken if a random sample is to be obtained. Is systematic selection applicable to unnumbered documents? Explain.
5. Salvador Corporation made an investment in Letter.com, Inc., in exchange for 100,000 options to purchase Letter.com’s stock at $20 per share. Since the stock options are not marketable, Salvador’s management has this derivative valued by a security appraiser. The appraiser uses an option-pricing model to determine the fair value of the derivative for the financial statements. Describe how you would audit the valuation of the stock options.
6.An accountant of an audit client made the following statement: “It is important to read the notes to financial statements, even though they are presented in technical language and are incomprehensible. Auditors may reduce their exposure to third-party liability by stating something in the notes that contradicts completely what the client has presented in the balance sheet or income statement.” Evaluate the above statement and indicate:
a) areas of agreement, if any
b) areas of misconception, incompleteness, or fallacious reasoning included in the statement
7. Jane Wilson has prepared personal financial statements in which her assets are valued at her historical cost, less appropriate depreciation. Is this presentation in conformity with generally accepted accounting principles? Can a public accounting firm audit these statements and issue a standard unmodified opinion?
This situation comprises fraud. Rogers and Green seem to be guilty of gross negligence, which is equivalent to constructive fraud. According to Rezaee (2002), constructive fraud does not need to show intent but rather an unfair advantage of one over the other. The auditing company engaged in the act of providing falsified information but not with the intent of financial gains. Gross negligence may be taken to mean constructive fraud since the auditors are misleading the users of financial statements on the degree of credibility used in the preparation of financial statements.
A business risk is a threat to accomplishing a company’s or organization management objectives (American Institute of Certified Public Accountants, 2006). Business risk mitigation is important for a company because it prevents client’s products and services from becoming outdated due to changing technology in the client’s industry. Mitigating a risk in a technology company will ensure that the company changes its products to match the current technology hence the products will not fall short of marketability.
An example of the business risk of material misstatement is inventory overvaluation. For example, the company can affect the judgments used in establishing accounting estimates or create forces to control financial statements to attain the financial objectives. This behavior in the company will lead to overstated figures in their inventory.
Effective internal control measures are critical areas of requirement as per the auditing guidelines. Concerning such importance, I would respond to the president by informing him on the importance of instituting and maintaining efficient internal control. Internal control is a fundamental responsibility of the management. This assertion implies that the material weakness in the internal control ought to be reflected on management letter to be presented to the internal audit committee as a form of effective reporting system [Alexander, Britton & Jorissen, 2007: Barth, Landsman & Lang, 2008].
The president is asking the auditor to violate accepted accounting standards. I will also remind the president of the important of establishing and maintaining an efficient internal control that should be composed of the control environment, monitoring, accounting information system, control activities and risk assessment (Lenz & Hahn, 2015). I will emphasize to the president the importance of obeying integrity and ethical values in conducting and presentation of financial statements from internal controls. I will bring the attention of the president to the significance of hiring competent and qualified employees and structuring an effective board of directors so as to deal with issues of weak internal controls that which if not checked will bring down the credibility of the company. Finally, I will advise the president on the importance of company instituting and adhering to management philosophy, organizational structure, human resource policies and guidelines, responsible finance and accounting department since they are key tenet in achieving strong internal controls.
Systematic selection is a probabilistic sampling technique employed by auditors when randomly selecting samples from a population. Black (2012) explains that the technique involves picking every item at a certain number in a population. The method requires split sampling of the population into similar sizes to make the sampling interval. The starting points should be random when random number generators or tables are used.
When selecting a random sample, it is important to take caution. Auditors should ensure that selected interval between subjects does not replicate certain outlines of traits present in the population (Black, 2012). The auditor should also ensure that all components of the population have equal chances of selection as the starting points. Systematic selection can be applied to unnumbered documents. When the documents are unnumbered, the auditors just count off the sampling interval to pick the documents or use a ruler to determine the range. Therefore, systematic selection offers the advantage of sampling unnumbered documents using random samples.
Auditing valuation of stock options requires development of an effective audit approach. The essential procedures for financial statements review include inquiry of the management of the company and investigative measures performed on the statements on previous financial statements, budgets, and other operational data (FASB, 2001). I will also inquire about the measures taken by stockholders, committees of the board and the board of directors (Arens, Elder & Beasley, 2012). These investigations will focus on whether the financial statements obey general rules of accounting principles, modification of business actions, and important subsequent events.
In conducting an audit of stock options, auditors assess the risk of material misstatement. As an auditor, I would test the fair value measurement through various ways such as (a) Testing of assumptions by the management and the model of valuation used, and available underlying data: (b) developing estimates of fair value that are independent to corroborate the reasonableness of the companies estimate (Lenz, 2015).. The third step, (c), would involve reviewing subsequent events and transaction undertaken by the organization and (d) evaluating and testing of the process used by managements of Salvador Corporation to develop an estimate. Besides, I would evaluate for completeness, existence, rights and obligations, valuation or allocations and presentation and disclosure of the underlying documents (Rezaee, 2002).. It is also important to obtain evidence about the efficiency of both the operation and the design of control to decrease the evaluation level of control risk. Testing the company’s consistency for the process used in determining fair value estimate is also crucial to successful auditing of Salvador corporation stock options (Arens, Elder & Beasley, 2012)..
- areas of agreement include:
- The first sentence is true. Financial statement notes should be read carefully as they provide useful financial information.
- Complex financial information sometimes involves the use of technical language to present. Auditors may convey views on financial statements presented in agreement with a financial reporting framework. Special purpose framework, such as the cash basis is a good example. Such auditors’ reports state indicate the framework used and that the framework is a foundation of accounting.
- Extra disclosures notes could reduce auditor’s exposure to third party liabilities because disclosures are not necessarily contradictions.
- An area of misconception is in the statement that use of technical language by auditors is incomprehensive. Technical language is part of notes on financial statements and considering them as not being comprehensive is deceiving. It is false to assume that management of financial statements is the responsibility of auditor.
Jane’s presentation is not in accordance with the accepted accounting principles. Personal financial statements’ accounting principles require asset valuation at the current value estimates, and rather not the historical cost (Barth, Landsman & Lang, 2008). The auditor can only offer a qualified or adverse opinion. A public accounting firm can audit this personal account and provide unmodified opinion . The opinion will indicate whether the summary of financial statements is fairly acknowledged in all materials and respect to essential financial statements (Rezaee, 2002).
Alexander, D., Britton, A., & Jorissen, A. (2007). International financial reporting and analysis. Cengage Learning EMEA.
American Institute of Certified Public Accountants (AICPA). (2006). Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement.
Arens, A. A., Elder, R. J., & Beasley, M. S. (2012). Auditing and Assurance Service An Integratd Approach, 14th Global Edition. New Jersey: Printice Hall.
Barth, M. E., Landsman, W. R., & Lang, M. H. (2008). International accounting standards and accounting quality. Journal of accounting research, 46(3), 467-498.
Black, K. (2012). Business statistics: For contemporary decision making. Hoboken, NJ: Wiley.
FASB, I. B. R. (2001). Insights into Enhancing Voluntary Disclosure. Financial Accounting Stabdards Board Steering Committee Report, Business Reporting Research Project.
Lenz, R., & Hahn, U. (2015). A synthesis of empirical internal audit effectiveness literature pointing to new research opportunities. Managerial Auditing Journal, 30(1), 5-33.
Rezaee, Z. (2002). Financial statement fraud: prevention and detection. John Wiley & Sons.