The Lakeside Company: A Look Inside a CPA Firm

i. Introductory Case
Discussion Questions:
(1) What are the main duties of each of the positions that compromise
Abernethy and Chapmans engagement team (i.e., partner, manager, senior
auditor, and staff auditor)?
- The main duties of each of the positions that compromise Abernethy and
Chapmans engagement team are as follows:
Partner: At the point at which the audit teams and managers are satisfied
with the evidence they have analyzed and are ready to issue their opinion,
the partner is responsible for determining whether the firms signature
will be attached to their report.
Manager: The manager supervises the audit team, or in larger/busier firms,
multiple audit teams simultaneously.
Senior Auditor: is responsible for conceiving the audit plan, coordinating
the audit either on-site or over the web, and typically reviews the
procedures undertaken by the staff auditors.
Staff Auditor: is responsible for performing most of the first-level audit
analysis and procedures, including verifying and controlling account
confirmation and analysis. The staff auditor is usually under the
supervision of the senior auditors.
(2) What is the purpose of having both a partnership-in-charge and a
consulting partner on each audit engagement? Should the partners be
rotated periodically? Why or why not?
- The purpose of having both a partnership-in-charge and a consulting
partner on each engagement is that the partner-in-charge is the definitive
decision-maker in the engagement, whereas the manager and senior auditors,
who still make decisions, must get permission/approval from the partner-
in-charge. Moreover, the consulting partner is responsible to bring
objective angles to issues that arise in the audit to the table; this
includes such actions as reviewing the decisions made by the audit team.
Its wise to have these individuals circulate between different positions
from audit to audit to ensure that they remain independent in their
positions from any biases or personal conflicts. Finally, under the
Sarbanes-Oxley Act requires that the Leading Partner and the Reviewing
Partner are identified and must be rotated every 5 years.
(3) Can an accounting firm hope to accrue any real benefit from a
marketing campaign such as the one carried out by Abernethy and Chapman?
Should the management of a company select its auditors based on
advertisements alone?
- In regards to whether or not the management of a firm should select
auditors based on advertising, I feel that prospective clients should not
base their decision in choosing an auditor based on advertisements solely
alone; advertisements that are made by the firm itself can be heavily
biased or only pose selective messages about the firms successes, and not
necessarily every aspect of their practices or competition. Moreover, an
unfair system could exist in which audit firms that perform work of a
higher quality would lose out on clients because of their inability
to/lack of will to spend money on advertising; the result of this pattern
would lead to an audit market saturated with a smaller number of firms
that decide to advertise, and would thus attain more business regardless
of the quality of their work. Hover, considering this stance, I do feel
that firms should be able to advertise as prospective clients could become
aware of the firm due to advertising, which of course generates interest
in the firm. However, prospective clients that notice a firms advertising
should do more research into the auditors reputation, prior clients,
quality of work, and competition before taking them on as their audit
provider.
(4) Larger (often national or international) CPA firms have acquired many
smaller firms. Why might a larger organization consider purchasing an
accounting firm such as Abernethy and Chapman? Why might Abernethy and
Chapman agree to be acquired? Are such mergers good for the auditing
profession, generally speaking?
- Typically, larger CPA firms have acquired many small firms, such as
Abernethy and Chapman, in order to acquire their client base, move into a
new geographical area or area of industry, or to increase the operating
revenue of a currently operating firm/subsidiary in the area that competes
with the firm being acquired. A & C might agree to be acquired for a few
key reasons, including the fact that competition from larger audit firms
is a substantial threat for smaller or even mid-sized firms, especially
since most clients that grow seek a larger firms name on their audit
report to show a higher degree of integrity in their reporting. Moreover,
smaller firms may be able to benefit from the support and resources large
firms can provide them, granted that their operations remain after their
acquisition; for example, larger firms will be able to hire more exclusive
or expensive industry experts, enabling the firm to take on more clients
in specialized industries.
(5) The case stated that, during busy periods, individuals may move from
one are of the firm to another, for example from consulting services to
assurance services. Are there any potential problems with these movements
within the firm?
- The only issue that may arise in individuals moving from one area of the
firm to another could be a compromise of the auditors independence in
appearance. For example, an employee may create a friendship/relationship
with a client under one line of service, and could then be assigned to the
audit team of the same client if they move from the consulting area of the
firm to the audit area, for example.
Exercise:
 (1) Review the quality control standards of Abernethy and Chapmen,
and prepare a memo to Ms. Malott addressing the firms policies. From
the information provided, how does the firm appear to meet or not
meet each of the quality control standards? If additional information
is needed, state what information you would need to have to make the
assessment. What recommendations for improvements do you have for the
firm? Be sure to consider all of the elements of Quality control as
required by Standard of Quality Controls Standards No. 7, A Firms
System of Quality Control, issued by the AICPA. The elements are (1)
leadership responsibilities, (2) relevant ethical requirements, (3)
acceptance continuation of clients, (4) human resources, (5)
engagement performance, and (6) monitoring. [See template IntroCase-
1.doc].
Standard Existing Recommendations Additional
Procedures Information
Leadership Partner The firm Management
Responsibilities supervising should addressing
the audit consider which specific
system issuing a policies the
top-down staff engage
management need
policy improvement.
regarding
the quality
expected of
all staff.
Relevant Ethical The firm According to The firm should
Requirements should and the AICPA include
does require Code of additional
its staff to Professional rules to
sever all Conduct: include the
vestments in employees immediate
the clients. are not family of the
required to staff, which
sever all are not
ties to the explicitly
client. included in the
However, in case
this case, information.
the firm
crosses the
line for the
independence
rule.
Acceptance and Firm mentions Controls Seek out
Continuation of new marketing should be in reviews of
Standards program place to their own/other
reduce risks firms?
involved in
attaining
 new clients
that will
gain new
interest in
the firms
services.
Human Resources The firm Firm should The firm may
currently consider want to
considers changing its establish a
prior procedure to system in which
experience specify technical
and overall which type assessments can
competence in of education be carried out
assigning they require after each
staff to for the 40- engagement.
engagements. hour rule.
Only The
Accounting- Accounting-
Major College Major rule
Graduates should be
that sit for sufficient
the CPA as many
within one other firms
year of in the
employment industry
are hired. even hire
40 hours of non-
education accounting
required focused
(general?) graduates.
Promotion
system
considers
seniority
Engagement Firms Firm should Documentation
Performance requirement consider a processes of
for a consultation audits so that
consulting mechanism to they are able
partner on enable to review prior
each outside engagements for
engagement; sources, quality
consulting such as control.
partners industry
approve of, professional
but are not s, to work
directly on
involved with engagements.
the
engagement.
Management
chain: staff
 auditors
report to the
senior
auditors, who
report to the
managers.
Partner-in-
charge
supervises
all audit
activities.
Monitoring DeAnna Malott Firm should Certain types
is assigned standardize of documents
to monitor a should be
the quality documentatio identified as
control n system for necessary in
standards. quality keeping quality
controls if control
they had not standards
done so effective. (EX:
already documents from
staff proving
financial
independence
from clients).

