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Auditing Cases
SOLUTIONS MANUAL 12e
Table of Contents
John M. Trussel and J. Douglas Frazer
A Note on Ethics, Fraud and SOX Questions
2
A Note on Research Assignments
3
Introductory Case
5
Case 1
14
Case 2
22
Case 3
33
Case 4
44
Case 5
58
Case 6
74
Case 7
82
Case 8
92
Case 9
101
Case 10
110
Case 11
116
Case 12
125
Case 13
136
To provide a means for improving the writing skills of students. From all
reports, accounting majors too often leave college lacking in the basic
ability to compose and construct sentences and paragraphs. Accounting
and auditing (especially as one moves up in an organization) obviously
require skills other than the purely quantitative.
Memos, reports,
footnotes, audit and accounting guides, etc., all require accountants and
auditors to be effective communicators of the written word. Indeed, the
instructor may want to team up with a member of the school's English or
communications department to enhance the effectiveness of these
assignments. The auditing instructor can then evaluate the technical and
research portions of the assignment, while the English instructor would
make suggestions as to grammar, syntax, construction of sentences and
paragraphs, logic of the thought process, etc. As a preliminary step, the
instructor may want to assign articles such as "Word Crunching: A Primer
for Accountants" from the March 1990 issue of the Journal of
Accountancy.
decision.
-
INTRODUCTORY CASE
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
(1)
The staff auditor performs many of the detailed audit procedures, such as
preparing and controlling accounts receivable confirmations. In general the work
of the staff auditor is controlled by the audit program and supervised by the
senior auditor.
The senior auditor coordinates the audit at the client's location and performs
many of the more difficult audit procedures, such as analytical review
procedures. Usually the detailed work performed by the audit senior is more
sophisticated and requires the experience gained by someone holding that rank.
The audit senior is supervised by the manager.
The manager and the partner have supervisory roles. Managers and partners
often have more than one audit team under supervision at any given time.
The partner is the person who has responsibility for determining whether the
firms signature can be attached to audit report.
(2)
The partner-in-charge of an audit is the definitive decision-making position on the
audit team. Although the manager and senior auditor make several decisions,
they must get ultimate approval from the partner-in-charge of the audit. The
consulting partner's role is to add a further degree of objectivity to the audit. The
consulting partner reviews and critiques certain crucial decisions made by the
audit team, such as the final audit report. The partners should be rotated to
assure independence.
Sarbanes-Oxley (SOX-S203) requires the identification of a Leading Partner and
a Reviewing Partner. Both partners must be rotated every five years.
(3)
An accounting firm is a business like any other, and its management must
recognize that a marketing strategy is probably necessary to generate a
continual flow of sufficient operating revenues. However, in the accounting
profession, disagreement exists as to the extent that such marketing should take.
In the past, overt marketing was not permitted since it was considered to be
unprofessional. This position was supported based on the reasoning that a firm
should be selected based solely on the quality of its service. No reliable system
existed, though, for conveying such information to potential clients. Hence, firms
with many clients tended to remain large, while smaller firms often found growth
to be nearly impossible. In the free market system espoused by the United
States, restrictions on such practices as advertising and solicitation were
inevitably overturned. Over the past three decades, attitudes toward marketing
have changed dramatically as competition has become much more intense.
Advertisements by CPA firms in newspapers and magazines are now common.
Newsletters such as that distributed by Abernethy and Chapman are also
frequently used to increase a firm's name recognition in the business community.
In the current world of business, some type of marketing strategy seems
imperative if an accounting firm is to compete. Whether that marketing should
extend to formal advertising is often a question of firm policy. Most importantly,
the firm must ensure that potential clients know of its presence and the services
that it offers. A client will probably not select a CPA firm based on advertising.
However, the client may initially become aware of the firm only through some
type of marketing.
Interestingly, some members of the accounting profession view marketing as
having had a negative impact on the profession as a whole. Price competition for
new clients is often associated with the marketing of a firm. These critics assert
that lowered fees result in sloppy and hurried audit work that can decrease the
overall reputation of the profession. (Additional resources discussing this issue
can be found in the "Suggested Readings" at the end of this case.)
(4)
A national or international CPA firm might consider acquiring Abernethy and
Chapman for several reasons:
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The larger firm may be interested in moving into this geographical region,
and buying the local firm will provide an instant base on which to build a
practice in the area.
The larger firm may already have an office in this location and feels that
combining the practices will reduce expenses.
Abernethy and Chapman might have several reasons for viewing an acquisition
in a favorable light:
The smaller firm may have trouble dealing with increased competition from
bigger firms. Often clients may decide that a change to a nationally known
CPA firm should be made to add extra stature to the audit report. If a local
organization has only a few large clients, it cannot economically afford to
lose a significant amount of revenue in this way. A merger may help the
firm to keep its clients.
-
The regional firm may also desire the additional backup services offered by
large organizations. National CPA firms usually have experts in many
industries as well as in specific audit areas who are available for
consultation. In a smaller firm, this degree of assistance is not always
available when a difficult accounting or auditing problem is encountered.
Many mergers have occurred in the auditing profession during recent years.
