MASTER OF ACCOUNTING

AUDIT THEORY & PRACTICE (BAC7044)

WEEK 2: CASE STUDY
THE NORTH FACE, INC.
GROUP MEMBERS: WEEK 2
1) KAYALVILI
2) MOHD SYAMZARI

CASE STUDY: THE NORTH FACE, INC.

SUMMARY
Summary
Founded in the mid-1960's by Hap Klopp, The North Face, Inc., was a premier
supplier of high-quality hiking, camping, and outdoor gear. In July 1996, North
Face's went public. Initially, it sold at $14 per share, then peaked at $30 per share.
In March 1999, NASDAQ halted public trading of North Face stock following the
company's announcement it would be restating financial statements due to "bad
bookkeeping".Christopher Crawford (CFO) boosted company sales by negotiating a
barter transaction structured to avoid triggering materiality levels.
Result: In May 2000, VF Corporation bought North Face for $2 per share. (Knapp,
2013)

CASE STUDY: THE NORTH FACE, INC.

QUESTION 1
Question 1
Should auditors insist that their clients accept all proposed audit
adjustments, even those that have an "immaterial" effect on the given
financial statements? Defend your answer.
Answer for Question 1: Auditors should not insist that clients accept all proposed audit
adjustments.
Auditors are not perfect and clients should therefore have the right to
reject proposed audit adjustments.
If a client does not accept a proposed audit adjustment, the auditor should
generally be more suspicious as to the possibility of fraud and
misstatement.

CASE STUDY: THE NORTH FACE, INC.

QUESTION 2
Question 2
Should auditors take explicit measures to prevent their clients from discovering or
becoming aware of the materiality thresholds used on individual audit
engagements? Would it be feasible for auditors to conceal this information from
their audit clients?
Answer for Question 2: Levels of materiality determine the nature, extent and timing of the substantive
testing.
Auditors should not reveal materiality levels to their clients.
Deloitte might have considered increasing substantive testing in this area given
Mr. Crawford's inquiry.
Auditors must consider both qualitative and quantitative elements when
assessing materiality.

CASE STUDY: THE NORTH FACE, INC.

QUESTION 3
Question 3
Identify the general principles or guidelines that dictate when companies are entitled to record
revenue. How were these principles or guidelines violated by the $7.8 million barter transaction and
the two consignment sales discussed in this case?
Answer for Question 3:-

The two customers did not pay for the merchandise which means there was not a true exchange.
The transactions were not finalized until the customer resold the merchandise, which means the
sale was not "realized".
Statement of Financial Accounting Standards (SFAC) No. 5. Revenues and gains are realized when
products, merchandise, or other assets are exchanged for cash or claims to cash.
The revenues are considered to have been earned when the entity has substantially accomplished
what it must do to be entitled to the benefits represented by the revenues.
SFAC No. 48, Reve ue Re og itio Whe Right of Retur Exists, prohi its a seller fro
recognizing revenue when the given customer can return the product and the ultimate
payment to be received by seller hinges on the customer reselling the product.

CASE STUDY: THE NORTH FACE, INC.

QUESTION 4
Question 4
Identify and briefly explain each of the principal objectives that auditors hope to
accomplish by preparing audit workpapers. How were these objectives undermined
by Deloitte's decision to alter North Face's 1997 workpapers?

Answer for Question 4: Objective: Obtain reasonable assurance that the financial statements are free
from material misstatement.
Audit documentation is a written record of the auditor's conclusions providing
support of the auditor's representations.
By altering the audit evidence, Deloitte implied that the conclusion reached in
the original audit was not supported.
Other objectives are existence, completeness and disclosure.

CASE STUDY: THE NORTH FACE, INC.

QUESTION 5
Question 5
North Face's management teams were criticized for strategic blunders that
they made over the course of the company's history. Do auditors have a
responsibility to assess the quality of the key decisions made by client
executives? Defend your answer.
Answer for Question 5: An incompetent management team would provide a greater inherent risk
within the audit.
Auditors would have to recognize whether a management team would be
more or less likely to catch mistakes made in the financial statements.
A less competent management team would require greater audit
procedures overall because the inherent risk is greater.