1. Analysis of a Potential Audit Client

Discussion Questions:
(1) Why would the owners of Lakeside as well as the companys banks
require that an independent CPA firm perform an annual audit?
- The owners of Lakeside, as well as the companys banks/lenders
would require an independently-performed audit, as financial
statements in general are frequently and heavily relied upon by
their users, such as the financial institutions already mentioned,
as well as the companys stakeholders who are making decisions
regarding their investment or services towards the company in
question. Moreover, as financial statements are not typically
sufficient in portraying the actual qualitative position of the
firm, auditors provide reviews of the internal controls and
effectiveness of management to give a greater portrayal of the firm
in question. Thus, both credibility in reporting and assurance of
the quality of management of a firm is typically a minimum
requirement to financial institutions and public markets for the
end users.

(2) This case implies that no auditor with the firm of Abernethy and
Chapman has an in-depth understanding of the consumer electronics
industry. Is a CPA firm allowed to accept an engagement without
having established the necessary expertise to oversee the audit?
 Would the knowledge required to audit a consumer electronics company
differ significantly from that needed in the examination of a car
dealership? Does the auditor have an obligation to discuss his lack
of expertise, or his plans to obtain the expertise with the client?
- In this case, Abernethy is certainly allowed to accept an engagement
without having established the necessary expertise to oversee the audit,
but they must consider two things: Firstly, they need to either perform
some preliminary research into whether or not they will be able to
become proficient in the industry-specific accounting problems that
might arise, and secondly, they are required to be proficient in
auditing a firm of that specific industry by the end of their audit
engagement. Separately, the knowledge required to audit a consumer
electronics company would certainly differ significantly from that
needed in the examination of a car dealership, as the nature of each
industrys respective inventories, accounts receivable, payment methods,
and regulations differ substantially. For example, auditors examining a
car dealership would need to be able to verify inventory valuations set
by different market standards, while issues like obsolete or damaged
merchandise would be more prevalent in the evaluation of an electronics
distributor/retailer. Finally, while it would be unethical to present a
lack of experience without a disclaimer to a prospective client in a new
industry, the auditors are not obligated to disclose their lack of
experience, nor are they obligated to discuss how they plan to attain it
before or during the audit.
(3) Auditors must assess the possibility of fraud risk factors.
Fraud risk factors are events or situations that would indicate an
increased possibility that fraud has occurred. Lakeside has recently
created a profit-sharing bonus plan. Why might such an incentive be a
special concern to an auditor?
- As an auditor, I would bring special attention to the profit-sharing
plan Lakeside has put into place for a few key reasons; firstly, a
profit sharing plan, which intends to additionally compensate staff for
higher income and profits, could be reached by the staff in means that
involve corner-cutting and gouging to reach the desired higher profits &
income, with a lack of regard to the time spent on, and the quality and
thoroughness of the work.
(4) Rogers wants Abernethy and Chapman to assist his company in
developing new accounting systems. Does a CPA firm face an
independence problem in auditing the output of systems that the same
firm designed and installed? Does your answer depend on if the client
is publicly traded or not? How so?
- I would support that if a CPA firm were to engage in developing or
installing an Accounting Information System for a client that they are
also auditing, an independence problem could exist; auditors aware of
the AIS source and installation may be less skeptical about the
information that the AIS outputs. However, if a CPA firm were able to
 isolate its AIS and Audit divisions to the point that there is a strong
isolation between the two, the firm should otherwise be able to offer
these two services without much independence concern.
(5) After the discussion at the CPA firm, Andrews was assigned to
visit the headquarters/ warehouse of Lakeside to tour the facility.
What should Andrews observe, and what factors should he be especially