Critics assert that this trend has reduced competition and will inevitably lead to a
decrease in audit quality. Proponents counter by stating that mergers lead to
more efficient operations and, thus, improve audit quality. Obviously, mergers
will create a drastic change in the profession as more of the smaller firms
disappear. Audit work in this country may possibly become concentrated within
the largest CPA firms. Whether this result is good for the auditing profession may
be merely a question of perspective. To the smaller firms struggling to survive
and grow, the mergers are usually considered a threat as the bigger firms
become more competitive. To the larger firms, the chance for continued growth
and more efficient operations is always an important objective.
See the Sarbanes-Oxley section below for a follow-up question related to the
impact of SOX on the auditing profession.
(5)
Moving staff from one area of a CPA firm to another can cause the perception of
an independence problem. For example, the appearance of independence may
be in question if a member of the consulting staff helps to install a new
accounting system for a client and then she moves to the audit staff to audit this
same client.
See the Sarbanes-Oxley section below for a follow-up question/answer related to
the impact of SOX, in particular the list of proscribed activities for registered CPA
firms.
SUGGESTED ANSWERS TO EXERCISE
(1)
The question requires students to address all the elements of a quality control
system, as included in Statement on Quality Control Standards No. 2. In some
cases, students should recognize the need for additional information.
To:
DeAnna Malott
From:
Date:
Re: Quality Control Standards at Abernethy and Chapman
Overview: I was employed by the firm of Abernethy and Chapman to review the
quality control standards within the firm. The following represents my evaluation of
these standards according to the six elements required by the AICPA.
Evaluation:
Standard
Leadership
responsibilities
Relevant
ethical
requirements
Existing
Procedures
Recommendations
Additional
Information
Needed
What specific
policies does the
firm have to
demonstrate
leadership
responsibilities for
quality within the
firm?
Acceptance
and
continuation of
clients
Human
resources
engagement need
Section 100-not sever ties. In this Rule 101 of the
case, the firm
Code. In this
exceeds the
case, the firm
minimum level of
should
conduct for
strengthen its
independence.
requirements.
The case does not
How does the
address other ethical
firm meet other
requirements.
ethical
requirements?
This case does
It is important to
40 hours of
continuing
education per
year; however,
the case does
not address the
issue of the type
of education
(e.g., accounting
and auditing
versus other
courses).
The firm
promotion
procedures
consider
seniority and
technical
competence,
which seems to
be an adequate
control.
Engagement
performance
that a minimum
number of continuing
professional
education hours be
in accounting- and
auditing-related
courses.
auditor is not a
direct part of the
engagement.
The firm seems
to have a clear
chain of
command and
adequate
supervision on
the audit. The
staff auditors
report to the
senior auditor,
who in turn
reports to the
manager. The
partner-incharge has an
overall
supervisory
position.
Monitoring
A comprehensive
system of
documentation of the
quality controls
should be developed.
Conclusion: The firm has many policies related to quality control standards.
However, the firm has room for improvement in many of the areas, particularly in
the acceptance and continuation of clients.
PCAOB
website
proscribed activities:
Proscribed activities under SOX (section 201):
Section 201: Services Outside The Scope Of Practice Of Auditors; Prohibited
Activities.
It shall be "unlawful" for a registered public accounting firm to provide any nonaudit service to an issuer contemporaneously with the audit, including: (1)
bookkeeping or other services related to the accounting records or financial
statements of the audit client; (2) financial information systems design and
implementation; (3) appraisal or valuation services, fairness opinions, or
contribution-in-kind reports; (4) actuarial services; (5) internal audit outsourcing
services; (6) management functions or human resources; (7) broker or dealer,
investment adviser, or investment banking services; (8) legal services and expert
services unrelated to the audit; (9) any other service that the Board determines,
by regulation, is impermissible. The Board may, on a case-by-case basis, exempt
from these prohibitions any person, issuer, public accounting firm, or transaction,
subject to review by the Commission.
It will not be unlawful to provide other non-audit services if they are pre-approved
by the audit committee in the following manner. The bill allows an accounting firm
to "engage in any non-audit service, including tax services," that is not listed
above, only if the activity is pre-approved by the audit committee of the issuer.
The audit committee will disclose to investors in periodic reports its decision to
pre-approve non-audit services. Statutory insurance company regulatory audits
are treated as an audit service, and thus do not require pre-approval.
The pre-approval requirement is waived with respect to the provision of non-audit
services for an issuer if the aggregate amount of all such non-audit services
provided to the issuer constitutes less than 5% of the total amount of revenues
paid by the issuer to its auditor (calculated on the basis of revenues paid by the
issuer during the fiscal year when the non-audit services are performed), such
services were not recognized by the issuer at the time of the engagement to be
non-audit services; and such services are promptly brought to the attention of the
audit committee and approved prior to completion of the audit.
The authority to pre-approve services can be delegated to 1 or more members of
the audit committee, but any decision by the delegate must be presented to the
full audit committee.
Partner rotation - The rotation of the lead partner and the reviewing partners
are required by the SOX Act.
Quality Control Standards Registered firms must maintain the SEC
practice requirements:
AICPA Quality Control Standards for public company audits are summarized
at: http://cpcaf.aicpa.org/Resources/