a) Develop a checklist of five areas or issues that you would want to research before you accepted this firm as an audit client and give an example of where you might go to get some information about each issue.
b) Describe three organizations, boards, or groups that have legal authority to regulate aspects of your audit of this client and discuss how that organization, board, or group would regulate your work on this audit.
c) Describe two reasons why this firm may have approached you to do an audit. I am looking for substantive reasons that show you understand the importance of auditing in capital markets.
2) Using the components of the audit risk model and the concept of materiality, describe how an auditor determines or calculates detection risk.
3) Each of the following situations involves a possible violation by a member in industry of the AICPA’s Code of Professional Conduct. For each situation, indicate whether it violates the Code. If it violates the Code, indicate which rule is violated and explain why.
a) Bob Lanzotti is the partner-in-charge of the audit of Fleet Mobile Homes, Inc. Over the years, he has become a golfing buddy of Fleet’s CEO, Jim Harris. During the current year Lanzotti and Harris jointly purchased an exclusive vacation home in North Carolina. The vacation home represents more than 10 percent of Lanzotti’s personal wealth.
b) You are auditing a firm that you have audited for years. However, the auditee has yet to pay their full fee from last year’s audit and you have turned the matter over to a collection agency.
c) During the audit of a client, you found that the manager on the job had not reviewed a staff accountant’s verification of the auditee’s inventory balance at year-end. The client was a manufacturing firm and inventory represented 30% of their assets.
d) During the audit of client, you found out that the manager on the job, who you had recently hired from a major competitor on the auditee, had secretly shared details the auditee’s pricing strategies with his former employer.
4) For the following independent situations, assume that you are the audit partner on the engagement. For each situation, explain how you would modify your audit report and why. All situations apply to non-SEC firms and so the internal control report isn’t required and not part of this question. Be sure to cover all changes required to the report and be specific about which paragraphs must be changed and why. If you don’t recommend any changes, explain why not.
a) During your audit of Raceway.com, Inc., you conclude that there is a possibility that inventory is materially overstated. The Client refuses to allow you to expand the scope of your audit sufficiently to verify whether the balance is actually misstated. Inventory represents 12% of Raceway.com’s total assets.
b) You are auditing XYZ, Inc. and you have substantial doubt about their ability to continue as a going concern, but the circumstances are fully disclosed in the financial statements.
c) You complete the audit of Munich Department Store, and in your opinion, the financial statements are fairly presented. On the last day of the audit, you discover that one of your supervisors assigned to the audit has a material investment in Munich.
5) XYZ, Inc. is planning a major plant expansion recently expanded its plant. It plans to finance the expansion through a combination of a bank loan and stock offering. XYZ has engaged your CPA firm to audit its 2010 financial statements. They told you that they were going to give the financial statements to ABC Bank and other, unnamed banks and, that they would be included in the registration statement for the stock offering.
When you performed the audit of the 2010 financial statements, you did discover a material overstatement of inventory because you did not test XYZ’s physical inventory at the end of 2010. XYZ is a manufacturing firm and so inventory tends to make up a significant portion of their total assets. You were also aware of a pending product liability lawsuit that XYZ had not disclosed in its footnotes despite the fact that XYZ’s attorney informed you that XYZ’s liability under the lawsuit would result in material losses for XYZ. However, you issued an unqualified opinion on their 2010 financial statements and issued your report at the end of January, 2011.
In early February, 2011, ABC Bank relied on XYZ’s financial statements and your audit report and granted XYZ a $750,000 loan. In addition, XYZ raised $12,000,000 in June 2011 in a public offering of common stock. They included their financial statements and your audit report in their registration statement for the stock offering.
By July, 2011, XYZ was in financial trouble, but was able to stay in business because of the funds raised in the stock offering. They had lost the product liability law suit and could not pay the plaintiff the full amount of the loss. In addition, they defaulted on their bank loan and petitioned for bankruptcy. The bank lost most of the $750,000 loan and XYZ’s stock price fell sharply.
ABC bank has sued you for failure to exercise due professional care and for common law fraud. The stockholders also are alleging fraud under the Securities Act of 1933. All these transactions took place in a jurisdiction that provides for auditor liability for ordinary negligence to known and intended users of the financial statements.
Answer the following questions and include your reasons for them.
a) Will ABC bank be successful in their law suit against you for:
i) ordinary negligence?
b) Will the stockholders who purchased their stock in the stock offering for which XYZ used your audit financial statements succeed in against you with their claim of fraud under the Securities Act of 1933?