aware of during his visit?
- During a tour of the firm, Andrews should be aware of several key
items that could portray a clear picture of Lakeside and what the
prospective auditing process of the company would entail. These items
include: Inspect the inventory and note the type of inventory method
used, note the level, scale, and speed of production, review ledgers,
bank recs., financial statements, and order forms for clear and
sufficient preparation/recording, and observe the responsibilities
and effectiveness of managements controls.
(6) Is there any reason why Lakeside might not want to hire a CPA
firm that has other clients in the electronics industry?
- Lakeside may not want to hire a CPA firm that has other clients in the
electronics industry due to the fact that auditors may have access to
trade secrets and other competitive information that could potentially
be shared or leaked to other clients in the same industry. However, in
most cases, as auditors are bound to confidentiality principles, this
should not be a realistic problem.
Exercise:
(1) According to Statement on Auditing Standards, Consideration of
Fraud in a Financial Statement Audit, the auditor should consider
whether the information indicates that one or more fraud risk factors
are present. Fraud risk factors are potential problems or indicators
of potential fraud. Three conditions that are typically present when
fraud exists: an incentive or pressure to perpetrate fraud, an
opportunity to carry out the fraud, and the attitude to justify the
fraudulent action. Based on the conference with Rogers, perform the
following [Case1-1.doc]:
a. List the fraud risk factors that the CPA firm might encounter if
they accept this audit engagement. Be sure to include a
discussion of all items that will probably require special
attention during the audit. You should find at least 10 fraud
risk factors.
b. For each of these fraud risk factors, indicate how the auditor
should follow up on each potential problem if the engagement is
accepted. Consider how Abernethy and Chapman should include the
fraud assessment in conducting the audit.
Fraud Risk Factors Auditor Follow-Up
Internal Control: Company management Auditors should not only understand
admits that internal control is the current internal control system
outdated
IPO Possibility:
Loan/Lien Issues: Lakeside is
mentioned to have outstanding loans
6th Lakeside Company Store: Preceding
auditor issued a qualified opinion
from prior statements
Inventory Control/Value:
Distribution Operations:
Profit-Sharing Incentive: Lakeside
Company has recently begun a profit-
sharing bonus system for firm
performance
Related Party Issues: Mention of
business relationship between the
Lakeside Company and the Companys
president
Account Verification: Mention that
all distribution sales are credit-
based
Inventory Issue: Returns/Warranties:
Case mentions up to 20% of the
inventory items can be returned
within four months
(2) Based upon discussion in this case, prepare the auditors report
that King and Company rendered at the end of the year 2011
in place, but determine how reliable
the evidence it produces will be.
Auditors should be skeptical that
manipulation of the financial
statements is possible to attain
more capital in an initial public
offering.
Auditors should analyze each loan
agreement so that they can assure
that Lakeside is not in breach of
any contracts.
Auditor should be concerned about
any departures from GAAP so that the
issues that caused the preceding
opinion are either justified or are
resolved.
Auditors should be concerned with
the value, recording, count and
legal claim to the inventory of the
Lakeside Co.
Auditors should look into the fact
that lakesides sales has reportedly
increased dramatically in the past
two years; they need to ensure that
the sales are being recorded
correctly.
Auditors should be concerned that
employees will take advantage of
this system and find ways to cut
corners, rush procedures, or
otherwise find ways to either
increase profits or income without
upholding to the quality of work
that existed before the bonus system
was initiated.
Auditors should look into these
transactions to verify that they are
clearly disclosed so that no
independence issue exists or arises.
Auditors should investigate the
value of the accounts receivable
related to distribution and ensure
that accounts that are expected to
be received are indeed not doubtful.
Auditors should evaluate the size of
the contingent liability present in
the form of inventory returns
 engagement. How does this opinion differ from a standard auditors
report? [Case1-2.doc]
REPORT OF INDEPENDENT AUDITORS
Addressed to the Board of Directors of the Lakeside Company:

We have audited the balance sheet of the Lakeside Company as of

December 31, 2011, in addition to the related income statements, retained
earnings, and cash flows for this year ended. The reporting of these
documents are the responsibility of the management of Lakeside Company.
Our responsibility as auditors is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with auditing standards
generally accepted in the United States of America. These standards
require that we plan and perform the audit to obtain a reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining evidence supporting the amounts
and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and estimates made by management,
as well as evaluating the overall financial statement presentation. We
believe that the evidence we have attained in our audit provides a
reasonable basis for our opinion.
During the prior year, 2010, the Lakeside Company invested in a
retail store located in Richmond, Virginia. However, it is uncertain that
the Lakeside Company will make any return on this investment as the break-
even point was not reached by the year-ended. Our opinion is that it is
more likely than not that the value of the investment asset is lower and
should thus be adjusted in accordance with Generally Accepted Accounting
Principles. However, management of the Lakeside Company has committed a
departure from Generally Accepted Accounting Principles in that they have
not accounted for this loss.
Except for the effects of the departure from Generally Accepted
Accounting Principles mentioned above, the financial statements present
fairly, in all material respects, the financial position of the Lakeside
Company at December 31, 2011, and the outputs of its operations for the
year then ended are in conformity with accounting principles generally
accepted in the United States of America.

King and Company, CPA Firm

Dated [last day of audit work]